Cons of Investing in Commercial Property

By Stephen McClatchie

Before we get too excited and make a break for that commercial property for sale down the street or in the city, let’s not be too hasty. Every upside has a downside – we’ll take a look now at how your commercial investment strategy looks from the other side of the fence. When we reviewed residential property, we discussed that there is the possibility of purchasing the right property in the right circumstances using only a small amount or NONE OF YOUR OWN MONEY. When it comes to commercial property – this is generally not possible. It’s simply a case of lenders not wanting to lend as much against the security.

Lenders will assess each loan on its individual merits. The more you want to borrow against the property, the higher the interest rates and fees you will be charged. If you have captured a tenant with a long lease and high rent – this will be viewed very favourably by the lender. In addition, lenders set interest rates differently for commercial property compared to residential property. The interest rate is often based on a ‘rate for risk’ scenario – if you are perceived as a higher risk you will be charged a higher interest rate.

Be sure you understand how the interest rate is calculated on your loan. Some lenders will link your interest rate to the bank bill rate which moves every 30 to 90 days.

 As per residential property, you need to understand the market dynamics of commercial property. However commercial property information can sometimes be a little more difficult to obtain. Generally commercial and retail properties are highly sought after and vacancy rates are quite low. But buy in an area that has poor pedestrian traffic and you may have trouble finding your next tenant. Alternatively, if you buy in a shopping strip and the local bank or supermarket closes down – this could drive a lot of potential businesses away from the area and you are left with a commercial building in an unattractive strip.

If you have decided to purchase a property to house your business, such as a warehouse and then you move or sell the business, you may be stuck with a property that is hard to lease. As an inducement to your prospective tenant you may need to offer a rent free period in order to rent the premise out and make it attractive to the new tenant moving in. However if it is a long term lease, and regular rental increases have been built into the tenancy contract – it’s still a solid overall investment.

The commercial property market is subject to economic events such as interest rate rises, poor economic conditions or poor economic outlook. If retailers think the outlook for their business does not look good they will be inclined not to re-sign their lease. You will need to research very closely the capital growth potential in your commercial property as it may not be as great as residential property. Of course this all comes down to the individual property itself.

About Stephen McClatchie….

Cons of Investing in Commercial Property

Pros of Investing in Commercial Property

By Stephen McClatchie

There are many benefits that Commercial Real Estate can create within a property portfolio; the first of these is that higher rental yields can be achieved with commercial property over residential property at the current time. In fact, as a minimum the rent will increase with inflation every year and often it will increase at a rate higher than inflation. Essentially it’s up to you as to what you insert into your lease terms. You will need to be willing to negotiate over these terms and arrive at an agreement that suits both you and the prospective tenant. Tenants will EXPECT rental increases as part of the contract – this is not the case with residential property tenants.

Whilst a residential property lease generally last 6 to 12 months, commercial leases will be significantly longer. Standard commercial leases can be 3, 5 or even 10 years with the option to sign on for an additional 3, 5 or 10 year term. At the end of the first lease term you can review the rent up to the current market rental and increase it accordingly (most tenants will want to stay where they are as it is simply too costly to move).

If you purchase a commercial property which already has a secure tenant such as a government agency or bank, you are virtually guaranteed of many years with an excellent tenant. Although we all know nothing is for certain. However, here is a fantastic benefit when it comes to commercial real estate. Your tenant will pay most, if not all of your ongoing expenses such as council rates, water rates, a portion of your land tax and body corporate fees. All of these costs are included in the lease agreement.

Not only that, many commercial and retail leases often include a ‘make good’ clause. What this means is that at the end of the tenancy period the tenant must return the property to its original condition. That’s right, so you won’t be stuck with a hair dressing salon when your potential new tenants are likely to be restaurateurs. AND when your new tenant moves in THEY will pay for the cost of their fitout if they want to make any changes – so all onuses of paying the expense is on the tenant – not on you. At the end of the day everything is negotiable. You might want to pay some expenses in order to get a tenant to agree to a longer lease. From a cashflow perspective, things look great with commercial real estate. You simply negotiate the lease and cover the interest on your mortgage. Everything else is virtually up to the tenant. 

For most Real Estate investors, residential is the natural place to begin investing.

There are many benefits that Commercial Real Estate can create within a property portfolio; the first of these is that higher rental yields can be achieved with commercial property over residential property at the current time. In fact, as a minimum the rent will increase with inflation every year and often it will increase at a rate higher than inflation. Essentially it’s up to you as to what you insert into your lease terms. You will need to be willing to negotiate over these terms and arrive at an agreement that suits both you and the prospective tenant. Tenants will EXPECT rental increases as part of the contract – this is not the case with residential property tenants.

Whilst a residential property lease generally last 6 to 12 months, commercial leases will be significantly longer. Standard commercial leases can be 3, 5 or even 10 years with the option to sign on for an additional 3, 5 or 10 year term. At the end of the first lease term you can review the rent up to the current market rental and increase it accordingly (most tenants will want to stay where they are as it is simply too costly to move).

If you purchase a commercial property which already has a secure tenant such as a government agency or bank, you are virtually guaranteed of many years with an excellent tenant. Although we all know nothing is for certain. However, here is a fantastic benefit when it comes to commercial real estate. Your tenant will pay most, if not all of your ongoing expenses such as council rates, water rates, a portion of your land tax and body corporate fees. All of these costs are included in the lease agreement.

Not only that, many commercial and retail leases often include a ‘make good’ clause. What this means is that at the end of the tenancy period the tenant must return the property to its original condition. That’s right, so you won’t be stuck with a hair dressing salon when your potential new tenants are likely to be restaurateurs. AND when your new tenant moves in THEY will pay for the cost of their fitout if they want to make any changes – so all onuses of paying the expense is on the tenant – not on you. At the end of the day everything is negotiable. You might want to pay some expenses in order to get a tenant to agree to a longer lease. From a cashflow perspective, things look great with commercial real estate. You simply negotiate the lease and cover the interest on your mortgage. Everything else is virtually up to the tenant.

About Stephen McClatchie….

 Pros of Investing in Commercial Property