There’s little point investing in any property if you’re not going to get a decent return.
Here are six steps that help determine if a commercial property is an investment-grade asset and will therefore deliver strong returns.
Your property boasts both a high yield and capital growth
Some of the fastest and largest capital gains we’ve ever seen in property have all been from commercial real estate. So don’t believe that old myth that commercial properties don’t have capital growth. Although not all properties will have strong growth, you can certainly find it if you know where to look.
Our strategy combines a good mix of high yields and lower risk. These are usually undervalued commercial properties in high growth markets, in both regional and capital cities.
When you get this combination right, you will be giving yourself the best chance of strong capital growth as the markets will tighten under you.
You can purchase at a good price
In the quickly growing market of 2021, it’s becoming increasingly difficult to purchase properties at a good price.
We are seeing every record price smashed as thousands of non-traditional commercial investors flood into the market. As a general rule, we would recommend avoiding the auction process as this is where we see people paying the highest prices. Out of the 2,400 properties we’ve purchased for our valued clients, we’ve never secured any at auction.
It’s common for those who are in the know to look at the terribly low yields achieved at a recent action and wonder why the buyer was so silly to go settle at that price. At Rethink Investing, 70 per cent of our purchases are off-market transactions. This means we can purchase without competition (which is the opposite of an auction process) and lock in the best price possible.
You’ve locked in a great loan
Work hard to make sure you have the best financing deal. For instance, an interest rate 1 per cent lower on average could reduce your payback period by an entire year. Also consider the difference between longer loan terms, lease doc loans vs full doc loans and the difference between the residential lending process and the commercial lending process.
Remember, property investing is a game of finance, if you know how to play this game, you will go further with your investing.
There’s potential to add value
Commercial property comes with the terrific advantage of being able to add value and therefore increase overall returns. Buying under market value is the golden nugget because it immediately increases the value of your property as it’s already worth more than the purchase price. We seek to purchase under-market value properties that often need work done on leases, renovations and even developing.
These strategies can put our clients instantly ahead of the rest.
Adding more square meterage to a property or dividing-up space can also add significant value as does adding highly desirable assets such as storage or parking, as all are highly sought after by tenants.
You’ve identified a property with a rental upside
Commercial property is different to residential in that it often comes with long leases and typically has scheduled rental increases built into the lease.
These factors are crucial, as the scheduled rental increases are a key contributor when making money in commercial property.
Each year, the rental increase built into the contract, which you can negotiate as the owner of the property, gives you more cash to grow your income.
So you’ll know exactly how much rent you’ll be receiving per annum in year one, two, three and so on. This makes it easier to bank on your cash flow returns, which should be significant when done right. Connected with this is the fact that the value of a commercial property is directly proportionate to the income it generates. You’ll create capital growth/equity by adding in the annual rental increases to the lease because the extra income raises the value of the asset.
If you were to triple the rental income, you’d potentially triple the value. If you understand how to find properties that have a rental upside, you can create equity quickly by increasing the income.
Basically, the predictability of the lease and its inbuilt annual percentage increases actually helps you predict capital growth more confidently than with residential. And you can plot out these numbers even before you purchase the property. And that’s why we love it.
You have a strong debt reduction strategy in place
A high-yielding commercial property can pay itself off in 10 to 13 years (half the time of a standard 30-year loan contract — sometimes even sooner).
The high cash flow from the net lease can be so strong that if you can put the surplus rent back into your mortgage or offset account, the debt will rapidly reduce without you having to make any extra payments.
A strong lease with built-in annual rent rises, a great loan and low-interest rates will all help you pay off the property even faster each year.
Take the example of a property, for instance, which has a 7 per cent net yield and 3 per cent annual increases in its rent. The property is completely paid off in 11 years, without the owner having to inject any of their own funds. More importantly, this property offers a passive income of $80,169 with zero debt at year 11.
Furthermore, if this particular property had a 4 per cent increase or a 7.5 per cent initial net return, the debt would be squared off in under 10 years.
Some of the properties we have found our valued clients have had yields over 9 per cent but, there is a balance between yield and risk that should be carefully maintained.
There’s no point in having a property with a 10 per cent net yield if its re-leasing qualities are poor, as this will lead to longer vacancies should your current tenant ever leave, and longer vacancy periods would obviously lengthen your loan payback time frame.
