I love commercial property. It’s been the one investment model that has changed my life more than any other.
I’m biassed ok, let’s just get that out of the way.
When people tell me how good commercial is I’m quick to tell them, they are preaching to the converted. But for those not already converted… here’s why I find is so much better than residential.
The biggest reason I believe is that the positive cash flow is so much more effective than other types of investing.
When you buy a residential property, say a single family home, tenants typically sign a 12-month lease.
Additionally, there is usually a clause that if they leave before 12 months, they will need to find a tenant to replace them so that the rent is still covered.
In commercial although it’s possible of course, I’ve personally found it very rare to have a tenant ask for a 12-month lease.
Think about this: If you were to be starting a new business you are going to do a fit out of a commercial property in order to have it suit your needs. Do you really want to risk the landlord changing his mind and kicking you out after 12 months?
So in commercial there are usually options… a 12-month lease with 2x 1-year options to extend the lease.
More common is a 3+3+3 year lease or even a 5+5+5 year lease. This means that it’s much more likely to lock tenants in for at least 5 years, guaranteeing your income.
In residential it’snot uncommon for a lease to switch to month by month after the first 12 months. If this is the case rents can sometimes go on year by year without much attention to rent increases.
Commercial leases never go month by month, not if I have anything to do with it. What this means is that you need to include rent increases into the lease so that this is just part of the agreement.
You understand what you’ re up for, and so does the tenant.
The one big difference that makes an enormous difference to the ease and flow of cash from your investment is the expenses.
In residential you, as the landlord are responsible for paying your mortgage, of course, but you’re also responsible for maintenance issues. If the hot water cylinder fails, you have to fix it. If a tap breaks, it’s up to you to call a plumber and get it sorted. All those expenses are going to eat into the income you receive as rent.
Not so with commercial. They, the tenant, have to cover all of that, and it’s all written into the lease.
The lease terms will outline exactly what you are up for (usually anything major or structural) and what they are up for, usually all the rates, and utilities, land tax, fit-outs, damages and even a repaint of the outside of the building from time to time.
Expenses for residential, including hiring a rent manager, could be anything from 1% to 3% of purchase price. That’s a lot of money if you consider that you are also going to be paying probably 5% in interest on your loan.
That means that the management and maintenance of your property are going to eat into your profit quite substantially.
When you own a commercial property, not only do you not have those little critters eating away at your profits but quite often rents are typically higher than residential rents, so you can see how there are many things working toward giving you a better result.
But the last thing I want to cover, and this is something unique to commercial, is value and capital growth.
With residential property, the value of the property is based on a few different factors.
You might have a property in a good area, or an up and coming area, or an area that is falling in popularity… each of these things will have an effect on the value of the place.
Then there’s the property cycle that roughly estimates that property will increase in value every 10 years. This is, of course, a gross generalisation averaged over the entire country and specifically directed at the capital cities… There are many places where this is not true at all.
You might want to spend some money on renovations which will increase the value of the house. The question is will the capital growth caused by renovating outweigh the time and money spent on doing the work?
When it get’s time to get a new valuation, even the mood of the valuer and the risk profile of the bank can have an effect on the result you get.
Here’s the cool thing about commercial property and this is the one thing that has helped make me lots of money over the years.
Value is determined by the value of the lease… that’s all.
What that means is that if you buy a commercial property where the rent is below par for the area, and you put the rent up… the value of the property goes up… simple as that.
If you buy a warehouse, and you divide it into two and reduce the rent on both by 30%, but you’ve increased the overall rent because you now have two rents coming in… your value goes up.
Got some spare land out the back of a shop and can find a way to rent it out…? let’s say you build a second building, or a shed, or use it for boat storage…
It doesn’t matter how you do it… if you can increase the rent of a property, the value will go up.
My first property was an old butchers shop that I bought vacant, and simply by getting someone in there and getting a lease in place I tripled the value of the place in under six months.
When it comes time to buy your first commercial property, there are some things to look out for, but if you can get into the right property, you can achieve some amazing results.