I get this question a lot from people starting out in commercial property.
I've got a bunch of equity in my home or residential property portfolio, and I keep seeing properties that are in the (insert large number here – between 1 and 5 million)…
Would I be better off buying a ‘X' million dollar property or buying ten smaller properties?
And like all great questions around property, the answer is always the same:
If you already have a decent sized portfolio, then the next step might be that you go for a more valuable property.
THE BIG PROPERTIES
Million dollar properties tend to fall into two categories.
1. One large building that houses a single tenant like a Bunnings or an Aldi for instance.
2. A multi-tenanted property which is all on the same block of land – maybe even in the same physical structure like a group of shops, a shopping centre or a small mall.
These are two very different beasts.
The first is typically a single tenant, and that's all there is on the block. On the one hand, you've got a great tenant. One that is probably backed by a big company who wants a very long term lease and always pays on time.
On the other hand, you've got a property that is most likely not got any upsides or opportunity for improvement…
It's a “set and forget”. You buy, it's positive cash flow, and you get paid year in year out. But that's where the story ends.
The other beast is the multiple tenanted property. You'll have various tenants, some of who may come and go. Your leases will be much shorter depending on the type of business in there, and your rent may be a little lower by comparison (although this may not be the case)
But you will have the opportunity to strata title the shops, which will give you an exit strategy. You may even have blocks out the back of the shops, or the chance, depending on the building and the council, to improve the property, or develop the property further, adding additional rentable areas.
You could add residential on top or out the back or spit shops into smaller shops… you have way more possibilities, but this comes at the cost of less stability.
Ok, so that's the big properties…
THE SMALLER PROPERTIES
The other option is to take that money and buy several smaller properties.
This is much more of a mixed bag.
In some ways, it's like option two from above.
You avail yourself of all the potential opportunities you get from multiple tenants and have all the same downsides as well…
But there are a few extra things to consider.
Your cap rates are all going to be different because your properties will be in different areas and of different kinds. That's not good or bad; it probably means that it's a bit more work for you in looking around for properties that have good returns.
You will most likely have a range of different properties and in different locations as I've said. This will give you a much safer portfolio in the long run because you not only have multiple tenants on separate leases, but they will also be in different areas so if one area starts to fall in popularity it's just as likely that the others will remain unaffected.
Some may even increase in popularity, driving up the cap rates of that area.
The one big advantage of investing in multiple properties is that you can look for properties that have upsides. You will find different upsides in different properties, so you don't have to put all your eggs in the one basket.
In the big property-option 2 example (multiple tenancies) I talked about the possibility of developing for instance. But that's a big commitment. Developing property takes time and can bring added risk into the equation.
If you have several properties you may, for instance, have one that has development potential… and you need 18 months or more to realise that potential…
But you may have one that can be strata titled, or divided into smaller shops, or has a back yard that can be used for small storage units.
These are all options that don't take that long and can increase your equity quickly.
You can see that my preference, generally speaking, is to go for smaller properties to diversify as it gives me more options…
But I love property, and I'm still very hands on with my investments. I understand that some people just want the income and not the headache of managing the other strategies… if that's the case, then bigger investments are probably the way to go.
As I said, it depends, but hopefully, you can see the factors involved and make your decision accordingly.