Forget About Serviceability – This Fixes That!

If you are serious about property investing then it’s probably going to be something you do more than once.

Yep – I know there are a stack of people out there in property investing land who have bought themselves an investment property, maybe even two…

In fact that’s the vast majority of people in Australia who call themselves property investors.

But those guys aren’t serious.

The reason they have only bought one or two is that they are probably negatively geared and they have run out of serviceability. There’s no more cash from their working available to “invest” into another property.

It’s learning to balance equity and serviceability that is the real trick.

You’ve got to know how to do that in order to be able to keep borrowing and buying new properties.

You’ve got to make sure you can service the loan and you have to have the equity or the cash to be able to finance the “hurt money” the banks want you to have in the loan.

Otherwise they won’t lend to you.

If you’ve got one and not the other – you’re kind of stumped…

But here’s where commercial property can be a bit different.

Quite often when you go to a bank looking for a loan for a commercial property they will want you to put in more money than if you were borrowing for a retail loan.

There have been great changes in commercial loans in the last few years and I’ve seen rates come down and Loan to Valuation Ratios (LVR) go up as high as 80% (it used to be 60%)…

…meaning you have to put in way less “Hurt Money” … but they still don’t compete with the possibility of 90% LVR that some retail lenders allow.

The difference is that your serviceability requirements will be quite different.

Most residential investment properties due to house prices vs rental rates mean that they will be cashflow negative or at best neutral.

(Yes of course there are cash flow positive residential properties but most people don’t know how to find them and even when they do they’re not nearly as positive as commercial)

Because commercial properties can be found that have really solid positive cash flow it means that when you go to the bank you are going to them with more of business proposal.

What do I mean by that?

Well, when you go to the bank for a business loan they will want to know your cash flow and profit forecast. They want o make sure that you will be earning enough money to be able to pay the loan repayments.

They also want to know how long it will be before your business is expected to be in profit. The shorter time that is the happier they will be.

The shorter the time before you are in profit the greater the chance that your business will succeed and that they will get their money back.

It’s kind of the same when you go to them with a loan for a commercial property.

It’s a business proposal… since commercial is a business.

Lenders will want to know how much your ‘business’ is going to make and how long it will take before you start making that…

This is where choosing the right commercial property comes into play.

I never buy a commercial property unless it has two key factors…

One – It must be positive cash flow (and a decent positive cash flow… 8% yield or more)

Two – it must be positive cash flow from day 1.

When I go to the bank with a commercial property under my arm… I’ve got two things to show them…

The equity that I have from other properties that I can use to cover the Hurt Money, and then cash flow I will get from that property based on the cap rate and the agreed purchase price, which will cover the serviceability.

If they can see that those two things are in place then I will more than likely get the loan.

I will interject here with one other thing they will consider and that is the length of the leases you’ve got in place…

If you are buying a $10m property leased to Bunnings they’re very unlikely to have a problem with that. Alternatively if you are buying a much cheaper property, have a lower yield and have a short lease they are going to view that as much more of a risk… and they might start looking at what else you’ve got in place to cover the repayments should the lease break.

The longer the lease the better for you. If you’ve got a multi-tenanted property they will look at the WALE which averages the leases over all the leases you have on that property…

Again… it comes down to choosing the right property and locking in the right lease.

Going back to those two main things though…

Neither of those two things have any relationship to my income at the end of the day because the right commercial property is self servicing.

The income from that property needs to be able to cover the loan repayments, any expenses not covered by the tenant, the loan repayments for the portion of the purchase price that has come from equity from other properties…

…And give me an decent income for years to come.

The right property will do that…

So when it comes to buying property after property and growing your passive income, the issue with commercial property is rarely serviceability because the property itself covers that.

If there is an issue at all it’s making sure you have the equity to cover the hurt money in the next property…

…and that’s where upsides come in…

…but that’s a story for another time.

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