When you start a business there are a lot of expenses.
If you have offices or a shopfront there will be a fitout.
There’s stock to buy, maybe staff to pay and legal and insurances which you need to get in place before you can even open the doors.
All of that adds up to a big outlay up front before you’ve even made a single brass razoo.
People generally know this and it’s not uncommon to factor into a business plan that the business won’t make any money for a year for two.
It takes that amount of time to clear those encumbrances, pass breakeven and actually start earning money.
You know this going in, so it’s not a problem.
When you buy a commercial property it’s often the case that much the same thing can happen.
Yes, it is true that your commercial property can be case flow positive from the first day of owning it, it can also be true that there are things you need to factor in.
Let’s have a look at some of those.
Praemonitus, praemunitus as the Romans used to say.
That’s “forewarned is forearmed” for us Aussies.
I’ve been in the commercial market for a long time. I’ve seen al kinds of conditions so the fluctuations of the market tend not to bother me.
Right now the yields, especially in major capital cities are quite low.
So it means that the returns are not that great if you were to buy in this low yield areas. But thats only true for a period of time.
If you know what you’re doing when you buy, you should be looking at the lease conditions. You need to make sure that there are annual rent rises that are in line with CPI.
What this means is that, you might buy a property which in year 1, 2 or 3 may not look that good on paper. Get to year 4 or 5 and suddenly markets have shifted, rents have gone up and suddenly you’ve got a winner that gives you a great little income.
Obviously if you’re trying to accelerate your wealth as fast as possible this may not be the property for you, but it’s worth keeping in mind that if you’re thinking long term and building a retirement fund, what the property produced in the first few years may not be a worry for you.
It’s not uncommon that when you look at commercial you will find properties that are run down, in need of repair or just plain unsuitable. Things change over time and once upon a time that property may have been the height of suitability… But now people want more stylish entryways, better toilet facilities, lifts etc
If you are buying as property with a tenant in place, as you should be, it can work out well for you to do some renovations.
It’s good to ask the tenant what he wants or needs to make it more suitable for them, but you can also make some of your own calls on this.
The good thing is that this can pay you back in two ways. Improve the property and a valuer will see that and value the property higher. Make the property better for the tenant and you can ask more rent.
And, as you know, higher rent will count against the value of the property and boom, that’s going to increase the value as well.
Upsides are those things that could dramatically improve the property, either in terms of usability, suitability, or in value.
In short this could be things like buying a deal with below market rent, or a multi tenanted property which you can strata giving you a range of exit strategies and increasing the value of the property.
Often engaging these will cost you money upfront, just like when you start a business, but you are ultimately opening the door to greater income and equity by spending that money, so it all works out in the end.
Sometimes, especially if you are close to your borrowing capacity, a bank will put a condition on the loan along the lines of “You need to pay $100,000k back in the first year, to reduce the exposure”
On the one hand this means that for the first year (or whatever the conditions are) you are paying the bank a much higher proportion of the income in repayments that you might expect to.
The silver lining is that this usually only happens because you are close the the max the bank will lend… And it means that you’ve probably got yourself into a property that has a higher value and higher return than you probably thought you were going to.
So you don’t make as much cash flow in the first year… Big deal…
Next year you’re going to be pleasantly surprised, and because of annual rent reviews, happier still the year after that.
In fact I often tell people who still have jobs or businesses, and are more planning for their retirement rather than looking for instant cash flow, to pay off as much as they can from their loans…
Give the entire cash flow if they can do without it in the short term and pay down the loan as fast as they can.
The more you can pay off the more cash flow you’ll end up with when you do eventually need it.
A lot of this comes down to defining a winning strategy for your situation and the specific deals you are looking at. There are quite a few factors to consider to get this right. Check out this webcast which will give you a small headstart and an opportunity to get a BIG headstart and put you on the path.