Investments bring profit over time. However, to be an owner of commercial property, you must understand the fundamentals of commercial property investment and stay abreast of legislation and regulations—which can often be complex. Below, Tony Kidd explores important aspects to consider when buying commercial property for investment for the first time. Read on to understand key aspects of this type of investment.
Before Purchasing a Commercial Property
First, it is important to understand the different types of commercial property listings available in the market. These can include properties such as office buildings, retail (small and large format), shopping malls, warehouses, industrial, and specialty buildings (such as petrol stations or mixed-use), to name a few. You also need to understand why you want to invest in commercial real estate; that can then guide you in your search for the right opportunity.
It is wise to pay attention to the commercial market long before you are ready to buy. And before you find a commercial property to purchase, it’s prudent to line up your financing options and ensure that you can borrow what is required.
Buying commercial real estate involves a lot of complicated aspects. Even experienced investors know that it is important to be surrounded by the right team of experts to make sure their investment has the best chance of success.
It’s wise to have your team already on hand, even before you start scanning the commercial property pages. If you find the right help upfront, you’ll immediately know who to turn to when questions or problems arise. These people will include:
- A property lawyer who specialises in the commercial sector
- A property valuer
- A building consultant
- Your commercial property agent/consultant
You may also want to find out what a commercial property manager charges and what their scope of work would include for their fee!
Finding the Right Commercial Property
Then the fun part starts…you’re ready to start shopping for the right property in your market. Your commercial real estate consultant can help you locate properties that meet your criteria. You will need to pay attention to important factors like the building type, location, construction materials, zoning, types of tenants, and tenant covenants (defined as the main lease terms to the lease(s)).
When you find a property that you want to buy, it’s time to do some heavy research. Again, your sales consultant can likely help you here but do your due diligence on the property as well. Normally, a clause can be inserted into your contract allowing for a period to conduct due diligence before you go unconditional. At this time, it may be important to engage your specialist consultants to provide advice on specifics relating to the building that you are looking at. You can never have too much information about a property; some of the things you should research include:
- Its location—is it in a desirable commercial area?
- What has the property been used for in the past?
- Is it zoned for what you want to use it for?
- Can you change its use with the local authority?
- Tenant/Lease covenants
- Are there rental arrears?
- Are the rental rates below, at, or above market?
- Breakdown of net income including outgoings and what can and cannot be recovered from the lessee(s)
- Does it need significant repairs now or in the short to medium term?
- Is the cost of repairs recoverable from the lessee(s)?
- Are there any ongoing disputes?
- Does the property fit in with your investment portfolio?
Understanding Property Yields
Unlike most residential property, commercial property values are driven by property yields (or capitalisation rates). A yield is defined by how much cash an asset produces each year as a percentage of that asset’s value. Yield is calculated for commercial property, as the percentage of rental income against the purchase price.
The yield will be dependent on several factors including economic climate, geographical location, assets class, the risk associated with that particular asset class, investment size, type of tenant, tenant covenants, market rentals, and build quality, to name but a few. Research can also be undertaken on what yields are being achieved for a particular asset class in a certain location (e.g., industrial buildings in Te Rapa, Hamilton).
Know Why the Property is Being Sold
Once you find a property you like, it’s prudent to find out why the owner wants to sell it in the first place. Here are a few common reasons why owners sell their investment properties.
- The market is strong, and the owner thinks he or she can fetch a good price
- The owner wants to cash out funds for another investment
- There are tax advantages to selling
- Rental income has stalled or isn’t performing as hoped
- Long-term tenants are ending their lease
Knowing why the current owner wants to take the exit ramp could help you when it’s time to negotiate a purchase price.
Create Your Offer to Purchase
You’ve now found the perfect property, and your sales consultant can help you write up your offer to purchase. Have your lawyer review it for good measure before you sign and submit it, and make sure your offer has a due diligence period with an escape clause if certain things go wrong (like zoning issues or the property failing to pass inspection).
Learn the Ropes with a Trustworthy Team of Professionals
Most real estate investors start small and work their way up to commercial properties, but not all. Regardless of your experience, a commercial property might represent a sound investment opportunity, if you take the time and learn the ropes first.
Of course, any investment—commercial real estate included—comes with risk. This risk is magnified if you try to jump into buying a commercial property without a solid plan in place. For this reason, it’s important to consult with professionals, assemble a trustworthy team, and do everything you can to protect your assets in the event of a problem.
If you’re considering investing in commercial property, contact your local NAI Harcourts commercial sales consultant who will ensure you have access to the information and expertise you need to succeed.
-Tony Kidd