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Many investors are still attached to the idea of only investing in residential property, but this is rapidly changing, writes Scott O’Neill.
While many investors have long understood how lucrative commercial property can be, it can take a bit of a mindset switch to embrace commercial as an option.
If you’re looking at a starting point, here are five property plays to show you how best to use commercial property to your advantage and set you up for financial success.
1. Start building your $100k passive income.
Always compare apples to apples and have a close look at the income your deposit can generate for you. For example, if you owned three residential properties worth $700,000 each, and they were all completely paid off, you would have $2.1 million worth of property assets. Sounds great, right? However, at a 4 per cent gross yield, your income on your debt-free property would only be about $60,000 per annum after council rates and water bills, insurance and maintenance costs have been taken into consideration. You would also need to factor in income tax that would be payable on your $60,000 rental income. For a portfolio worth $2.1 million with no debt, $60,000 in gross pre-tax income just doesn’t cut it, I’m afraid!
So, what if instead, you invested $2.1 million in commercial property offering a 7.5 per cent net return. With the tenant picking up many of the ongoing costs, such as council rates and maintenance, this investment would pay you an eye-watering $157,500 per annum after costs. Of course, income tax is still payable on these profits, but if you’re comparing commercial with residential returns over the long term, there’s a clear winner here and once you employ a solid debt pay-down method and are debt-free, that income will go straight to your pocket, all while you sit back and relax.
2. Pay your debt down to zero in just 10 years.
A strong debt reduction strategy uses the income from your commercial property’s rent to pay down the loan over time. This will allow you as the commercial property owner to pay your debts down to zero in half the time of a standard 30-year loan contract – sometimes even sooner. A high-yielding commercial property can pay itself off in 10 to 12 years. The high cash flow from the net lease can be so strong that if you can put the surplus rent back into your mortgage or offset account, the debt will rapidly reduce without you having to make any extra payments. If you have a strong lease in place, you’ll also benefit from the built-in annual rent rises, which will help you pay off the property even faster each year!
3. Add value through your commercial property lease.
Commercial property comes with the terrific advantage of being able to add value and therefore increase overall returns. Buying under market value is the golden nugget because it immediately increases the value of your property as it’s already worth more than the purchase price. At Rethink Investing, 68 per cent of the properties that we purchase are under market value and that puts our clients instantly ahead of the rest. Adding more square meterage to a property or dividing up space can also add significant value as does adding highly desirable assets such as storage or parking. These are both highly sought after by tenants. Increasing rents can have a huge effect on the portfolio, as it increases cash flow and capital growth. And finally, increasing the length of your lease will increase the security on the property, which will mean investors will value your property at a higher rate.
4. Check the numbers so that you don’t overpay.
We’ve frequently been in the position where we’ve had to submit an offer by a deadline, with no time to spare, even when waiting on due diligence information. For an inexperienced buyer, this pressure could be enough to overlook details which could significantly impact the final price you settle on, and therefore your overall returns. Agents often present approximate numbers as outgoings, so if you don’t check them, you may end up with a property that is not generating the assumed income, which can mean overpaying for the property when it’s too late to renegotiate the lease. Remember, agents represent the seller, so they’ll generally underestimate the numbers to help the vendor get a better price. Also, remember that while agents do their best to present the exact correct information, it’s in their best interests to do so, sometimes they are supplied incorrect information from the vendors themselves. It’s up to you to cross-check everything. And if numbers don’t stack up, be ready to walk away.
5. Consider syndication.
Syndication allows you to acquire a portion of a high-value commercial asset while guaranteeing you a split of the rental income, enabling you to ‘shoot higher’ than your budget would otherwise allow. A syndicate is an organised group of individuals, corporations or entities, and it can also be professionally run as a managed fund. The group works together to pursue and promote their collective business interests. Although like anything, there are pros and cons, some benefits include:
Scott and Mina O’Neill are co-authors of Rethink Property Investing and founders of Rethink Investing.
Property refers to either a tangible or intangible item that an individual or business has legal rights or ownership of, such as houses, cars, stocks or bond certificates.