Buyer beware: The potential issues of owning commercial properties

While there are benefits to investing in this type of property, failing to do due diligence may cause significant losses, he said.

“They've got to be the right ones, like medical assets [and] really well-placed warehouses … None of that off-the-space kind of stuff ... that goes vacant,” according to him.

The property professional listed the most common challenges that investors can face when investing in commercial properties:

Under-the-table arrangements

Based on his own experiences as a buyer’s agent, Mr O’Neill knew that renting, buying, and selling commercial properties can often involve under-the-table arrangements.

He explained: “Remember [that] the value is determined [by] the rent. So, let's say the market rent is $50,000 and he's paying $75,000. Effectively, [the] property is worth ... $250,000 more if it was in that price bracket.”

“That's a big kind of risk, so you've got to look at square metre rates,” the property professional highlighted.

Once, Mr O’Neill was looking into a cafe in Hobart that has an attractive 9 per cent net return, only to find out that the rent was around 50 per cent above market rate. Apparently, the previous tenant had a year left on his lease, but he wanted to go, so he convinced the investor to sell the property.

“He'll vanish and someone's going to be left with a property that they're going to have to rent for considerably less … Someone [actually] bought it, poor bugger,” he shared.

Unpredictable lessors

Aside from under-the-table arrangements, another risk associated with commercial properties is the unpredictability of lessors.

Having a business tenant is often seen as an advantage since they tend to stay longer, but like any other tenant business owners can change their minds anytime. Unless you have personal guarantors, you will most likely suffer the consequences of these unforeseen decisions, according to Mr O’Neill.

In one particular instance, the buyer’s agent had a tenant “go crazy” and suddenly close shop for an unknown reason. The matter went up to court and basically dragged on to be a five-month process—and it’s still currently ongoing.

Mr O’Neill shared: “I had a convenience store and the tenant ... I think she went crazy or something—shut the business up … It looked pretty ugly, but I had a personal guarantor, so we went through the courts.”

“She had a house as well, so that's going to be mortgaged off … All the costs will be paid. All the solicitor fees [and] the downtime in rent will be covered,” he added.

However, according to him, it may take a while before he could have the property leased by a new tenant.

Other tenant-related issues

Even if your business tenant doesn’t go crazy, they can still present issues along the way, especially if they become too close to you.

According to Smart Property Investment’s Phil Tarrant, rental payments could be a “slippery slope”, unless you’re catering to medical businesses and other “high-repeat services” providers.

He said: “It's probably one of the benefits [of] having a good manager. You know when you get too close to the person … they go, ‘Oh, business is slow. I can't afford my rent this week. Can I pay it next week?’ ”

At the end of the day, aside from ensuring that you get good and responsible tenants, Mr O’Neill encouraged paying attention to the industry you buy in because it could determine the demand that your property gets.

Moreover, study the asset in relation to your target demographic as well as the thriving businesses in the area to minimise risk and increase the chances for success, Mr Tarrant said.

According to him: “It all goes back to knowing why you're buying a particular asset, who the demographic is that's going to be renting it from you, and the business they're in to make sure that there is a high demand and frequency for continuity of cash flow.”

Tune in to Scott O’Neill’s episode on The Smart Property Investment Show to know more about the fundamentals of investing in residential and commercial properties.