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Because commercial has the potential to pay itself off in just 10 to 12 years, that means debt-free passive income much sooner.
Many are waking up to the fact that commercial property investing can be incredibly lucrative, and, if you know what you’re doing, it can mean reducing your debts much faster than you would think. Among all of the pros for commercial investing, one that stands out is the fact that high-yielding commercial assets have the ability to pay themselves off in just 10 to 12 years. Keen to hear more? Take a look at our pay-down strategy, to see exactly what it takes to retire off a passive income with no debt after just 10 to 12 years.
Due diligence and financial planning
Firstly, you need to carry out strong financial planning on the property and the tenant to ensure you have consistent/uninterpreted rental income for the long term. The more consistent the rental income, the faster you can pay off the debt you acquired on the property. Make sure you do your due diligence on the tenants business sector, the asset class itself (e.g. industrial, retail, office etc) and the local economy. When you get your due diligence and financial planning right, your reward will be larger returns and the benefits of capital growth and built-in rental increases.
Out of the thousands of commercial properties advertised on the web, many might be ‘investment quality’ but only a tiny portion are what you’d consider ‘high-quality investments’. We always consider the quality of asset as one of the most important factors when buying commercial real estate. It’s not just about yield, it’s about rental growth, easy re-lettability and strong tenants. These factors are most often found in good quality urban markets. However, don’t discount the fact this can exist in strong regional centers as well. In order for our pay-down strategy to work, buying a high-quality commercial asset in any asset class is imperative.
Higher net yields
We are currently finding high-quality, tenanted commercial properties in capital cities with yields of between 6-9 per cent. This difference in the interest rates versus yields on offer is currently allowing us to enjoy some of the highest cash flow we will ever see in a property market (at any period). It’s why we see so much value in commercial investments right now, and a key reason we can pay off commercial property faster.
Uninterrupted cash flow
The key to an effective pay-down strategy is to have continuous rent coming in. We personally like buying vets, dentists or warehouses leased by established businesses who are happy in their location. On top of this, the property needs to have strong re-lettability, so if you ever did lose your tenant, demand would be high, and you could replace them quickly.
Secure the best financing deal possible
An interest rate 1 per cent lower on average could reduce your payback period by an entire year. For more information, check out the payback calculator on our website: www.rethinkinvesting.com.au/property-investment/calculator/
Strong debt reduction strategy
By using the income from your commercial property’s rent, we can 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.
Interest rates come into play, too, and these typically start at 3 per cent for a commercial property depending on the lender and whether you opt for fixed or variable.
Using the debt reduction calculator on our website www.rethinkinvesting.com.au/property-investment/calculator/, (seen below) you can plug in the numbers on a commercial property to discover how long it would take to pay off your debt.
In the above example, the property has a 7 per cent net yield and 3 per cent annual increases in its rent. The property is completely paid off in 11 years, without the owner having to inject any of their own funds. More importantly, this property offers a passive income of $80,169 with zero debt at year 11.
The table below (also drawn from the RI calculator), shows the numbers for the first 10 years.
Note: If this particular property had 4 per cent increases or a 7.5 per cent initial net return, the debt would have been squared off in under 10 years. Some of the properties we have found our clients have had yields over 9 per cent but, as previously mentioned, there is a balance between yield and risk that should be carefully maintained. For example, there is no point having a property with a 10 per cent net yield if its re-leasing qualities are poor, as this will led to longer vacancies should your current tenant ever leave, and longer vacancy periods would obviously lengthen your loan payback time frame.
These types of returns can only be gained from high-quality commercial assets, which is why this is an extremely important asset class for investors looking to speed up their journey towards early retirement. The table doesn’t factor in vacancy or tax; however, many properties can have the same tenant for decades. There are also good tax benefits for commercial property through depreciation. So, depending on the tax structure you’re using, there may not be a large amount of tax payable, which will keep your costs down.
Each step may require more work than when purchasing a residential property, and you do need a higher deposit, but with the right financial set-up you’ll be able to pay it off faster — the numbers speak for themselves! And once it’s paid off, you’ll be able to enjoy the solid passive income generated by the rental payments. That’s where the real ‘lifestyle’ benefits kick in!
Scott and Mina O’Neill are co-authors of Rethink Property Investing (Wiley $29.95) and founders of Rethink Investing, Australia’s number one buyer’s agency for commercial property investors. After retiring at the age of 28, they now live off the passive income generated by their personal $20 million property portfolio and have helped over 1,800 clients purchase around well over $1 billion in Australian real estate. Find out how to do the same at www.rethinkinvesting.com