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Rethink Investing’s Scott O’Neill looks back at his most recent commercial property deals and pinpoints valuable lessons investors can learn from them.
Speaking on the latest edition of The Smart Property Investment Show, Mr O’Neill shared some key tips for investors looking to succeed in commercial property.
Mr O’Neill described his recent buy, a 150 sq m warehouse in the northern Gold Coast region, as his “go-to type of property”. With a yield of around 7.2 per cent, the property was snapped for $360,000, with an existing two-year lease contract with a drone repair and manufacturing business.
With the average rental yield in the area at 6.5 per cent, “we’ve essentially bought below market value”, he said.
According to Mr O’Neill, this type of commercial property simply takes care of itself, so much so that the buyer felt confident enough to jump on it as their first foray into commercial property investing.
“We don't really care about the business because it’s so easy to re-let these – we’re talking less than two months’ vacancy because there is such good demand for this type of stuff. It's low-risk, with 3 per cent increases in the rent and, like I said, a good groundswell of tenant activity.
“There’s still risks with that, and we’re really going to go tell them, ‘What if you got to three months’ vacancy?’ In their head, they’ll think, ‘That's not going to be for at least two years, because that’s what the lease is. By then, I’ll have buffers,’” Mr O’Neill highlighted.
His advice: Look for “extra demand” because “the more the rent grows, [that brings you] capital growth as well”.
The deal brought in a triple-income property spanning 4,500 sq m, with national businesses on a five-year lease, which brings an overall 7.8 per cent net return, according to Mr O’Neill.
Essentially, they generate a $215,000 income from the $2.75 million purchase. Accounting mortgage and depreciation, passive income still lands at around $140,000 to $150,000, the director said.
“These triple-income type of properties are very popular because if you lose one tenant or even two, that third remaining tenant will still be enough to cover your mortgage. That one property, even with debt at 2.75 per cent, is an incident retirement for many,” Mr O’Neill said.
Ultimately, this property deal showcased the power of commercial property investment as a safe way of generating wealth.
According to Mr O’Neill, the only way it could go wrong is if the economy takes a massive turn, which then leads to the closing down of major businesses.
His advice: To minimise risk, be careful of the type of businesses that leases the property.
“We’re very careful of retail. Because if you buy high-end fashion or high-end restaurants, they’re the first to go [when the economy turns].
“In this building, there were government tenants in it, so there’s safety in that. There’s not a great deal that can go wrong, unless it’s the worst luck in the world and all three tenants go at once. But I could not imagine that happening,” Mr O’Neill said.
Mr O’Neill took advantage of the stamp duty exemption to purchase a 230 sq m industrial property located only five kilometres from the CBD for $550,000, which came with a lease to an electrical power company.
The property generated a 6 per cent yield, which is “about as low as we’ll go at Rethink Investing”, the director said.
“The reason we went that low is because it looked to be in a good location, easy to re-let, similar to that first deal I mentioned. There’s lots of tenants backed up if you lose this one.
“And there’s no stamp duty, so your return on equity is quite good because you don’t have to cop that $20,000 bill at the front,” Mr O’Neill explained.
With a 6 per cent net cash flow and a low mortgage fee, the property was earning $23,000 worth of income after all costs.
According to Mr O’Neill, positive cash flow considered, this comes out as a great diversification play for a residential-heavy portfolio, which can ultimately change an investor’s cash position for the better.
His advice: Don’t hesitate to mix residential with commercial properties and get the best of both worlds.
“I'm a big advocate of having both residential and commercial. One of the reasons to have commercial is to offset a little bit of your negative income from residential. It allows you to hold your residential a little bit more easily.
“You can just close your eyes to residential, hold it for a couple decades, and you’ll do well. Mix that with a bit of commercial, boost your cash flow up. You need a bit of both, that’s my long and short of the summary of it,” the director highlighted.
For this deal, Mr O’Neill went medical – a $2.95 million facility renting for around $221,000 to $222,000, with a yield of 7.5 per cent and three existing tenants.
While it could be a downside that medical properties are often specialised spaces, which makes it harder to replace tenants, this type of assets often garners very long-term occupants, according to the director.
The secret to keeping tenants: Just talk to them.
“Part of my due diligence was I called up each of the tenants. They said things like, ‘This property was purpose-built for us 10 years ago. We love it, we’re not going anywhere’.”
“Spoke to another guy who’s had four other places around and he said, ‘Save my number, I’m really keen to chat whenever you want’. Just really helpful as he was looking for another site because he was expanding.
“Just so much confidence. That’s the good thing about medical,” Mr O’Neill said.
While there are naturally less tenants to choose from for medical properties, once an investor lands a secure tenant, they’re likely to do good for a long time, especially in good locations.
This property, in particular, is a corner site located only across the road form a major shopping centre, which offers good visibility.
“That’s the only worry with medical – just make sure the building is suitable for the people. That’s the reason we call them up. Is the property needing work in your opinion? How many staff do you have this time versus last year? Who takes over when you’re on holidays? What’s the plan with this building? Do you want the owner to fix anything they haven’t fixed? These are the questions we ask.
“Just have a long chat and you’ll get to know what’s really going on through that,” Mr O’Neill advised.