Buying Commercial Property
Expert Advice from Neil Singer (January 2014 Newsletter)
Commercial property can prove to be one of the most lucrative investments; however, there are certain factors that investors often overlook when purchasing commercial property. By following the tips provided, this may help you with you your investment plan and may let you stand a greater chance of achieving your goals
Look at commercial properties that are already earning profits
If you are acquiring a vacant commercial property which you do not intend to occupy yourself, you will not have an income producing investment at the outset obviously. You will have to advertise your space to tenants with the associated risk of voids and holding costs, namely rates, service charges and maintenance. So, unless you a professional investor, it would be safer and perhaps more sensible to focus on properties which are already let to a tenant.
Common profitability measures include
Net Income Yield
The net initial yield for of a commercial property is an industry standard measure for comparing one property against another. The industry will add typically 5.8% to a purchase price to represent the costs of acquisition, and when divided into the income this produces a net industry-standard return. This enables an investor to assess in their pricing the relative risk for a property.
“Cap” – or capitalization – rate, is the multiplier applied to an income stream when assessing the value of an investment property. So clearly the lower return an investor will require will generate a higher capitalization rate, when assessing their offer (1/x). Forget the science of ‘how much profit will I make in the future when I sell’, as no-one knows; the measure is what would you be happy as an income return for buying the property in question. Based upon the coupon you feel appropriate, you can seek a higher income from a riskier property or a lower income from one regarded by the market as safer.
Cash on Cash
Investors relying on financing to purchase their properties often use the cash-on-cash formula to estimate the return on the amount invested on property by an income-producing property. This is simply a measure of taking the income from the property and reducing it by the cost of finance to produce a “true” net income. Since by borrowing from a bank the investor does not need to invest so much equity, the net income is considered as a percentage of the equity invested. Logically therefore, if the cost of debt is higher than the income yield on a property,
the net income return you receive will be lower than were you buying the property entirely for cash; the reverse if the cost of debt were lower than the income return. However, remember how in recent years this gearing has caused so many issues with investors as banks have reduced considerably the levels of debt they are prepared to offer on re-financing.
Evaluate the lifetime of the property in question
The lifetime of a property relates to the maintenance of the property. The property that you invest in may have to undergo repairs or may have to be revamped to suit current styles over time. It is important to set up a plan for dealing with these upgrades and repairs. However, if you are buying a safe property let on a lease which requires the tenant to deal with all property repairs, this is less of a consideration and instead one should consider how much would be required to invest at the property at the lease end in order to attract a new tenant.
Consider the environment
Does the property in question have a problem with pollution emissions? It is important to bear in mind that if your property contributes to waste, it will be your responsibility to manage it. Large scale environmental cleanup may cost a lot of money. Rather look at properties that effectively manage waste. Generally, a purchaser of a property outside a town centre would be best advised to undertake an environmental assessment prior to purchase. This is easy to organize but can identify future potential risks which could cause you to reassess the investment attributes. Most educated sellers will have an environmental survey to hand which can be reviewed, even if it requires an update.
Take your time
Investing in commercial property often takes longer than acquiring a residential property. This is normally due to selling agents failing to supply a complete package of information. There are however many estate agencies that do provide additional information. Take your time to ensure that you have taken into account all the necessary factors before making your investment decision.
By following the tips discussed above, you will hopefully identify an investment to suit your needs.