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The PROPERTY DOCTORS, Sydney Australia Novak Properties
EP. 1389 HORRIBLE MISTAKES WHEN BUYING COMMERCIAL
Think you understand property investment because you've bought a home? Commercial property operates in a completely different universe, with rules and risks that can blindside even experienced investors. As our seasoned expert with 14 years in the field reveals, commercial property owners can lose half their investment value overnight through tenant-related issues.
The magic of commercial property lies in understanding that unlike residential investments, where you're primarily buying bricks and mortar, commercial value is heavily weighted toward who occupies your building. A Commonwealth Bank tenant might instantly add hundreds of thousands to your property's value compared to a local accountant paying identical rent. This creates both extraordinary risk and opportunity - our expert shares how one vacant shop selling for $700,000 was worth $910,000 just one week later after securing a tenant.
Understanding yield expectations is critical when evaluating commercial opportunities. Beachfront properties might command 4-5% returns, while similar properties just kilometers away on main roads should deliver 6-7%. Different asset classes – offices, industrial spaces, retail – each have their own yield benchmarks. For those ready to enter this high-stakes arena, diversification is key: buildings with multiple tenants across different sectors provide insulation against vacancy periods (typically 3-6 months in commercial) and changing market cycles. Ready to put your money to work in commercial property? Start by forgetting everything you know about residential investing, maintain conservative borrowing (50-70% rather than 95%), and look for flexible spaces that appeal to diverse tenant types rather than highly specialized fit-outs that limit your options.
Good morning everyone. Watch this episode of Morning Minutes to hear the do's and don'ts of buying commercial property. What to look for. Some of the horror stories where owners have lost half the value of their property overnight more than meets the eye.
Speaker 1:Bird more than meets the eye I can't believe you still got this. Welcome everyone to Morning Minutes, episode 1389. Myself, michael Bergio, mark Novak buying commercial property what to look for. This topic was actually requested by a friend of mine and I find this is very common, where a lot of people know what to look for when buying residential people. Everybody knows an agent or a friend of an agent in real estate, so it can be very easy to get information. You just google what to look for buying residential property and you can get a very thorough list. But commercial property is not necessarily the same, is it? Mark it sort of like.
Speaker 2:But commercial property is not necessarily the same, is it, mark? It sort of like feels hey. Like when you go through a residential you get a feeling and you've known that your whole life what feels good and doesn't feel good. But commercial is not that at all. It's got to be backed up with. Is it science, numbers? No, you know there's stuff that goes into it and you'd think I never knew that just quickly run us through the main things.
Speaker 2:When you're looking at a residential property that people look for apart, from the emotion I think when you go through and you feel good in a place, you're like, yep, natural light, um, you know, you look at yep, you know good size balcony you'll say what a lovely yard or it looks. It looks nice from the street. The kitchen and bathroom are modern, so a lot of it's quite, it's very visual, it's very and I think, inherently, you know what you like and don't like when it comes to living in a place. You probably, I guess you call that experience. You know, you know all the homes you've lived in or places you've visited. That's your reference point. But it's not the same in buying commercial property.
Speaker 1:No. So on, like residential, you would like you get a strata report. You may get a builder report and obviously have your solicitor checked, tracked. But a big part, I think one of the glaring differences, the tenancy profile when you're looking to buy a residential property, if it's rented or not rented, it's here nor there. And if it is rented, you mainly only ask two questions, which is how much does it get and how long is the lease, and it really doesn't go much deeper than that. But when buying commercial property and where I've seen owners lose half the value of their property overnight is through the tenancy A lot of value for a commercial property is brought by the income that tenant is paying for the shop.
Speaker 1:So when you're looking to buy a commercial property you need to ask, well, who's the tenant, how long have they been within that property, and sort of do a bit of a brief overview of the strength of their business. Then you've also got to look at well, how much rent are they paying and would that be achievable? Again, that's not a big question in residential. If you hear a unit's getting 500 a week, it's you just assume you're going to get 500 for 85 20. But in commercial property, you, you, they may be getting 500 a week, but you may only be able to get 200 a week if that property came empty now and that would have a big um, a bigger impact on your property and the value.
Speaker 2:So you've almost, you've almost got to conduct your own market appraisal of the what that property would rent for, even if it's got a tenant in there. You got to go okay, what's the likelihood? So you're doing an appraisal. Then I think you've got to do like a check on the tenant. Um, because there's so much value that's weighted on that tenancy being on that property, you're actually paying more because they're in there. So then you want to make sure that how is their business and who are they?
Speaker 1:And very different to residential Correct and when this allows the opportunity for people to get burnt right. But it also allows the opportunity for people to make some great investments and make some great money. We're typically in residential to increase the value. Yes, you can do all the cosmetic changes. Let's say we're talking about an apartment. You can do all the cosmetic changes with renovating the kitchen, renovating the bathrooms. But within commercial property you may look at a shop for sale and you may own a property nearby. Or you've seen a property rent for, say, $800 a week and the property you're looking to buy you've noticed it's only getting $500 a week. So you buy that property knowing you could get a higher tenant in there and that 30% is effectively 30% in capital growth. So sometimes in residential you've got to wait five years.
Speaker 2:In commercial you can get that overnight and I guess you get people punting you almost like it's like punting on horses a little bit. Um, probably, you know you, you well, clients are buying properties, they're looking and go. Actually, you know what I reckon I can actually add value to this if I make this one premises, two premises Do you know what I mean? And then they rent them out separately, they push those rents up and then there's a value out there, so very different to the resis, totally when you look at it that way.
Speaker 1:So tenancy profile is a big part, looking when to buying and then also the rental yield, cap rate. Um is some of the internal dialogue you may hear agents or referring to a property and that's we all sort of. Look at the interest rate we're paying on a mortgage. You're getting a loan, you're paying six percent. Now the cap rate is a rental return that that if you're looking at a commercial shop, let's say the income is $60,000 a year and you can buy it for a million dollars, that's got a rental return of 6%. Now different areas will charge different rates.
Speaker 1:So for example, down at DY Beachfront you may see a strata property have a rental return of four to five percent.
Speaker 1:But then, let's say, using pit water road in dy, so only a kilometer, a couple kilometers away they may be between sort of six to seven percent yields.
Speaker 1:So knowing what type of um yield should be on the top of property, based on its location, is a big thing as well. Because if you're a new buyer to a carrier, you may see the pitwater road properties at a 5.5 percent, comparing it to the beachfront at four percent, thinking it's a great buy, but in fact it should be at a much higher yield. So that's a key factor knowing what yields go on what type of properties and the the easiest conversion. If you're on the residential mindset, think of those waterfront properties they're the ones that will be on the lowest yield. Those luxury properties and more your typical standard two bedroom apartment would be on that typical higher yield of six to seven percent um when interest rates around covid we saw that was around five to six percent. So there has been an upward pressure um on the yields and a lot of that's from like mark what was covid commercial loans at three percent and now they're six, seven, eight, 9%. So it all plays a factor.
Speaker 2:Yeah, the interest rate swings in that. Now, michael, in terms of when buying and mistakes people make, there are and those yields you're talking about, there are different yields for different assets as well. So, for instance, if you're buying a United service station as an investment, it would be a different yield or a different type of buyer than if you're buying the office asset class or the industrial asset class or the, you know, retail asset class. So offices as an asset class, they also hold different yields as well. They get a different rate of return on what you're buying them for.
Speaker 1:yeah, yeah, it can be definitely very intimidating for someone for the first time on the outside looking in.
Speaker 1:So just before I use the example of two strata shops one beachfront, one on a main road that could be different yields.
Speaker 1:Now you take the same property and you go well, you put Commonwealth Bank in there as one tenant and then you may put a physio as another tenant or an accountant each, each of those, even though it's the same property, because of the tenant within the property, you can expect a different sale yield as well.
Speaker 1:And that can show you the power when you own one of these properties, how important tenant selection is. You could have both tenants paying $50,000 a year and with Commonwealth Bank as your tenant, you that for 1.1 million, or as a an accountant in there, you're selling it at 900,000, for example, and a lot of that is brought on by the perception of security for that buyer. A lot of people will look at an asset that has a national banked, has a national bank backing it, or like a KFC some of these more public sector what do we call them like your A-grade businesses renting the property. People tend to see a bit more security compared to, potentially, a business run by one person and we saw it a lot during COVID just how quickly a lot of those closed where it was the public, publicly traded companies there that they weren't as quick to close.
Speaker 2:Michael, how long have you been doing commercial for?
Speaker 1:Just over close to 14 years now.
Speaker 2:Yeah, you got five million dollars in all the beach's commercial purchase. What would you buy?
Speaker 1:there's, I would what I said five million, a big building with lots of little tenants having a good mixture. I can definitely see the appeal where some buyers go if I've got five million industrial or commercial industrial will be the best market at the moment.
Speaker 1:But if you can find a mixed-use building which has a combination of industrial offices and retail, that is the best long term. Because even in my career I've seen swings where retail was the hottest commodity and warehousing was the toughest to lease and sell and now we're seeing industrial as one of the most premium and retail struggling. So if you can get a building with lots of little tenants especially because what people need to understand with commercial property doesn't matter if you buy the beachfront building or you're buying a property on a busy main road, it can always take. There's always vacancy. There's not one asset class that I can go that always rents within a week. Nearly every style of property. Yes, it can be found. Yes, you can find a tenant within a week, but typically you've got three to six months vacancy. You can find a tenant within a week, but typically you've got three to six months vacancy.
Speaker 1:So if you can imagine, if you've got a building with lots of tenants, it you may never have a hundred percent income efficiency, but you may always live between 90 to 95, rather than buying one big property with one tenant and then you've got vacancy for three, three months up to a year. So I like having can see for three months up to a year. So I like having a little attendance. And I always say with residential the mindset is I can get a loan for 95%, I've got 5%, I'll get a loan for the rest with commercial buy a cheaper price point and have a far less of a loan. So typically the banks already want to see a 30% deposit. Try and do 50 to 70% deposit and protects you against that vacancy because a lot of people will pay a premium. Like just a quick story, I had a shop empty which was going to be sold for $700,000. I found a tenant and then sold it for nine hundred and ten thousand dollars a week later.
Speaker 1:So you can look at that from two ways yeah, that's 20 capital growth or even more within seven days, based on the tenancy profile. So you could look at it going well. If I just buy that property vacant and find the tenant, I can make that 200 grand. So that's where you can what would you buy for?
Speaker 2:what would you buy for two million bucks? Horrible mistakes when buying come on um property. What was that sorry would you mean, what would you buy for two million dollars?
Speaker 1:what would I buy for two million?
Speaker 1:yeah yeah, oh, there's. It's anything really with the right like offices can work. Retail there's no specific. I think it's easier. What wouldn't I buy and it's something that's got a very specific use is where you're trying to stay away from. Like, say, for example, it was fitted out for not a restaurant but, like I know in the past, like a meatpacking premises where it's got lots of cool rooms, very specific floor fit outs, very specific room fit outs. That would be the. That would probably be one of the don'ts. Try not to buy something that's too specific where it will only appeal to one or two tenants, because then it makes it very hard to find a new tenant. The best commercial properties sometimes are just an empty box and then it appeals to any tenant. A cafe could go in there, a physio could go in there, so, um, it's.
Speaker 2:Yeah, the question is easier that way around there, mr burjo, I hope you help people out there today. I've got a funny feeling. It's hard to get this advice guys. It is very hard so to have someone 14 years experience talking about it. I love it.
Speaker 1:Good on your beautiful thank you very much, hey luke. Thank you, thank you.