Rethink Property Investing, Fully Updated and Revised Edition: Become Financially Free with Commercial Property Investing [2 ed.] 1394188579, 9781394188574

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F U L LY U P D A T E D A N D R E V I S E D E D I T I O N

B E C O M E F I NA N C I A L LY F RE E WI T H C O M M E RC I A L P RO P E RT Y I NVE S T I NG

RETHINK PR OPER T Y IN VESTING S C OT T O’ N E I L L M I N A O’ N E I L L

This revised and updated edition first published in 2024 by John Wiley & Sons Australia, Ltd Level 4, 600 Bourke St, Melbourne, Victoria 3000, Australia First edition published in 2021 Typeset in Liberation Serif 11pt/14pt © John Wiley & Sons Australia 2023 The moral rights of the authors have been asserted ISBN: 978-­1-­394-­18857-­4

All rights reserved. Except as permitted under the Australian Copyright Act 1968 (for example, a fair dealing for the purposes of study, research, criticism or review), no part of this book may be reproduced, stored in a retrieval system, communicated or transmitted in any form or by any means without prior written permission. All inquiries should be made to the publisher at the address above. Cover design by Wiley Front cover image: © bingokid / Getty Images Table sources: Tables 1 and 2: © Australian Taxation Office for the Commonwealth of Australia. Figure 6: © Reserve Bank of Australia. All photos owned by Scott O’Neill, except P209: © Ray White Tradecoast Murarrie. P200: © Cushman & Wakefield. P216: © DFR Commercial. Disclaimer The material in this publication is of the nature of general comment only, and does not represent professional advice. It is not intended to provide specific guidance for particular circumstances and it should not be relied on as the basis for any decision to take action or not take action on any matter which it covers. Readers should obtain professional advice where appropriate, before making any such decision. To the maximum extent permitted by law, the authors and publisher disclaim all responsibility and liability to any person, arising directly or indirectly from any person taking or not taking action based on the information in this publication.

CONTENTS Prefacevii Introductionxxv

Part I: Moving Beyond Your Backyard Our first commercial property purchase Subsequent commercial property purchases What commercial property is (and isn’t) What you need to know first How do you make money out of this? Busting the myths

Part II: The 8 Steps

Step 1: Money habits Step 2: Investment mindset Step 3: Assembling your expert team Step 4: Asset selection Step 5: Method of sale Step 6: Finance Step 7: The negotiations Step 8: Managing the property and understanding the tax

Part III: Our Top 5 Property Plays

Play 1: How to build a $200 000 passive income Play 2: How a property can pay itself off in 10 years

1

5 9 27 41 61 69

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81 97 109 119 131 139 149 159

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Play 3: How to increase capital growth with value-­adds Play 4: How to check the numbers so you don’t overpay Play 5: How syndication can work for you

197 235 243

Conclusion263 Acknowledgements275 Common commercial real estate terminology 277

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PREFACE My wife Mina and I wrote the first edition of Rethink Property Investing in 2019 just before COVID-­19 hit our shores. By the time the virus reached Australia, we were finishing up the book. It was a very different market at the time. There was an incredible amount of fear around, causing a sharp decline in demand for property. Especially commercial property. To illustrate this fear, I remember my buyer’s agency business, Rethink Investing, had about 45 properties under contract at the time. However, only 16 ended up reaching settlement. People were using any excuse they could to exit contracts. In some cases, they even ran away at the cost of their deposit. Within a few months, though, this fear had subsided. Fast-­forward a couple of years: we have seen commercial assets grow a staggering 50 per cent in many cases. The 16 clients who remained invested in their properties, as well as the numerous others who preceded and followed them, have seen remarkable returns. As the property market has changed so much since the time of writing the first book, this updated version is more relevant to today’s market. We hope you enjoy.

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It was 31 degrees in late August, 2016. Life was pretty good as Mina and I lay on a beach on Kos, in the Greek islands. We were halfway through relishing a six-­month break from Australia. To be honest, I felt guilty not working —­ I had worked 60 to 70 hours a week since I could remember. As an engineer who was normally required to be onsite, this feeling of freedom was new to me. I knew now I was never going back to a normal life. Skipping winter in Europe with no plan to go back to a certain job marked the point in my life where I had officially retired from my day job, age 28. At that time we owned a total of 25 residential and commercial properties scattered across four different states. It hadn’t come easily or by accident, though: we’d worked hard, saved for many years and obsessed over every property decision we made. Thousands of hours had gone into building this portfolio. But the result was that we had won back time in our pursuit of a lifelong ambition —­ to replace both of our incomes so we could do what we wanted on our own terms. Now we had taken the brakes off and flown to Greece to eat, drink, visit family and travel around Europe, using the passive income we had earned from our properties. It was a humbling feeling. A few months later, after some more travelling, we were back in Greece. The days were getting shorter and the summer heat was dissipating. As I sat by the water and watched the beach chairs being stacked away for winter (signalling it was nearly time to go home), I mentally reviewed our expenses over the past few months. After adding up all our accommodation, plane tickets, eating out and other expenses, our properties still produced more income than we spent. This was our ‘aha’ moment, when we knew life would be different forever. Our property rental income was now enough for us to live off —­ and retire on. It was one of the most exciting moments I have ever felt, because I knew we had ‘made it’ financially. And there was no reason why we couldn’t keep travelling indefinitely. I felt like we had none of the stresses normally triggered by having to go back to jobs neither of us enjoyed.

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As a 28-­year-­old, there was a certain excitement that came from all of this. However, there was an empty feeling there too, like something was missing, which was strange considering we had reached such a long-­held personal goal. It made me think, what’s next? How had we got here? We had been offering some investing advice on the side; maybe we could take this to the next level and use our experience as a platform to teach others. And why not? We seemed to be the only people I knew at the time chasing this high-­yielding commercial and residential investing strategy that worked so well for us. Many others in the industry were preaching outdated and slower ways to build wealth that we simply didn’t agree with. We could see there was an opportunity to show people what to do and how to do it, and just what was achievable. It struck me then that our success owed much to the fact that we have always looked beyond our own backyard —­ beyond our familiar territory in Sydney, and even beyond the traditional investment focus of residential property —­ to commercial property. We like to do things differently, to challenge the status quo. We like to take calculated risks, and we soon realised that you can invest outside where you live. You can look to different asset classes to get you there, and discover that the local residential market is not the only way. Each time the benefit was greater cash flow and better capital growth. Our long-­term cash-­on-­cash return has been 35 per cent since 2010 for the capital we have put into properties. This return came from high average yields, strategic leveraging and never neglecting growth in any investment. Many of our deals had equity upside in them as well, which contributed to this very high return-­on-­equity figure. We will explain more of this later. Our success has come from our move to invest in the commercial property market. It allowed us to build a much larger property portfolio than we ever could have with purely residential. Commercial property has held the key to our future wealth and underpinned why we set up our business, Rethink Investing, to help others on the same road. With that business we have helped more than 3500 investors purchase more than $3 billion worth of high-­yielding commercial properties. This figure makes us easily the largest buyer of commercial property in Australia, outside the fund manager space. ix

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As a result, we’re part of a new generation of investors. We don’t invest like our parents; we found a different path from the one they followed to create their wealth. We chose to focus on higher cash flow investments rather than the outdated negative gearing model, because it works for this decade! Seven years after that ‘aha’ moment on the beach, life is very different. We have been hit by the coronavirus pandemic, as well as sharply rising inflation, asset values and interest rates. Although these have all provided challenges, they have also created opportunities that have allowed us to grow our portfolio from $12 million, back in 2016, to more than $75  million. We also have a couple of commercial developments underway, plus another purchase or two happening in the next 18 months, which should take us over the $100 million value. We have learned new concepts such as ‘lockdowns’, ‘social distancing’, ‘flattening the curve’, ‘energy crisis’ and ‘quantitative tightening’. And now, most people would know Kyiv is the name of the capital of Ukraine. It’s been a fascinating and daunting era for humanity, with a substantial influence on commercial property. Those who have been able to brave the uncertainty when it came to investing in commercial property have been significantly rewarded on their investments. But we expect the times ahead to be no different. There are always going to be threats to the commercial market, but our job as investors is to weigh up whether opportunities outweigh the risk of investing. I think the more you understand how commercial property works, the more confidence you will gain in the asset class itself. Because every time you purchase a property, you are rewarded with cash flow each month you hold. With this in mind, the main thing you need to check is if the property will be re-­let fast or if the current tenant is going to stay for a long time. Once you understand this concept, you’re less interested in what the media has to say about the situation. In recent times we have been lucky enough to create a new nationwide movement towards commercial property from educating tens of thousands of people in commercial property with the first edition of this book, which is the best-­selling commercial property book of all time in Australia, and our x

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monthly podcast Inside commercial property. Being part of this movement helping large numbers of new investors to move towards commercial property makes me pinch myself and be thankful. I see educating people on a commercial asset class as one of my last greatest missions over the next decade or two. There is so much out there for residential property yet so little on commercial property, which in my opinion is a superior asset class with greater returns in both cash flow and capital growth. So alerting people to this new investment option could set their families up for better financial futures. Back to the last couple years. It’s mind-­blowing to think that, even among all this chaos, more people than ever have had the confidence to move towards this asset class. The reason? The numbers simply work. Investors, once enlightened on this asset class, see this as well. It’s still an underutilised asset class that we judge will become more mainstream over the coming years. As residential property fails to help most people build a retirement-­grade passive income for their future, they will be forced to consider higher-­income asset classes like commercial property. Or they will be tied to their jobs supporting inefficient residential property portfolios longer than they would have anticipated. We believe that investing now into commercial property is one of the greatest opportunities we will see. The fact is that the commercial property asset class is becoming more popular year by year. This is significant due to the short supply of commercial property. To illustrate this, according to the Australian Bureau of Statistics, there are more than 550 000 residential properties sold and/or purchased per year in Australia. With commercial property, there are only around 20 000 per annum. Just imagine if an extra 10 000  investors move from residential to commercial property. That would have effectively boosted demand by an incredible one-­third, which will boost capital growth. Over time, as more people pour into this asset class, fighting over a limited supply of assets, the demand:supply ratio will favour those who own commercial property. Short supply in high demand is why I am confident in this asset class. With our commercial properties, we’re seeing net yields of 6, 7, 8 or even 9 per cent plus. Not to mention capital growth on top.

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Our message is simple. Don’t think of commercial property as a risky investment just because you don’t fully understand the risks, myths and rewards. I have personally found in my early years when seeking guidance that most people who have an opinion on commercial property have never invested in it themselves. My best advice would be to listen only to experts who personally have invested heavily into commercial property, not your random uncle at the Christmas barbecue or your mate who is a residential real ­estate agent. I have found in my own circles that non-­commercial owners will always tell you there is nothing but risk in this asset class, mostly because they don’t understand it and hence fear the unknown. All good investors understand there is risk in any investment you make. Commercial property can punish you if you get it wrong, but the damage can be mitigated when you know what you’re doing. I am confident that commercial investing is a safer option for Mina and myself than residential investing. This might sound like a controversial statement, but let me explain why. You can control more, you can target specific subsectors of the economy that you know are sturdy, you can carry out higher levels of tangible due diligence, to the point where we can outperform the general market better than the homogeneous residential markets. Just remember that commercial property will give you a higher return; however, if you get it wrong you can get punished more. So this is not a space to go into in half-­measures. If you don’t have the time, seek professional help using commercial solicitors, commercial insurance brokers, commercial buyer’s agents and a great commercial accountant. Mina and I target the most resilient types of businesses. As we’ve seen, our strategy of buying medical, logistics and other essential services–type investments with strong tenants has proven to be resilient in recent years. In our personal portfolio we have tenants such as ALDI, KFC, Hungry Jacks, IGA, Chemist Warehouse, childcare and medical centres, as well as dozens of other strong tenants. We still own several residential properties that initially helped us build the capital required to purchase our first commercial property. For residential xii

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we always targeted higher-­yielding properties that were relatively affordable for both tenants and first-­home buyers while still being in good growth areas with strong yields. And tight vacancy rates are also a must. I want to use these pages to explain how commercial and residential properties will perform differently over time. We will bust the famous myths for both asset classes so you will be more informed from an unbiased investor who has invested heavily in both commercial and residential property. We will also reference how these asset classes performed differently in our last two most significant economic black swan events, COVID-­19 and the global financial crisis of 2008–09 (GFC). As I have always believed, to be a great investor you must study and understand how major economic events have affected property markets in the past. Without this understanding you will likely buy into the daily mainstream media sensationalism of 50 per cent crashes and the forever fear of the impending doom of the property market.

The GFC results

•

ASX: 54.5 per cent fall —­ The ASX 200 hit a high in November 2007 of 6851.5 before tumbling 54.5 per cent to a low of 3120.8 in March 2009.

•

Residential property: 7.6 per cent fall —­ According to CoreLogic data, the average capital city property price fell 7.6 per cent over 13 months from peak to trough (mid-­2007 to early 2009) during the GFC.

•

Commercial property: No reliable data for sub-­$20 million assets. (Note —­ this is one of the biggest issues with commercial property in Australia. Reports are only available for large-­scale assets that are mostly traded on the stock market, owned by fund management companies. For example, the Reserve Bank of Australia reported that prime office space fell 24.7 per cent in 12 months. Many well-­k nown REITs fell by up to 40 per cent in value between 2008 and 2009.)

Although the data are weak for the types of commercial property we consider, it is still clear that the GFC was by far the worst economic event in recent history for commercial property. One reason is that lending practices pre-­2007 were vastly more relaxed than what we see now in the xiii

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2020s. As this was a recession driven by a ‘credit crisis’, leveraged assets got hit the hardest. Developers and real estate investment trusts (REITs), where debt levels were at their highest percentages, were some of the most affected sectors in the GFC. However, it’s worth noting that REITs are the top end of town, the types of commercial properties we own in our super. For example, companies like Stockland, Goodman Group and AMP Capital. Since this book focuses on direct investments rather than multinational syndicates, we won’t go too deep into this sector as it does behave differently to the $500 000 to $20 million investments we’re focusing on. First, how did the GFC affect the commercial market before and after the initial event? You may remember that Australia fared better than other developed countries at the time due to a booming resource export market to China. This softened the blow to the economy. However, there was still a great cost, particularly to the stock market, which ended up dropping almost 55 per cent in total. Interestingly, residential fell only 7.6 per cent to trough before recovering. You will witness in all major economic events, such as the 2001 dot-­com bubble, the 1989 ‘recession we had to have’ and earlier examples, that the stock market always fell significantly more than the property market. We put this down to a number of factors, but most notable is that real estate is an illiquid asset during a financial crisis. You can’t sell a property in a day. However, to truly understand how the GFC impacted the commercial markets I would like to break it down into subsectors —­ office, retail and industrial —­ as they all varied greatly in investment performance.

Office The Australian office market was significantly impacted by the GFC in 2008–09. The market experienced a sharp decline in demand for office space, resulting in a decrease in rental rates and a rise in vacancy rates. This was due to a combination of factors, including a decrease in business confidence, a decrease in consumer spending, and a decrease in foreign investment. The market also experienced a decrease in the number of new office developments, as developers were reluctant to invest in new projects

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due to the uncertain economic environment. As a result, the office market in Australia experienced a period of stagnation, with rental rates and vacancy rates remaining relatively flat until the market began to recover in 2011. According to the Property Council of Australia (PCA), the office market in Australia experienced a total capital growth of 8.2 per cent in the five years following the GFC of 2008–09. This growth was driven by strong demand for office space in the major cities of Sydney, Melbourne, Brisbane and Perth.

Retail The Australian retail market was significantly impacted by the GFC. The commercial property market saw a sharp decline in values, with retail property values falling by around 20 per cent. This was due to a combination of factors, including a decrease in consumer spending, a decrease in demand for retail space, and an increase in vacancy rates. The GFC also caused a decrease in the availability of credit, which further impacted the retail market. As a result, many retailers were forced to close their stores or reduce their operations. The Australian retail market began to recover from the GFC in 2010, with the commercial property market seeing a gradual increase in values. Between 2009 and 2019, the retail market saw an average annual capital growth rate of 6.2 per cent, according to the PCA. This growth was driven by an increase in consumer spending, the improvement in the global economy and the introduction of government stimulus packages. The retail market also benefited from the increase in demand for retail space, as businesses began to expand and invest in new facilities. By 2013, the commercial property market had largely recovered from the GFC, with retail property values returning to pre-­GFC levels.

Industrial The commercial property market in Australia was significantly impacted by the GFC. The industrial market was particularly hard hit, with vacancy rates increasing and rents declining. The industrial market was particularly vulnerable to the GFC due to its reliance on the manufacturing and export

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industries, which were heavily impacted by the crisis. The industrial market was also affected by the decline in consumer spending, as well as the decrease in business investment. As a result, the industrial market saw a decline in demand, leading to a decrease in rents and an increase in vacancy rates. The industrial market in Australia began to recover from the GFC in 2010. This recovery was driven by a number of factors, including the introduction of government stimulus packages, the improvement in the global economy, and the increase in consumer spending. The industrial market also benefited from the increase in demand for industrial space, as businesses began to expand and invest in new facilities. By 2012, the industrial market had largely recovered from the GFC, with vacancy rates decreasing and rents increasing. The PCA reported that the industrial market saw an average capital growth of 8.2 per cent per annum between 2010 and 2019.

In summary During poor economic times, you normally see real-­estate transaction volume drop, which means people effectively try to wait out the poor economic times with their properties, but they sell their liquid assets to make ends meet. You should also remember that a lot of real estate has no debt, so people are often not forced to sell their properties. Property owners will always be stressed in economic downturns. However, they will generally rethink selling within a few months, realising that this is still an asset they wish to hold for the long term. This thought process is one of the reasons they don’t all sell en masse. This is the same for both residential and commercial property. However, history shows the office market seems to have a greatest volatility compared to retail and industrial property in down terms. I learned from the GFC that when it came to commercial real estate there was a lot of fear that seemed to peak for about two years, which felt like a long time when you were in the middle of it. There was effectively a deleveraging of the system and that affected all levels of the commercial markets. Anecdotally, I remember assets such as industrial properties were extremely difficult to sell at the right price. This is particularly interesting xvi

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right now as industrial property is the current darling of the commercial world. Everyone wants it and it’s viewed as a very strong asset class with very little downside. However, back in 2009–13 this was the opposite. So always remember that, although an asset class could be strong in today’s market’ that may change in the decades ahead. That’s why it is always wise to diversify into different asset classes, rather than just focus on one pool of assets. These are all important factors when you are building your own portfolio.

The COVID-­19 results ASX: 32.5 per cent fall —­ The ASX 200 hit a high of 7139 in February 2020 before tumbling 32.5 per cent to a low of 4816 in March 2020. Residential property: 2.1 per cent fall —­ CoreLogic data shows that national home values declined by 2.1 per cent between April 2020 and September 2020, before soaring amid low interest rates, high household savings, government grants and a sharp reduction in the supply of housing. Commercial property: 10–15 per cent fall but rapid recovery —­ The Property Council of Australia (PCA) estimated the commercial property market had fallen this much since the start of the pandemic. Despite the swift resurgence of the industrial and retail sectors beginning in September 2020, the office market has yet to fully recover and continues to experience difficulty in regaining its footing three years later. Again, there is simply no mainstream commercial price data out there. We could reference some of the top end of town published reports, but they are not relevant to the sector of the market we are referring to. This lack of useful data is a shortcoming of commercial property, particularly in the sub-­$20 000 000 price points where individual investors participate. So, how has the coronavirus affected the commercial market before and after the initial event? This was an economic event like no other, unlike the GFC, which uncovered the weakness in the credit system. The pandemic was much less focused on punishing highly leveraged entities; it was more concerning for everyone’s tenants’ ability to pay rent. It was the most daunting period in modern history for investors in terms of income not being paid by tenants. xvii

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In many cases, zero rent came in due to mandatory lockdowns that crippled businesses around the world. I remember this was one of the most nerve-­racking periods as an investor. I had my buffers in place, but since I had never lived through a pandemic there was no telling how long this situation would last. However, within a couple of months the Australian government announced the JobKeeper policy, where the government would pay businesses’ staff costs if their revenue dropped by more than 30 per cent. This had a major positive impact on commercial tenants paying their rent on time and in full. At the same time the interest rates were reaching record low levels. For example, my commercial rates went from about 5 per cent to 2.5 per cent, on average. This increased our portfolio’s income significantly and allowed us to get well ahead on our mortgages. Many investors were in a similar situation and this created confidence in the market. As investors realised the sky was not falling in, they started investing heavily due to the low rates. Everyone was sitting at home with not much to do, so many turned their attention to investing. According to CoreLogic, this caused the commercial markets to jump around 30 per cent over the following two years. The residential markets performed similarly, with a 25.5 per cent increase since the pandemic low. Again, to truly understand how COVID-­19 impacted the commercial markets I would like to break it down into subsectors —­ office, retail and industrial —­ as they all varied greatly in investment performance.

Office The exact amount of capital decline in the office market in Australia after the COVID-­19 pandemic is difficult to quantify. However, according to the PCA’s June 2020 Office Market Report, the capital values for office markets across Australia had fallen by 2.2 per cent in the 12 months to June 2020. CBD office space has struggled the most, and will continue to do so. Fewer people will commute to our capital city centres on public transport in order to sit in an airconditioned office tower where the risk of infection is greater.

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In fact, in Australia’s capital cities the average office vacancy rate was circa 7 per cent. By July 2021 it was 12 per cent. All cities suffered except for Canberra, which was shielded by government jobs. However, as time passed, workers returned to normal life and the vacancy rates dropped. Interestingly, there were double-­digit capital-­growth rates for most CBD office markets over the two years that followed COVID-­19’s introduction to Australia. So even the most feared subsector of the commercial market made very good returns for those who participated in it.

Retail The Australian retail market experienced a significant decline in capital growth in 2020 due to the COVID-­19 pandemic. According to the PCA, the retail sector saw a 7.2 per cent decline in capital values in 2020, compared to a 5.2 per cent increase in 2019. Another property type that faced harder times during the actual lockdowns was retail. Forced closures made it difficult for customers to visit their favourite stores, which led to more online purchasing. However, unlike offices which took longer to recover, strong essential-­service retail assets rebounded with a vengeance, seeing some of the fastest capital-­growth rates ever in commercial property. For example neighbourhood shopping centres had yields of 7.5 per cent pre COVID-­19 and the same properties were selling two years later at 6 per cent yields. This represented a 25 per cent increase in price before the increase in rents had even been factored in. People found comfort in assets that had supermarkets, pharmacies, bottle shops, fast food and many other nationally branded retailers. Mina and I targeted this asset class heavily as we found the fear caused by COVID-­19 provided us with an opportunity to buy well. In fact, three out of four of our last purchases were shopping centres with the above types of tenants included in their mix. However, one thing that the pandemic did expedite was the demise of weaker businesses. The media used the term ‘zombie business’ to describe this type of business. Once the JobKeeper payouts ceased, these businesses went under. We found often that these types of struggling tenants were poorly located retail shops that didn’t have a competitive edge when it came to parking, age of building, location, etc. So, when you are doing xix

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your due diligence on a property, it’s important to see how your tenant went through the COVID-­19 period. You will gain some great insights into your tenant’s potential for future success, as well as being able to recognise the higher risk nature of some retail properties.

Industrial It is difficult to accurately measure the exact amount of capital growth in the industrial market in Australia since the onset of the COVID-19 pandemic. Nevertheless, the Property Council of Australia (PCA) has reported that the industrial market never fell in value. In fact, it experienced a capital growth rate of 8.2 per cent in 2020. This was at a time when many asset classes we still falling or just beginning to recover. This is indicative of the resilience of the industrial market in Australia. One of the greatest beneficiaries of the changing human behaviour from COVID-­19 was the industrial market. Most capital-­city industrial markets jumped by more than 50 per cent in capital value over a two-­year period from 2020. At the same time the industrial rent values jumped by up to 30 per cent. No other asset class performed better. A 2023 Saville’s report has revealed that industrial property rent values are still showing strong growth, with an increase of 24 per cent nationally in 2022. This is indicative of the continued strength of the industrial property market, and is likely to be of great interest to investors and developers alike. As more people purchase goods online, there is a greater need for logistics, storage and manufacturing, all of which reside under warehouse and industrial property roofs. This has meant that warehouses in many areas have been more in demand from tenants and owners alike. In fact, we have seen industrial properties reach vacancy rates as low as 0.8 per cent nationwide in 2022, making Australia the tightest industrial market in the developed world at this time. What does that mean for industrial investors? Many things. Firstly, it’s lower risk because vacancy periods will be shorter; secondly, this causes rental rates to grow faster than any other asset class. Thirdly, a combination of rental growth and a deemed lower risk to the public has turned this asset class to be viewed almost like a safe-­haven-­type investment. Rapid capital-­growth rates have been driven by both investor and owner-­ occupier demand. So, if you purchased an industrial property anytime in xx

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the past, you would have done very well as a direct result of the change in consumer behaviour caused by the impact of COVID-­19. Medical properties and other specialist-­type businesses such as childcare centres have also powered through the COVID-­19 environment with greater ease, compared with the discretionary spending, retail-­type businesses or office space. These types of businesses, often backed by government incentives, don’t suffer the same volatility as private businesses. The demand for medical real estate picked up during the COVID years. There was a predicable focus on health in our community and this was no different from an investment point of view. Low stock and high demand were common themes for this subsector. Given the country’s growing and ageing population, as well as the growth of specialised health services such as mental health, aged care, cosmetics and other allied health industrials, one would expect medical properties to have strength in the coming years. Childcare commercial properties have also become stronger investments over the years as they are underpinned by high occupancy, long leases and bipartisan government support. When you find a quality childcare centre with a good tenant in place you can have confidence as you know the tenant themselves had to meet stringent government requirements to be able to operate. The Department of Education and Training conducts mandatory assessments of childcare centres each year, which landlords consider as having an extra set of eyes looking over your investment. However, there are two things that would worry an investor about this asset class: 1. Government incentives may be pulled back. 2. Competing childcare businesses may lead to overdevelopment. You need to be comfortable with these two points before you invest. I am confident that, upon reading my remarks, you will recognise that the various types of commercial real estate have distinct supply and demand dynamics. This is precisely why I am so passionate about this sector: there is no single market to focus on, which means that, with the right knowledge, you can make more informed investments. xxi

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When it comes to investing in property, it is important to take a longterm view and understand the fundamentals of how businesses operate. In the current climate, the performance of different types of businesses can vary significantly, and it is essential to consider the potential impacts of the COVID-19 pandemic. By taking a comprehensive approach to understanding the market, investors can make informed decisions that will help them to achieve their long-term goals. In relation to COVID-19, here’s what we’re seeing:

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Interest rates. After all-­time lows for a couple of years, we have seen a normalising of the rates. A good commercial investor must plan for changes in rates. A rule of thumb is to make sure you can survive with two years of cash flow at a rate 2 per cent higher than what your current rates are. If you can get though that ugly situation, the chances you will be forced to sell will be very low. Each year you can hold the property, you will see a rising of your rent levels. This will soften the blow of the extra rate costs. If rates drop back down again, then you will most likely experience strong capital growth as well as improved cash flow. So it’s always better to hold if you can rather than sell. Unless, of course, you find a better use for your money.

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Due diligence. Prior to the onset of the COVID-19 pandemic, it was much more difficult to accurately assess the strength of a tenant. However, the pandemic has provided a unique opportunity to gain a better understanding of a tenant’s financial health. By requesting bank statements, we can gain insight into whether the tenant has paid their rent in full, if they have received any rental reductions or JobKeeper allowances, and if they have maintained the same number of employees throughout the pandemic. This information can provide us with a greater level of confidence when considering a property purchase.

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Growth. The value of commercial property has been steadily increasing due to a combination of falling interest rates and increased buyer demand. Although interest rates have recently started to rise, the shortage of available stock has meant that the value of commercial property has not been significantly affected. It is important to note, however, that when making a decision to xxii

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purchase a commercial property, you should not rely solely on the current interest rates, as these are subject to change. In recent years I have seen owners reluctant to sell their assets while they see no better options out there for making a good return on their investment. Increased demand but lower supply is fuelling the growth equation. Of course, some sectors are suffering (such as the CBD office market, as noted), but others have never seen such great demand. This demand is largely from residential investors who have turned to commercial property in search of better returns. Increased demand over limited supply = capital growth, which is the central premise of this book. All of the knowledge and experience we have built up over the years informs the way we help our clients through our business, Rethink Investing. In turn, this inspired us to write a book to offer guidance that will help you on your own journey to wealth and independence. There’s much to learn, but we were determined to keep it engaging and relevant, drawing on our blueprint we use every day with our clients, the ‘8 Steps’. We’ll share our own story too, so you can better understand our passion for commercial property investing. Our long-­held passion is to help others on their investing journey and to reach out to more and more people by sharing a proven process that can be replicated again and again. As we have grown, so has our portfolio —­ now valued at more than $75 million. At the time of writing we enjoy a passive income (after taking care of our home mortgage) more than we need to live off from 63 tenants spread over 29 properties. We have also decluttered our portfolio by selling down some of our lower-­value residential properties to transition into higher-­value commercial properties. This has made our portfolio more profitable by maximising the free cash flow it produces. Except for 2020 and 2021 (constrained by COVID-­19 travel restrictions), we still travel to Europe every year to visit family and escape Australia’s winter for Greece’s summer. After ‘rentvesting’ for nearly 10 years, we finally bought a family home to live in. Later we will explain why we decided to set up our investment portfolio before we purchased a principal place of residence (PPOR). xxiii

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Back at the start of our journey, the option of investing in commercial property seemed like it was out of our reach, but now we embrace it, confident in its power as a tool for building passive wealth. We made it happen by taking risks and pivoting from the typical. As you read this book you’ll find that, with a few exceptions, we speak to you with one voice. We’ve always invested in property together and have shared the load in running our business, so rather than attributing every decision or action to one or the other of us, it made sense to simplify matters by using the first-­person plural. Of course, we bring different strengths to the business. Mina looks after the property management and running our portfolio. This includes managing the many insurances, tax matters, different rental managers and the general day to day of the portfolio. With 63 tenants, this is a big job that needs extremely good organisational skills, one of Mina’s strengths. Mina has also helped build the Rethink Investing business with Scott. It’s never easy working directly together in a start-­up, but it’s been a rewarding experience that has been one of our greatest achievements. Scott’s greatest skills include understanding the market, finding great commercial deals and negotiating purchases while following first principles —­ in a nutshell, buying the right property in the right market at the right price. He has negotiated thousands of property purchases for Rethink Investing’s clients, totalling more than $3 billion in settled properties. This depth of experience is one of the reasons we have done so well. See you on the other side of the backyard fence!

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INTRODUCTION Scott’s story Creating a $75 million-­plus property portfolio doesn’t happen overnight. It doesn’t happen in your own backyard either. The path I took was shaped by a childhood and early adulthood spent obsessing over the Australian property market. I learned the foundations of property investing a lot earlier than most, as a youngster growing up in Sydney, through patience, persistence and playing the market. I grew up in the Sutherland Shire with two younger sisters. My parents worked hard, Dad as an accountant and Mum as an engineer draughtsperson. They were also keen property investors. I learned a lot from them as investors, even though they followed a very different strategy from the one I ended up adopting. Their strategy, which was a common one in the eighties, nineties and noughties, was to buy negatively geared properties and collect a larger-­ than-­normal tax return in return for a cash-­flow loss on property. What bothered me about this strategy was that generally it was effective only if you had a large PAYG taxable income that could be offset by a loss through property income. This meant you needed to show a cash-­flow loss from your properties just so you could get some extra tax back in xxv

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your tax return. To me this didn’t seem like an avenue to retirement. How can you achieve your retirement goals if your properties don’t provide positive cash flow? The answer is you can’t, so it wasn’t an approach I wanted to replicate, especially since house prices were getting so high compared with my income. Rather than acquiring a property to generate a cash-­flow loss in the name of a tax refund, I wanted to buy properties that made month-­to-­month cash flow–based profits, as any good business should. I viewed building an investment portfolio as just like building a business. I don’t know any business that goes out there to deliberately make a cash-­flow loss just to claw some extra tax back later. Don’t get me wrong. I do recognise the long-­term benefits of capital growth with the negatively geared tax outcome on property investing. It’s just that I want the instant profit that higher-­cash-­flow assets can offer. What I have found throughout my investment career is that some of my highest-­ yielding investments have also produced some of the highest growth rates. So I don’t buy into the idea that you have to choose either cash flow or growth. The truth is, you probably want both. This realisation helped shift my investment mindset towards a positively geared one. To better explain how I view property investing, I use the simple analogy of a café business. The way I see it, you wouldn’t go and buy a café to lose $100 000 cash flow on the understanding that you’d be able to claim $30 000 back. I would prefer to make $100 000 cash flow and then pay 30 per cent tax. I have always thought that making money is better than saving money. It’s remarkable how many people get this part of property investing wrong. Getting on the right side of this simple cash-­flow equation was a vital part of my early investing journey. At the age of 17, I already knew I wanted to get into the market. So I got together with a close mate and we pooled our modest savings from regular part-­time and casual gigs: at McDonald’s, at dealerships cleaning cars, and working as a surveyor field hand. Off we trotted to the bank with our hard-­earned savings (which represented about a 5 per cent deposit on a unit we were looking at). As you would imagine, the bank said ‘no deal’ and to come back when we had more savings and full-­time jobs. We felt rejected, but not deterred. xxvi

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After I finished school I started studying for an engineering degree at Sydney University. While studying, I managed to secure an average of four shifts a week at the Sharks Leagues club and during the university summer breaks I took extended working holidays. One highlight was spending a ski season in Whistler, Canada, when I was 20. I worked as a cook in the Longhorn Saloon, which helped fund the trip, and even got to have an amazing heli-­skiing adventure in the Rocky Mountains. A year later I moved to the Gold Coast for the surfing. I worked in a famous Gold Coast nightclub into the early hours of the morning and was clocking up some good travelling experiences too. Possibly without realising it, I was laying the foundations for my future career in property. Working hard to earn money while studying was important, because it meant that instead of being flat broke I was thinking about buying a property. These early experiences of working outside my hometown helped break down a lot of mental barriers when it came to investing. To me, all of Australia was my backyard. My growing familiarity with other areas meant I was not bound to certain locations. This mindset was extremely important in the grand scheme of things. It would later even help me purchase a property overseas. After travelling and working, I somehow finished my university degree and took up a full-­time role as an engineer building railway lines in Sydney. The hours were long, sometimes including weekend and night shift work; furthermore, the project had only two more years to run, and I wasn’t sure where my next job would be. This was when I became determined to not fall into the traditional trap of working until I was 65. I think it had a lot to do with my nostalgia for the good times I’d had when travelling and working different jobs, before being confined to my full-­time engineering role. I began to visualise what my life might look like in 40 years if I stayed this course. The fact that I didn’t have a passion for engineering meant I wasn’t that happy with my prospects. However, I was young and didn’t have any other burning desires (except for travel), so for now I didn’t really see any other option. I had also just met my future wife, Mina, and I was happy in my personal life. Why rock the boat? xxvii

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Well, there’d be no book if I’d stuck with that way of thinking! Later that year I began sniffing around the property market again.

Taking the first step A year later, in 2010, I was 23 —­ and it was time. I wasn’t going to let the bank reject me again, so I took in a hard-­earned deposit of $60 000 and we finally got a loan approved by the bank. Our first property was in Sutherland —­ yes, in my own Sydney backyard. It was a freestanding house with a granny flat and cost $480 000. We did a 90 per cent lend with ANZ. Because the granny flat and the house were rented separately, there were essentially two rental incomes on the property, producing a total rent of $660 a week. This income was enough to cover all the interest, maintenance, insurance, rates and other holding costs. In fact, after all those costs we were left with over $200 a week cash as a passive income. So, in a way, we had just bought ourselves a $10 000 per annum pay rise! At the time, all the media outlets were producing regular doomsday articles predicting an imminent 30 to 40 per cent price drop for the Sydney property market. I won’t lie: as a first-­t ime investor I was spooked by these articles, but I decided to push on through as I knew the fundamentals of the property were strong. I was still getting a return on investment via cash flow, and this made me feel a lot better about entering the market for the first time. It also helped that I had a strong mindset around building a large portfolio, and I still do. Today, even with the recent falls, that Sutherland property is valued at more than $1.25 million, roughly $700 000 more than we paid for it. I’m glad I didn’t listen to the media doomsayers, because had I bought into the property crash fear we would have lost a small fortune in opportunity costs. At the time I didn’t yet know how the media uses ‘clickbait’ articles to sell papers. One way around that was self-­education. So I read thousands of property comments and opinions in web forums, and I devoured every property book I could find, though few of them discussed commercial property. The more I read, the more I realised that buying and holding for the long term was the true path to financial freedom. What helped me in xxviii

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2010 was that most people were fearful of price falls and had a negative mindset, which meant we could buy property at a great price. It wasn’t so very different from what we saw in 2020 with COVID-­19. We bought our second property in Maroubra in 2012 through ANZ with 85 per cent leverage and no lenders’ mortgage insurance (LMI). It was a unit, and its value rose $300 000 in just four years. Admittedly, lending was a little easier back then, and at the time we were creating equity while maintaining cash flow. So Mina and I were quickly thinking about our third property.

A lightbulb moment In the European summer of 2013, while we were in Greece, I was thinking about what was waiting for me back in Australia. Mainly a new job in Port Macquarie that required us to relocate. It was a large and potentially stressful role that encompassed responsibility for three separate business units (quarries, logistics and concrete production) —­ a very big role for someone my age. Sure, it was an exciting opportunity, but I was moving away from family and friends to progress my career —­ which, as I’ve said, I was never passionate about. I’ve found that when I’m on holiday I can often think more clearly and deeply, and right then I knew something was wrong. Something was missing. My mind turned to our two investment properties: the highly positively geared dual-­ income house in Sutherland and the slightly negatively geared property in Maroubra, both in Sydney. Both had produced significant capital growth over the past few years. In fact, we had made more money from these two investments than from my entire salary over the same period. Even better was the cash flow we were receiving on top of the growth. At the time, the Sutherland property was producing a net income of nearly $300 a week. We’d owned it for three years and in that time we were able to increase the rent another $100 per week since we first purchased it. As I was sitting on that Greek beach, it hit me. What if I could somehow purchase another five properties similar to the one in Sutherland, but outside Sydney? Sydney was getting expensive even for renters, and the xxix

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numbers weren’t stacking up to buy a big family home either. For our first two properties we had restricted our search to our own neighbourhood. What about investing further afield? I worked out that I could earn more than $7500 a month clear plus capital growth if we bought another five properties elsewhere in Australia. This figure would constantly grow over time as well. And we’d have enough passive income to live for the rest of our lives in Greece, Bali or somewhere else with lower living costs. We could have a comfortable retirement, all achieved through property. Sounded like paradise compared with working in a mine until my late sixties! It had taken me three years from buying that first property to reach this ‘aha’ moment, and it cemented forever my commitment to investing in property. Without a passive income, there can be no retirement unless you sell off your assets. And property investment in areas outside the familiar would be a great vehicle to create that passive income. Furthermore, by setting a solid goal, we would have something concrete to work towards. With that in mind, our first goal was to replace Mina’s income, and the goal after that was to replace mine. In 2013, Mina and I relocated to Port Macquarie for my demanding new job. Not long after the move we were able to buy another property for around $450 000, using an 80 per cent loan and 20 per cent cash we’d saved from working. This next purchase has always been one of my favourite properties: four units on one title with a price of $425 000. It was far from my familiar patch in Sydney, and almost everyone I talked to about the property at the time expressed concerns: it was too regional, it wasn’t going to attract any capital growth, the banks wouldn’t like it, and the tenants would give you too much trouble. And so on. But the numbers worked. At the time, the average yield in this area was about 4 to 4.5 per cent, yet this small unit block was showing a gross yield of 9.8 per cent generated from four separate tenants each paying $200 a week! It was clear that the cash flow would be better than anything else in town. I also knew that the property would be easily relet, because it was one of the cheapest places to rent in the town and just 300 metres from the beach.

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Finding tenants fast was always important for me, as income security was what I was investing for. So the length of time needed to find tenants is one of the most significant factors. This is particularly important in commercial investing, so all our experiences with residential properties were laying the foundations for our commercial property debut. Our fourth property search started quickly. We had our Port Macquarie unit block (bought for $425 000) revalued at $500 000 six months later. This meant we had more equity to spend, on top of the savings we had put away. This fourth purchase was almost a replica of that small unit block, but it was on the Gold Coast. Again, it was very high yielding (it had a gross yield of about 11 per cent). So once the outgoings and the mortgage were taken out, we were left with another $18 000 in passive income from the purchase. Adding this $18 000 to the other incomes generated from our other properties brought our total property passive income to around $65 000. The fifth purchase was another unit block on the Gold Coast. For the deposit we used equity from our Maroubra property, which had grown in value. We bought this at roughly $40 000 below market value, which was another good source of equity down the track. This slightly older unit block was clearing $16 000 per annum in passive income between the three units. You’ll have noticed that I always look at the income after mortgage costs for these properties, as this gives me the actual workable income. For many others, the costs and the mortgage are a secondary part of the equation. We also started strata-­titling the property, which would create more equity and free up another deposit for a rainy day. Our sixth property was an undervalued, slightly older house in Brisbane. This was sitting on a good-­sized block that could lend itself to upgrades down the track. We paid $270 000 for the house when all others on the street were selling for about $50 000 more. The yield was around 6 per cent. After all costs this left us with another $5000 per annum surplus in cash flow.

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Our seventh property was another unit block in Port Macquarie: five units on one title that we strata-­t itled for a profit. We bought the Port Macquarie unit block using equity from one of our Gold Coast properties plus equity from our first property in Sutherland and some cash savings for stamp duty. Finance was more difficult for this property. It was one of our more stressful purchases due simply to our running out of available funds for the purchase. We also had difficulty keeping the bank on time for settlement. It was a painfully slow process, and it felt like the bank was looking for reasons not to grant us the loan. Also, the agent had multiple backup buyers lined up, which meant we were going to lose the property if we couldn’t get the loan approved in time. Fortunately, it all worked out. The bank wanted a larger deposit, so at the last minute I had to obtain a personal loan to cover a cash shortfall. The purchase price was $710 000, and after strata-­titling it the property was revalued at $1.2  million. Although it was more stressful than the others, it was one of our best deals. The equity we created by buying it at such a good price led to further purchases down the track. Our eighth, ninth, tenth and eleventh properties were created by splitting up the seventh property into five units, all on separate titles. This freed up a lot of equity, which allowed us to go on a little shopping spree. The twelfth purchase was another unit block, this time in the regional NSW town of Cooma. You can tell we were becoming a little obsessed with unit blocks! By now we had found it to be a winning formula, as commercial property has since become. It was four units on one title, for which we paid $195 000, and it would be revalued at $300 000 just two years later. Using the profits from our capital growth, we then bought several houses in Queensland and South Australia, and at this point things started to move more quickly for us. My approach has always been to study, study and study some more. I reviewed several hundred properties online every week, year after year, which added up to more than 100 000 properties over the years. I would enter the best of these properties with all their attributes and numbers in spreadsheets for comparison. When I was looking to buy, I would review xxxii

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them, assessing every cost and risk. When I was ready to purchase, I knew every unit block in the country that was for sale. To help the decision making, I’d list all the investment strengths and weaknesses along with all the numbers on the properties. This register would include outgoings, renovations required, potential rent, upsides, street quality and even appearance. It all helped me grade and compare properties faster. We now use a similar system at Rethink Investing, which allows us to compare every commercial property on the market. It takes a team of us to handle the workload, but we know we’re identifying the best deals available around the country at each specific price point. When I started to realise there weren’t enough good deals advertised online, I began doing letterbox drops to prospective properties to let them know I was willing to put in an offer on their property without the need for a real estate agent. I was doing everything I could to increase my chances of getting a good deal. While putting a lot of time into my investing, I was also consciously saving every dollar I could. I took on a lot of minor renovations myself; for example, I sanded floors and had a go at a kitchen. I was managing all our properties, which involved everything from advertising on Gumtree to tenant interviews to dealing with maintenance call-­outs. Although it was time-­consuming, it helped us save money faster and get to know our properties better. Throughout this time I was also studying for an MBA and working full time. As I mentioned earlier, building our property portfolio didn’t come easy. It took a lot of time and a lot of effort. But back to the lightbulb moment. By concentrating on buying properties that produced good passive incomes and not being bound to any particular location, we made better investment decisions. It felt like we were growing a business, acquiring $5000 to $25 000 extra positive cash flow each time we bought a new property. At just 26 years old, I was doing what it seemed like no-­one else at the time was doing. I became obsessed! But I knew this was just the beginning. My goal was to create a passive income of $150 000 before I was 28, at which point we could decide never to work again if we chose. We were well on our way to achieving our plans. xxxiii

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The big pivot By 2015, with Mina’s mum unwell, as she’ll explain later, we had moved back to Sydney from Port Macquarie. We’d enjoyed five years of successfully generating great returns from our residential property portfolio, but we’d started to run up against an obstacle: the yields were getting lower and lower. The residential market was getting tougher by the year because rents were not keeping up with the growth, which meant that replicating the quality residential investment deals we had once relied on to create income from positive cash flow was getting increasingly difficult. The unit blocks on the market were not as high yielding either. For example, our early unit blocks were producing gross yields of 10 per cent. Now the best I could find was 6 to 6.5 per cent. The falling yields were due to the significant amount of capital growth that the unit-­block market had achieved over the previous few years. I guess this was to be expected as the yields couldn’t stay that high forever. As more investors started targeting the same unit blocks I was, the prices grew. Over time the value was just not there anymore. So this effectively put an end to the unit-­block strategy that had been going so well. Which meant cash flow had to be found somewhere else. At the same time I was forced to accept lower yields than I wanted to in my searches, I was also faced with several tenancy-­related issues in my residential properties. One of the drawbacks of owning many rental properties is there are always issues to deal with, especially if you are buying at the cheaper end of the rental spectrum. For example, drug addicts at our first property would drop syringes into the toilet, which kept blocking. Not surprisingly, no plumber wanted to go around to my place after a while! In another we had to have the police intervene in a domestic violence situation. We also faced additional costs from property damage and unanticipated vacancies. Property investing isn’t much fun when you’re dealing with tenants coming and going all the time. But more about that later in the book.

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At one point I was personally managing nine properties in two different states without using rental managers. This was consuming a considerable amount of my time, and I was completing it outside of regular work hours. The way I saw it, we had two options. We could persevere in the residential property, where the cash flow was starting to head south. Or we could look again ‘outside our own backyard’ —­ to the commercial market. In my search for numbers that stacked up, I had started to research commercial properties. To my surprise, the numbers and yields were far greater than anything I had seen in the residential markets. I couldn’t believe it! To an obsessive number-­cruncher like me, it was a potential goldmine. It was almost too good to be true. How and why was this possible? I needed to make sense of it all, because if it was true, we could surely fast-­track our goals and retire even earlier than we’d first thought! I became convinced that to achieve faster results, I needed to move into the commercial property market. To do so, I dedicated a year to researching all aspects of the sector, from office space to retail to industrial, and even the development side. I looked into the history of commercial property and how the different asset classes preferred in previous recessions. With a particular focus on the GFC, which was still front of mind at the time. My goal was to find a property that could withstand a recession, with a high yield, a long lease, and a solid trading history in a market that hadn’t already boomed, preferably in an essential-service industry. When I asked others for their opinions, to my surprise it seemed like everyone was against investing in commercial property. Everyone. Family, friends, brokers, advisers —­ none of them seemed to understand the commercial property market at all. I asked them if they personally owned commercial property, but all I got back was crickets! Disappointed but undeterred, I decided to back myself, as I was now convinced that commercial property was potentially a very profitable market to get into. Up to this point, we had still only bought residential properties. You’ll read about our first commercial purchase in Part I. It was the start of my obsession with commercial property.

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Fast-­forward a couple of years to 2016 and we had achieved our goal of replacing both of our salaries. As related in the preface, I was still only 28 at the time and we had grown our portfolio to 25 properties in both residential and commercial when we decided to take off on that six-­month trip to Europe to celebrate our success. It was an exciting feeling, but it also made us think about taking what we had done to the next level. We owned four commercial properties that yielded a net income of $207 000, a considerable amount that gave us the opportunity to have more autonomy. The mortgage cost was around $75 000 for the commercial loans. So our income had jumped $132 000 from these four commercial properties alone. This meant our passive income sat at just under $300 000 from our total portfolio. We realised that we wanted to spend our future helping others achieve their own wealth goals —­ and so our professional business, Rethink Investing, was born. Today, through our business, we have helped clients purchase more than $3 billion of Australian real estate, most of it commercial property. And the numbers continue to grow every month. More and more people are realising the value of commercial property as a high-­performing asset class. I strongly believe it’s where cash flow can still be found in today’s markets.

Mina’s story My motto: I want to want to open my computer and work, not have to have to open my computer and work. The dream for me was a life where I had a choice of enjoying what is most important – to me that was time with family and doing things that bring most joy. But it took a long time and a lot of hard work to get to that point. And, like Scott, it all started with the positive cash flow mindset in my DNA. While Scott and I share the same approach to money today, our property journeys to get there have been very different. I can narrow mine down to two key principles: sacrifice and saving.

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Family values My mother came to Australia when she was about 10 years old with her family from Egypt. She was a hard worker and saver. From a young age she would help her mum and dad with rent, groceries and bills, and however else she could. She was also an opportunist. She found work wherever she could, which gave her the skills to work in many fields, from admin to retail. Above all she was a fantastic writer. Nothing would stop my mum from getting where she needed to be. My father came from a family of 12 from the small Greek island of Kos. He dropped out of school at 12 years old to work in the family business, becoming a butcher like his father and grandfather before him. His family was very poor. All 12 children slept in one room in their small two-­bedroom home. The aftermath of World War II was hard on Kos, and all members of the family had to work. Shoes, food and especially sweets (my father used to look at chocolates in a store window and rub his belly imagining he was eating them) were hard to come by in his village. When he arrived in Australia he couldn’t speak a word of English, but he was determined to make a better life. He found work as a butcher and sent the first few dollars he earned back to his parents in Greece. He worked day and night to earn a living in Australia, sending much of his hard-­ earned cash back to his family while also building his own nest. The lure of property first surfaced after he met my mother, when he declared he wouldn’t marry her until he could put a roof over her head. He made that happen in 1982, buying his first property, a three-­bedroom unit in Kingsford, Sydney, where he lived. When the recession hit in the early nineties, my father decided a change was needed. By 1992, with the economy recovering, he was presented with an opportunity to build his own unit block with shopfronts back home on Kos. He decided to move us all (my mum, my eight-­month-­old brother and me, then three years old) back to Greece while he pursued this business opportunity. The plan was for us to live there for five years then return to Australia.

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He built the unit block and each of his three brothers took ownership of one shop and unit plus a block of land at the rear. He then took over the family butchery business with one of his brothers and worked day and night to create a comfortable life for his family.  We ended up living in Greece for 10 years. My father had approached investing by asking himself two key questions: What is the point of investing without purpose? Why not make your money work for you? From a young age, these ideas were embedded in me as I learned by watching my parents and taking note of my surrounding environment. This started my journey of understanding commercial and residential investing. During the 1980s and 1990s, another global health crisis, mad cow disease, made its appearance in Europe, destroying many butchery businesses, and Dad was forced to pivot again. He decided to build more units and shops on the island and he also bought land. Today some of his properties still provide produce for the shop where he now works. My dad, the simple butcher, made a new life as a restaurant–café–bar owner changing what he knew for generations, taking a leap and doing something different to keep up with the evolving environment around him. Entrepreneurship was in his blood! To a young girl, witnessing all this was hugely formative. Dad still tells me, ‘You should always have money in your pocket. If you don’t, then don’t go out until you have some you can spend and some you can leave for a rainy day!’ He would also say, ‘Why not invest your money but make a profit after costs? To be successful, your mind needs to be sharp to understand how money will work for you.’ I can see how his mindset came to influence me even back then. For example, I can remember at age 10 puzzling how I was to afford a chocolate bar I particularly wanted. I decided to sell my sticker collection one by one until I had enough to buy the chocolate bar with a little left over to set aside for a rainy day. To achieve this, I had to make sure I sold each sticker for a little more than I paid for it, which meant I made a small profit so I would have to work maybe only half as hard to get my second chocolate bar.

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I loved the feeling of accomplishment when handing over my carefully earned cash, knowing I had also made a profit from the proceeds of my sticker collection. I loved the work side of it, but more than that I loved the reward! Dad’s business mind, his ability to teach me the value of family, and the importance of saving to achieve independence still inspire me every day. The way he rose above his humble beginnings to become an experienced businessman and property investor is something I’ve always admired and appreciated. Mind you, he did eventually come back to Australia and bought what he as a young man thought unimaginable — a property in Sydney. My mother, too, gave me the opportunity for a better life in Australia with good schools and a secure roof over my head. My parents were always looking for a good deal. When we moved to Randwick, after living with my grandmother, Dad wanted to upgrade to a larger home to accommodate our growing family. He’d bought it for about $450 000 —­ we lived there for six years —­ and sold it for $660 000. He found a larger home in Pagewood, in Sydney’s southern suburbs, though it needed a lot of work. When we found out it was a distressed sale (the owner had left suddenly to go overseas and needed a quick sale), we realised what a goldmine it was! By then I was 18 and had started to see things through their investors’ eyes. And I liked it! We could see the house wasn’t worth much, but we could buy the land, knock it down and rebuild, then one day sell it for a good profit. I still remember as clear as day the moment of excitement when this offer landed on our doorstep. Doing the calculations in my head on the profit to be gained was my own standstill moment that has continued to grow to this day. I will never forget that feeling —­ a feeling that drives me today to diverge and expand horizons and investing arenas. We ended up buying it for about $714 000 and living in a rental while building the new home for about $450 000. Five years later we resold it for $1.8 million. I’d learned my first lesson as a kid selling stickers, but now I was starting to think like a professional investor!

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A mother’s love Through my mother I learned to appreciate life in a different way. When I was 12 years old she contracted ovarian cancer. We moved back to Australia so she could receive the cancer treatment she needed through Australia’s superior healthcare system. Dad stayed on in Greece, so we moved into my grandmother’s unit, all of us sleeping in one room. My brother had a mattress on the floor, while Mum and I shared the queen-­size bed. Dad would visit for a few months every year then return to Greece to work. When Mum was well enough and I had started school, we moved into our own place, living in one of my parents’ investment properties in Randwick, in Sydney’s eastern suburbs. We’d also travel to Greece to visit Dad when we could. Over the years I saw what cancer could do to a person. Mum was my rock, my inspiration, the heart of me and our family; her example always encouraged me to do better and to be strong. She battled her illness for 16 years, suffering eight recurrences, a full hysterectomy and multiple chemotherapy courses. She was only 39  when she was first diagnosed, which was unusually young for this disease. If it wasn’t for her, I don’t think I would have been the person I am today. A person who thinks outside the box and finds alternative ways to set themselves up for a future that they want to live. The simple act of breathing and living day to day was hard for me and I learned that simple things shouldn’t be taken for granted and to make your work worth your time. After Scott and I relocated to Port Macquarie, I travelled back to Sydney every weekend for two years to spend time with her. I could feel in my bones that every moment spent with her counted, because I didn’t know how much longer her poor frail body could survive. When we found out she didn’t have many more months to live, we decided to move back to Sydney to stay close to her. We quickly packed up our lives in Port Macquarie and I quit my job in financial planning. Back in Sydney, for a time Scott and I lived on a mattress on the floor. We only had a few cups, a mini fridge and basic necessities, but we were close to family. By then we had 18  investment properties under our belt. Quite simply, if we hadn’t had those properties, which were accruing enough passive xl

Introduction

income to replace our salaries, I would never have been able to spend as much time with my mum as I did, especially during those last few months. I am so grateful that I was able to go every day to help her shower, to hold mini parties in the hospital and even host a mock wedding ceremony with my celebrant in the hospital. The staff knew Mum so well that we threw a separate party there in her honour, knowing she wasn’t going to be able to make it to our wedding. She passed away on 14 September 2015. Mum taught me two of my biggest life lessons: that life is precious, and that it should never be taken for granted. Life’s too short not to enjoy it, so I made a commitment to live it to the fullest. Her courage and persistence taught me to never give up on what you want and what you believe in. When things get tough and hard I think to myself: if, in her sickness, my mum gave up on me and my brother, where would we be now? So I pick myself up and move forward! The most important thing is to stay true to yourself and to act with honesty and passion, without worrying what others do around you. My mum and dad had no time for lies and deceit. Honesty and humility, and always doing the right thing, can take you a long way. ‘Patience is a virtue,’ she always said. ‘You’ll see, good things will come your way.’

Investment lessons From my parents I learned the value of clearly understanding what’s important to you and doing what it takes to work towards it. That’s what still drives me today. I learned that the main purpose of earning money is to allow you to live life to the fullest, because you never know when it may end. So I said to myself, how can I do that? Again, it was Mum and Dad who prompted me to find the answer in property investing. When our property investing journey began, we were like everyone else just starting out in the residential property market. We did our research, calculated our return and made sure we had a cash-­flow profit after paying all our expenses. Dad’s early lessons were always in my mind: Why not xli

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make your money work for you? What is the point of investing without purpose? No matter what I invested my money in, these ideas shaped my thought patterns. Dad also taught me to think of investing like building a business. Whenever you spend money on a business, you expect a return via cash-­flow profits in the short term. Investing in property should be no different. Another key idea was that while you should work ‘hard’, you should also work ‘smart’. Once again, I asked myself how I could get there. As Scott mentioned, our first financial goal was to replace my income, which would enable me to spend time with my mum and to enjoy the time I wanted when I wanted with my family. Our ultimate plan was to replace both our salaries, giving us freedom and independence, and eliminating the need to work for a salary all our lives. I soon realised I needed a plan with set goals that would give me the fuel to accomplish them. A big part of this was making sure I had cash in my pocket each year after all costs. This is my ‘positive cash flow’ mindset. Unlike my parents, I always struggled with the idea of buying an investment property that was negatively geared. If we purchased a property and found it hard to pay off, then how could we gain the flexibility of being able to travel each year? From very early on I knew the importance of prioritising good cash-flow investments over those that couldn’t produce a passive income. All these lessons inspired our first property purchase in Sutherland. I remember when Scott came to me and asked me what I thought about it. It was a run-­down dual-­occupancy home, with lots of work and maintenance needed. If it was to be our principal place of interest, it was basically a knock-­down rebuild. But we saw what it was rented for, how much our lending capacity was and what the loan repayments would be after all costs. When we ran the numbers it offered a good return, and the location was booming. Our second purchase, the Maroubra property, was partly based on emotion, mainly because it would be our primary residence. It was negatively geared and cost us more to live in than it returned financially, but at the time it was a place to live more than an investment. xlii

Introduction

Starting Rethink Investing We moved to Port Macquarie for the job that Scott couldn’t refuse, which would give us the kickstart we needed in investing. At the time my job prospects were limited, in Sydney, despite having a strong background in politics and journalism, specialising in advertising and national operations (working for large advertising agencies and television divisions), I went back to my roots in retail. As a young girl, my go-­to had been retail. I always wanted my mind to be active, I never stopped looking for challenges, and I was never afraid of hard work. My first job was at a store called GoLo. At the tender age of 14½, I was the youngest employee in the store, but in no time I rose from stacking the shelves to managing the tills and customer complaints and closing up shop. Within six months I was made supervisor. Moving to Port Macquarie taught me some valuable lessons, among them to never forget where you’re from —­ your roots. Eventually I had an opportunity to complete studies in human resources, which proved very helpful when establishing Rethink Investing. I also worked for a council in their communications department, and for a financial planner in administration and operations, and I even started to study financial planning. However, investing was always in the back of my mind and my focus remained on what jobs would get me to my final goal: a passive income. Having to learn and juggle so many different roles due to the lack of job prospects in a regional town, and prior to that having to find a job during the Global Financial Crisis, had boosted my skill set and increased my knowledge of property investing. That’s when we purchased our third property in Port Macquarie, the unit block with four two-­bedroom units on one title. This was our highest yielding investment to date. It produced more than $18 000 per annum after all costs, including the mortgage. When my mother passed away and we returned to Sydney, I had no job and Scott was already buying properties for friends and family on the side. I thought, why not help start to build a brand for our new business? I began working from a mattress on the floor. It was a new and interesting challenge. I shared everything I learned and wanted to help others do the same. I started to build the back-­end and core of the business. xliii

Rethink Property Investing

Based on my experience in operations, advertising, human resources and administration, I began to build what you physically see as Rethink Investing today. I started from scratch, having never done anything like it before, so it was a major learning experience. I knew it would change my life forever. While Scott was helping clients buy their properties to build their own portfolio, I was creating a database, building a website, designing marketing materials, introducing accounting software —­ you name it and I did it. Over the next few years we had a lot of success buying high-­yielding residential real estate. Our successes with the Port Macquarie unit block led us to chase similar high-­yielding investments. Eventually, though, as Scott has described, it began to get much more difficult to achieve the yields we needed in residential. Ultimately this led us to look over the fence at commercial real estate. As you’ll read at the start of Part I, our first small commercial investment generated a whopping $46 800 passive income after all mortgage costs and outgoings. We were living in Sydney, where the cost of living was pretty high, but that one property paid our rent and we still had a surplus! That’s the power of commercial property. Purchasing properties with this level of cash-­flow return, we were not relying solely on capital growth to profit. This took much of the risk out of the investments for us. For example, if we didn’t get capital growth every year on a property, that was okay because we were getting our profits month to month from the cash flow. I know now that I could never have bought a property in any other way to facilitate what I wanted in my own life and for my family. Today, as we strive to help others achieve their dreams and ambitions, just as we did when we started out, I never forget the freedom that property investing has provided for me and my family, and the lesson that as things change, you can change too. Now let’s get started!

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PART I

MOVING BEYOND YOUR BACKYARD

Often when someone tells me not to do something, I immediately want to know why not? —­ well, when it relates to investing, at least. I take calculated risks and I thrive on challenging the status quo. After all, if you follow what everyone else does, you get the same result, right? I always wanted a little more than the average result. Negativity in investing choices is something I’ve faced a lot throughout my investing career. Yet year after year it has continued to change our lives for the better. We encountered this negativity in spades when we decided to move into commercial property. It was 2015, and we had already built up a considerable portfolio of residential property. As we’ve mentioned, after several successful years purchasing residential houses and unit blocks, the cash-­flow returns were getting tighter and tighter. For example, the unit blocks we purchased in 2014 had gross yields of over 9 per cent, which was a great return! Eighteen months later the unit block market had grown in value, but the rents hadn’t. This meant that if we had put the unit blocks on the market, they could have been sold for a 6 per cent gross yield. This yield compression was fantastic for the capital growth of our existing properties, but the opportunity to find other good deals like this had all but dried up. We just knew there had to be other options beyond residential housing, and we really wanted to do things differently from how they had been done before. But before moving on to commercial property we made one last-­ditch effort to find another good-­value unit block. I printed off a stack of letters that read: To the owner of the building, My name is Scott O’Neill. I’m a local investor looking to purchase a unit block like this property. I’m willing to pay above market value for your property if you wish to sell it directly to me. Also, by selling to me directly, you will not have to pay a sales agent commission —­ making this a more profitable sale for you. If you would like to discuss this further with me, please reach out to me via … Over the following month I dropped off some 200 of these letters up and down the coast from Wyong to Byron Bay. Guess how many responses we got? Not many! And even those simply replied along the lines of, ‘We are

not interested in selling at this point of time, but we will keep you in mind for when we wish to sell.’ This was the last straw. I was now ready to learn everything I could about commercial property investment. For the next few months I taught myself everything I could on the topic. I started by asking other investors about their experience with commercial property. I heard many amazing success stories, from multimillionaires in the 1970s who owned large parts of industrial suburbs all the way down to small-­time investors who purchased a single retail shop. The more I spoke to people, though, the more I realised that not many people did this. And it was hard to find anyone who had started investing in commercial, especially younger investors. It seemed clear to me that in Australia the focus for investors was almost exclusively on residential, while commercial investing seemed like a forgotten part of the property investment world. As I spoke to more experienced commercial investors, a common theme began to emerge. Once they had purchased their first commercial property, they never went back to the residential market. This was due to two main factors: higher cash flow and better tenants. The cash flow could help us hit our goals, and better tenants would give us less hassle. Residential cash flow was no longer enough for us to reach our income goals, and at the time we were dealing with a few bad tenants in some of the houses we’d bought years earlier. The next part of my self-­education was to start identifying the types of commercial properties I wanted to invest in. Again, I did my research. I had read everything I could on commercial property, spoken to dozens of agents, banks, brokers and property experts, and had all my finance lined up, so I finally felt ready to jump in. Importantly, my mindset was prepared, and although I was nervous about lacking the expertise, I was hungry to start learning how to mitigate the risks and reap the returns.  —­ Scott

OUR FIRST COMMERCIAL PROPERTY PURCHASE We had bought our first residential property just after the GFC, so we were drawn to properties that were likely to hold their value in tough economic times. For example, our Sutherland house was near a train station and had two tenancies (a three-­bedroom house plus a two-­bedroom granny flat with its own entry). Our theory was that no matter how bad the economy, people would always need a cheap place to rent, and a train station ensured the property would always be convenient to those renters. We applied the same thinking to our first commercial property. We decided that we wanted to purchase a cheap food-­related business in a market that was not at its peak. Later in 2015, after months of searching, we finally found a commercial property that ticked all the boxes. It was two shops on two separate titles, one a mini supermarket and the other a fish and chip shop. Both had been in business for about 20 years. It was in Perth, so we couldn’t have picked a more geographically remote location if we tried! But, confident that the numbers would work, we decided to go for it. Not that we received any votes of confidence from the people closest to us. Everyone, including family members, told us, ‘Don’t do it. You’re crazy!’, ‘It’s too risky’, ‘It’s not the right time’. We saw this negativity as stemming from a fear of the unknown. Commercial property isn’t as ‘relatable’ as residential, and to many people it seems more uncertain and complex than residential. But we’d heard it all before, and we weren’t going to let the fearmongering turn us away. It just made us hungrier by confirming that 5

Rethink Property Investing

this was something not many people were onto, which made us like the idea even more. The fish and chip shop came with a solid three-­year lease, but the supermarket had only 11 months left on the lease. From our due diligence, we knew that both tenants had long, secure trading histories and we could see that this one never missed a payment. For us, taking on the 11-­month lease was a calculated risk, and in the end it paid off when we renegotiated the expiring lease into a 5+5-­year lease. Also, the market in Perth was in a state of decline, which presented us with a better opportunity to secure the property for a good price. Another tick. Here were the pros and cons of the property. Pros:

•

Two incomes spread the risk and reduced the likelihood of a total vacancy.

•

Both businesses had been around for 20 years. The prospects looked good for continuing stability long into the future.

•

Perth was a market that had suffered greatly in recent times, yet these properties were still renting out steadily.

•

The price was good and the net yield was about 7.5 per cent.

Cons:

•

The supermarket had only 11 months left on a five-­year lease. This represented a big risk.

• •

The property needed work to bring it up to date. Our mortgage broker initially recommended that we stick to residential lending, as they had less experience with commercial finance.

Now, this is where it got a little tricky. Once we found the property the doubts crept in. Was this really where we should sink our hard-­ earned money? First, our mortgage broker advised us to walk away from the deal. She warned that the interest rate was going to be higher; sticking with 6

Our first commercial property purchase

residential would have been much easier. Given that she was part of a residential specialist mortgage brokerage, this advice should not have come as a surprise. After all, the commercial sector was outside the scope of their core business. From our experience, a residential broker will generally prefer to write a residential loan than a commercial one. In our business, we see multiple clients each month wanting to invest in commercial property. Our firm advice is always to work with a mortgage broker who specialises in commercial loans. It’s all about having the right professional team around you, a key point we’ll cover later in the book. Next, Scott asked a Perth local he’d met and become mates with while travelling. He mentioned the area where the property was situated and asked what it was like. As he was a bit older and didn’t know Scott was already an experienced investor, he immediately sounded the alarm, arguing strongly against the deal, insisting the Perth market was ‘terrible’. This made us very nervous! After all, the mortgage broker had already expressed much the same view. Family members were also discouraging. Surely we’d bought enough properties, they argued. Of course, they worried about our taking risks they wouldn’t take themselves. Our plan attracted negative opinions from all sides, until we reached the point where we were seriously considering putting it in the too-­hard basket. So why did we eventually go ahead anyway? There was one blindingly positive factor we could not get past: the numbers were just too good! After all mortgage repayments, land tax, maintenance, insurance, rental management, rates and so on, we were still left with an annual passive income of $46 800 a year. That’s $900 a week for doing nothing at all! We had by then moved back to Sydney. With our commercial investment netting $900 a week as an income ($46 800/52 weeks = $900), we could pay 100 per cent of our rent at the time. At the time we were residing in the costly eastern suburbs of Sydney and with this property it could potentially cover our rent. For Scott, a former engineer and the son of an accountant, numbers will always speak louder than opinions. And the numbers won out. 7

Rethink Property Investing

So we decided to proceed, but we had to get finance and sort out the contract quickly. The problem was that three days later we were due to fly to Japan for three weeks. Mina’s mum had recently passed away, and we were looking forward to a much-­needed holiday. We did everything we could with the loan paperwork, but eventually we ran out of time and accepted that we would have to sort the rest out from Japan. On the date contracts were to be exchanged, we were in a hotel in Tokyo. Scanning 40 pages of a contract in the hotel lobby at three in the morning wasn’t easy, but we knew we had to beat another buyer to the punch. Finally we got the job done and the contracts exchanged. We then had 14 days to complete a valuation, get full loan approval, and arrange building and pest reports. We ended up needing 21 days before the contract went unconditional, but the agent was happy to grant us that week’s extension. It was a stressful ride, and we were unnerved by feelings of buyer’s remorse, but we did it. And once we’d settled we started collecting rent. We were commercial property owners! Eleven months later we successfully pulled off another great value-­adding play: we secured a much stronger lease with the supermarket tenant, having negotiated a new five-­year lease with a 4 per cent increase, which the bank looked on very favourably. We bought the property for $620 000, renting for $46 800 a year, with the tenants paying all the outgoings. Essentially, we had taken an average asset and turned it into a much more secure one simply by lengthening the lease. This added about $100 000 to the value, proving to us that commercial property can enjoy equity uplift, security and high cash flow. It has been a game changer, to say the least. We did it by not only looking beyond our expertise in residential, but also geographically beyond what we were familiar with. We would never have secured such a positive result by investing $620 000 in Sydney. Also, it is remarkable to think that we were able to offset our rental costs in Sydney with a single, low-priced commercial property. We had made sure we had everything lined up and knew exactly what we were getting ourselves into. Once we had our first commercial property in the bag, we were on our way. 8

SUBSEQUENT COMMERCIAL PROPERTY PURCHASES Now we should put all our cards on the table and show you the last five commercial properties we have purchased. The reason why I wanted to include this is because when I was looking for our first commercial property, the lack of mentors I could follow in the commercial field was a real problem. First of all I couldn’t even find commercial owners willing to talk to me about what and how to purchase a commercial property, let alone see the actual deals and their numbers. This chapter will help you see how we analyse deals and understand the issues that can come up. Since our first commercial deal, we have purchased another 12 commercial properties, taking our total to 13, which have 50 separate commercial tenants. We also sold several of our residential properties to transition into these commercial properties. However, we still have 13 residential tenants, taking our total tenant count to 63, which is a lot to manage. Over the next few years, Mina and I will sell down more of our residential properties as they are not really creating much value for us any more. By selling down, the idea is we will free up more equity as well as save time in managing these small unpredictable residential tenants. This is a common strategy many of our clients also follow. We call it decluttering the portfolio. We are not sharing this information to boast; rather, we hope to motivate others to follow our lead, as it has been successful for us. As we collaborate 9

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with clients, we recognise the importance of disclosing our own portfolio strategy. I will elaborate on our plan later but, in brief, we are still actively acquiring commercial properties when it is financially feasible.

Property 24 of current holdings — regional industrial showroom In 2019 Mina and I were looking for a safe and secure property for our self-­managed super fund (SMSF). This was a purchase we wanted no hassles whatsoever from. Our budget was about $800­ 000  in our SMSF as we had $250­ 000 combined from our PAYG super contributions. There was also a good lending product out there at the time for 75 per cent LVRs within a SMSF. I ended up finding a great off-­market deal through one of my contacts in Rockhampton. The property was a well-­positioned retail warehouse with a 7.5 per cent yield. The property is occupied by a global tenant on a 5+5-­ year lease. Since the time of purchase, the tenant has never been late with a payment. Even through COVID. The price has been rising nicely as well, with circa 10 per cent per annum increases in capital value.

Fast facts on this property

• • • • •

Asking price: $800­ 000

• •

Freehold land: 1200 square metres

Negotiated price: $745­ 000 Net return: $55­ 875 Net yield: 7.5 per cent (after 100 per cent of the outgoings) WALE: 5 years (WALE is an acronym for weighted average lease expiry. It is basically a measurement of the general time frame when all leases in a property will expire. It’s good to know because it indicates when the property is likely to fall vacant.) Valuation in 2023: $1­ 050­ 000 10

Subsequent commercial property purchases

Here were the pros and con of the property.

Pros:

• • • •

Great yield Global tenant Growing economy Recently completed fit-­out by the tenant

Con:

•

Regional asset (very minor con)

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Property 25 of current holdings — KFC + Hungry Jack’s + rental shops Our next property was the largest purchase we had ever made at the time, being almost $10  million in value. Mina and I put this property under contract in early 2021 and settled about four months earlier. At the time we were not really planning on purchasing a property of this size. However, we’d recently sold a few residential properties, which freed up some capital. One of our sales was our first unit-­block investment, which we purchased in 2014 for $425­ 000 and sold for $1­ 305­ 000. A tidy 307 per cent increase in value in just seven years! So we were sitting on a bit of cash again and we didn’t want to waste much time by leaving it to dwindle away in the bank. Shortly after that sale we stumbled on a freehold commercial investment in Greater Brisbane which included a KFC, a Hungry Jack’s, five smaller retail shops and 1000 square metres of free land that could be developed. It was an exciting prospect to have such tenants in our portfolio, so I started moving finances around to make the purchase possible. This included a delayed five-­month settlement and selling three other properties to get the job done. Interestingly, at the time NAB offered us a 2.2 per cent rate 12

Subsequent commercial property purchases

on a 65 per cent LVR. So, it was producing a $440­ 000 passive income on day one after 100 per cent of outgoings and mortgage costs. An instant retirement sort of property, with those numbers. Unfortunately, the rates were not that low at the time of writing this book. However, the rents have grown almost $100­ 000 since we bought the property. Therefore the current cash-­flow result of the property after 100 per cent of the outgoings including the mortgage is circa $350­ 000 per annum. Quick note: this is a great illustration of how rates can change your passive income over time. On 3 May 2022, the Reserve Bank of Australia (RBA) announced that it was lifting the cash rate from a historical low of 0.10 per cent per annum to 0.35 per cent per annum — its first rate increase since November 2010. Since then, the RBA has announced seven more rate rises in as many months (four 0.50 per cent increases, three 0.25 per cent increases), taking the cash rate to 3.10 per cent in its announcement on 6 December 2022. It is certain that more hikes and subsequent drops will occur in 2023. It is essential to keep in mind that interest rates are always fluctuating. Therefore, it is not wise to make a decision based on the current rate when buying a property. A 10-year rolling average is a more reliable indicator of your financial standing. This was a huge percentage increase that has negatively impacted our income from the property. Obviously, rates will go up and down as the economy dictates. However, more importantly the rents should keep rising over time. For the investor, the equation should look better the longer you hold.

Fast facts on this property

• • • • • •

Asking price: $10­ 450­ 000 Negotiated price: $9­ 800­ 000 Net return: $582­ 000 Net yield: 5.94 per cent (after 100 per cent of the outgoings) Blue-­chip fast-­food investments WALE: 7.29 years

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Rethink Property Investing

• •

Freehold land: 8773 square metres Valuation in December 2022: $12 700­ 000

Here were the pros and cons of the property.

Pros:

•

At our maximum budget, meaning it was the highest-­quality deal we could get into at the time; I would have preferred this rather than purchasing three $3 million deals that wouldn’t have had the same level of tenants

• • • • •

Recession-­proof asset Growth corridor in Brisbane Multiple tenants Good rental growth built into the leases Development upside a consideration, but not the reason I purchased the asset

Cons:

•

Yield of 5.94 per cent was lower than other options in this price point

•

We had a lot of holdings already in Brisbane

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Subsequent commercial property purchases

Property 26 of current holdings — Brisbane industrial property Also in 2021, we purchased a large dual-­tenant industrial warehouse in Brisbane not far from the airport and CBD. I’ll be honest, this was one of those purchases I didn’t put as much thought into. I’m lucky enough to know the Brisbane industrial market extremely well through helping 15

Rethink Property Investing

hundreds of clients into this market through my buyer’s agent business. In fact, on average we secure two to three industrial properties per week in Brisbane. So I didn’t need to do much extra homework as I know the vacancy rates, the correct market value, and the correct yields for each suburb off the top of my head. I still did the usual homework on the tenants but at the end of the day I was just buying a well-­located warehouse in a metro market. So, compared to some of my other commercial purchases, this was a low-­risk one. The only issue I saw was that the shorter of the two leases was above market value in terms of the rental-­per-­square-­metre rate. So that needed to be factored in the calculations.

Fast facts on this property:

• • • • • • •

Asking price: $6­ 250­ 000 Negotiated price: $5­ 500­ 000 Net return: $369­ 500 Net yield: 6.72 per cent (after 100 per cent of the outgoings) WALE: 3 years Freehold land: 2983 square metres Valuation in 2023: $6­ 500­ 000

Here were the pros and cons of the property.

Pros:

• • • •

Great yield Dual income Very tight leasing market Strong capital growth prospects

Cons:

• •

One of the leases slightly above market value Needed $25­ 000 spent to fix roof leaks

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Subsequent commercial property purchases

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Property 27 of current holdings — commercial development site In 2022 I spotted 2500 square metres of vacant land for sale right next door to a shopping centre Mina and I already owned. The zoning of this greenfield site is Local Centre Zone. This zoning meant we could develop more shops and car parks connecting to a shopping centre. This adjoining development would effectively increase the size of the shopping centre by adding three new large retail spaces plus more car parking for the centre. In my opinion the site was a bargain. They were asking only $600­ 000 and I ended up getting the property for $490­ 000 with a cash–unconditional contract. Shortly after settlement we submitted plans for the approval of 900 square metres of showroom–retail space plus 44 new car spaces. The DA was for a material change of use, where the proposal represents uses that are consistent with and anticipated by the planning scheme and local centre zone, and reflect and support the adjoining shopping centre.

Fast facts on this property:

• • • •

Asking price: $600­ 000

•

Value increase: circa $4­ 100­ 000

Negotiated price: $490­ 000 Freehold land: 2533 square metres Development costs: circa $2­ 600­ 000 + $490­ 000 for the land + purchasing costs

Here were the pros and cons of the property.

Pros:

• • •

Large capital uplift potential Complements the current development Controlling this land is important so we don’t have to compete with an external development 18

Subsequent commercial property purchases

Cons:

• • •

No holding income High-­risk strategy Need to secure tenants fast once completed, otherwise the development profit margin will be eaten away

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Subsequent commercial property purchases

Property 28 of current holdings — Perth shopping centre In 2022 I stumbled upon a rare off-­market ALDI-­anchored shopping centre for sale. The tenancy quality speaks for itself with ALDI, IGA, a childcare centre, a medical centre and pharmacy, plus 10 other tenancies. When I first found this property, I sent this to a client like I always do. However, they passed on the property, as did the next. At the time I was on our usual escape winter trip in Greece with my family, so I wasn’t really in the right mindset to purchase a property. However, after a couple of clients declined the deal, I started thinking this deal is just too good to waste if none of my clients wanted it. So, I made some phone calls to my mortgage brokers and four months later I was the new owner. You may ask why the others rejected the deal. There was no reason other than the fact this shopping centre was not on the East Coast. Which leads me to my next comment. As an investor this is one of my great mysteries of life. That is, why do so many people feel the need to invest close to where they live? The common comments are they want to be able to drive past the property often. Well, this is what managers are for. At no point will an owner be required to go out and change lightbulbs, clean toilets or carry out repairs themselves, especially at this price point. There are skilled professional property managers who manage all of this for you. Plus they create monthly reports that summarise the financials and maintenance program of the asset. Also, if this deal was in Brisbane (an equivalent-­ sized city), instead of the asset being $11 400­ 000 it would have been over $17 million for the rent and size of the asset. So you need to ask yourself, is it worth sacrificing great returns just so you can sit outside your property on a regular basis? However, I understand this makes people feel comfortable. I guess this is where all investors are built differently.

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Fast facts on this property:

• • • • • • •

Asking price: $13­ 000­ 000 Negotiated price: $11­ 400­ 000 Net return: $369­ 500 Net yield: 6.72 per cent (after 100 per cent of the outgoings) WALE: 3 years Freehold land: 17­ 500 square metres Valuation in 2023: $12­ 000­ 000

Here were the pros and cons of the property.

Pros:

• • •

Upside in the numbers Quality, well-­k nown tenants High yield

Cons:

• •

Need to fill a vacancy Large number of tenants

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Subsequent commercial property purchases

Property 29 of current holdings — industrial warehouse This much smaller deal is part of our super fund. We were looking for an asset to use some of the surplus funds we had in our SMSF. A low-­maintenance metro strata warehouse was the perfect deal for us as it required about $150­ 000 in cash to complete the deal. This was part of a complex with 19 other properties in a high growth corridor of Brisbane. Many of our clients purchased the neighbouring properties in 23

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this complex, where we negotiated a good deal with an 18-­month rental guarantee from the time of settlement. They are being built currently, so we will be settling with a brand-­new asset. At the time we put this under contract, there are 0 per cent vacancy rates for industrial properties in the area. Based on our own purchasing experience in the area, it takes three to four months to find the right tenant. So we believe the 18-­month rental guarantee from the developer should be more than sufficient to secure the right long-­term tenant. We are confident that tenants will be found quite quickly which in turn should increase the value of the asset once there is a tenant in place. One of the most difficult things to do in the current market is to find high-­ quality commercial properties for less than $1 million. We have found that industrial offers some of the lowest leasing risk due to short supply and high demand for rentals.

Fast facts on this property:

• • • • • • •

Asking price: $680­ 000 Negotiated price: $601­ 000 Net return: $36­ 060 Net yield: 6 per cent (after 100 per cent of the outgoings) WALE: 1.5 years Building area: 137.5 square metres Valuation in 2023: $601­ 000

Here were the pros and cons of the property.

Pros:

• • •

High depreciation Quality location 15 kilometres from Brisbane CBD Great dollar-­for-­dollar deal

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Subsequent commercial property purchases

Cons:

• •

Need to fill a vacancy within 18 months Part of a strata title

25

WHAT COMMERCIAL PROPERTY IS (AND ISN’T) Commercial property is one of the most misunderstood asset classes in Australia. This lack of understanding gives rise to many myths as well. Despite our many years of investing experience, it has taken us a long time to understand what commercial property is and isn’t. There’s no point in investing your hard-­earned money if you don’t really ‘get’ how it works and how you can make money from it. So let’s dive right in so you can really appreciate what we love so much about this investment vehicle.

What it is Commercial property can be defined as any property that is zoned or used solely for business purposes. It may include shopping centres, strip malls, hotels, retail stores, warehouses, restaurants, industrial spaces, farms, office buildings, childcare centres, service stations, data centres, roof space; even vacant lots that have been designated as commercial by the local government. They are the buildings you see every day as you walk around your neighbourhood. Just as everyone needs a place to live, most of us need a place to work. And just so you know, you can’t build a business on a residential property or a home on a commercial property. This is because owners or builders of commercial properties must meet certain standards when constructing a business, from the style and specifications of the building to the number

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of parking spaces provided. Councils also have different zonings and regulations that must be adhered to. They also might have different tax rates compared with other types of properties. Commercial properties can be divided into categories. Hundreds of different options are available, and choosing the right property and then the right tenant is often the most difficult part of starting your investing journey. However, commercial properties generally fall into one of four distinct asset classes. Each asset type has its own set of risks and rewards, as well as being subject to economic trends. As an investor, it’s a good idea to familiarise yourself with the basics of each, as well as understand their relationship to the current market. This will help ensure that your commercial property investment is a winner. The key asset types are as follows.

Office space Commercial office properties can range from a high-rise building in a city’s central business district to a smaller suburban office. These properties are located in both urban and suburban areas and are easily recognisable due to the fact that many of us work in them. In larger cities, they are usually found in the inner-city CBD, although some cities also have smaller business office parks or office campuses. These properties are typically used by professional service providers. One advantage of office investing is that you are most often dealing with quality professional tenants. These may include global accounting firms, legal practices or government departments. The downside of office investing is the sign-­on costs. To encourage tenants to sign a long-­term lease, office owners often need to offer incentives, which can take the form of a period of free rent, allowances for fit-­outs, air-­conditioning reconfiguration and internet services. Incentives are a result of you needing to compete hard to secure a tenant, as they usually have a lot of options open to them, especially in the CBD. To date, this sector of the market was hit hardest by the COVID-­19 pandemic as businesses chose flexible work-­at-­home arrangements to protect their 28

What commercial property is (and isn’t)

employees from the virus. However, offices in suburban areas tended to perform better as social distancing requirements had less impact on smaller office blocks that were less dependent on lifts and less affected by public transport constraints. Office leases generally vary from 12 months to 10 years, but most sit in the two-­to five-­year range. Investing in commercial office space, it’s important to consider key market factors like employment growth, business confidence, and workplace flexibility changes — something we’ve all learned to adapt to with COVID-­19. A quality office building will be:

• • • •

located close to food and retail amenities

•

close to other similar businesses.

near transport networks, or have ample parking for employees set in pleasant surroundings with plenty of natural light well maintained (saving repair costs since tenants finance these themselves)

Retail Retail tenancies could be anything from entire shopping centres all the way down to a 50-­square-­metre hairdresser’s shopfront. Retail properties are the sorts of commercial properties that most people will be most familiar with because we see and visit these businesses all the time. Used mainly to promote and sell consumer goods and services, they include supermarkets, department stores, specialty shops, convenience stores, pharmacies, hairdressers, hardware stores, liquor shops, food takeaway, discount stores and so on. Retail properties can be broken into two types:

•

Discretionary spend–reliant. These types of retail properties are subject to shifts in consumer confidence and the wider economic climate, which means retail property owners often struggle with 29

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extended vacancy periods if the economy is not performing well. They may include travel agents, fashion stores, high-­end restaurants and electronic goods stores.

•

Non-­discretionary spend–reliant. These types of retail properties tend to perform consistently regardless of consumer confidence and wider economic performance. They include, for example, supermarkets, allied medical shopfronts, fast-­food outlets and hardware stores.

Retail leases generally vary from 12 months to 10 years, but most sit in the three-­to five-­year range.

A subsector of the retail market: large-­format retail properties The large-­format retail sector is typically represented by homemaker-­type tenants as well as tenants previously represented in traditional department stores. Large-­format retail now comprises a whopping 35 per cent of all retail floor space. Many of these types of properties are freestanding or part of a larger complex. With this type of asset, you can expect long leases — three to 10 years in most cases — and tenants are very sticky once they are established. Prices start from around $2 million for standalone retail stores selling products such as furniture, floor coverings and other homemaker-­type goods. Complexes are generally purchased by institutional investors, as prices are often north of $20 million. In the retail sector, property-­market drivers include consumer confidence, interest rates, time of year, surrounding tenancy mix, and income growth. Investor demand is influenced by low interest rates, the strength of the housing market, and the economy’s general health. High-­quality retail properties will be:

•

highly visible from a main road or in full view if inside a mall — with access to ample parking

•

close to quality anchor tenants (also known as key operators); if inside a mall, the investment should have low vacancy rates

•

in an affluent location: wealthy people have more disposable incomes 30

What commercial property is (and isn’t)

• •

positioned in high-­population-­growth locations

•

able to offer zoning options, multi-­tenant uses, or the potential for future development.

occupied by well-­established tenants, likely to renew their lease long-­term (with strong covenants in place)

Industrial Industrial investment properties can range in size and in their potential uses. Industrial properties include heavy manufacturing, light assembly and warehousing. They are used to manufacture, process or store goods, and include factories, workshops and research facilities. Industrial properties can range in size from a small workshop of 50 square metres up to facilities of 200 000 square metres or more. Historically they generally provided higher yields than retail or other commercial investments. However, in recent years yields have tightened due to the perceived extra security you get from low vacancy rates, strong tenants and high capital growth. Due the boom in internet sales caused by changing consumer behaviour (spread up from COVID-­19 lockdowns) this asset class has attracted a lot of extra interest lately. In recent years vacancy rates have tightened to record lows and this increased demand levels as well, causing yields to now match those of retail or A-­class office space. In most cases industrial property is the cheapest type of commercial property per square metre. The spaces are usually relatively large and have often been reconfigured to accommodate heavy machinery. Their location is frequently chosen for easy highway access. They may include office space too. Often the specialised and frequently extensive nature of these fit-­outs can make it costly for industrial tenants to move properties. Generally, the larger the asset size, the smaller the tenant pool you have to choose from. But the benefit of larger warehouses is that the tenant needs to spend more money to move, which is likely to attract longer-­term tenants.

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For example, a 20 000-­square-­metre warehouse might attract a global logistics company. They would likely need to invest millions in relocation and fitting out expenses, so they would be unlikely to move unless absolutely necessary. Conversely, the smaller the asset size, the wider the range of potential tenants, making it easier to find a tenant. However, the smaller the tenancy, the higher flight risk. Industrial leases generally vary from two to 10 years, but most sit in the three-­to five-­year range. For industrial property investors, a prime consideration is the quality of road networks. Freeways and motorways provide access to metropolitan areas, as well as connecting prospective tenants to ports and cargo docks. Key property market drivers include the economy, access to important infrastructure, and interest rates. A quality industrial property investment will:

•

be in close proximity to food retailers and other amenities within population centres

•

be well-­maintained and secure, with an office area, a kitchen, toilets and air conditioning

•

include an external loading dock with heavy vehicle access and suitable height limits

•

have minimal or no restrictions on water usage, discharge or noise, with no major environmental concerns associated with the property investment

• •

offer flexibility for future additional offices or showrooms boast high ceilings, as many tenants use stacking shelves in warehouse space.

Specialty Most other types of commercial property fall into the specialty category. Specialty commercial properties could be anything from a service station to a childcare centre to a hotel or pub. We’ll run through a number of the most common examples you will see in the commercial property market. 32

What commercial property is (and isn’t)

Medical Medical tenants are often very stable as they are backed by non-­d iscretionary spending type customers. By this, I mean that custo­ mers need to visit these properties regardless of the economy, which makes them very attractive tenants for investors. Often zoning for medical tenants is more restrictive than for general retail, even though they can be in similar locations. The negatives are that the yields are often lower because people pay a premium for a medical asset versus a standard retail type. If you lose a medical tenant it can be harder to find another, as the pool is smaller than for other types, which can create longer vacancy periods. Prices for medical properties can be as low as $300 000 for a small office suite all the way up to hundreds of millions of dollars for a large, freestanding, purpose-­built medical centre or private hospital. Medical leases generally vary from three to 10 years.

Childcare The childcare sector has been one of the fastest-­growing commercial real estate investment class in recent years. Investors have been attracted to the long-­term leases and strong federal government support of the sector. Many of the businesses are also listed on the ASX. The risks of this sector come from the single-­purpose-­type nature. That is, if you own a childcare where the business fails, this might be due to too many other childcares being built in the area. In that case it would be very difficult to replace your tenant if the location is inferior to the other childcares in the area. However, when you get this sector right you will enjoy very long-­term leases: generally 10 to 15 years with as much as 30 years of options.

Petrol stations Petrol stations thrived during the pandemic as public transport was abandoned and many took to the road for a quick escape. However, many investors question the long-­term viability of petrol stations as 33

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most car markets across the world double down on the electric vehicle production commitments. Similar to childcare properties, petrol stations often have long 10- to 15-year leases backed by ASX-­level tenants. Some petrol stations also have future development upside. You need to be wary of the environmental costs in remediating these sites. There is also the issue with bank financing for petrol stations. Most banks won’t lend you more than 50 per cent for this asset class. When the average price is around $5 million, this is a lot of cash you need to put into the deal to make it possible.

Car wash investments These are similar to petrol stations, where they are located on busy roads with a single type of tenant suitable for the site. The positives with these sites include long leases, a business that holds value (if it’s profitable) and potential for redevelopment if it’s a good freehold site. There is less of an environmental concern with these assets, as well. Financing can be difficult: 50–55 per cent loans are the most likely scenario. The leases will generally be five to 10 years in length.

Boarding houses A boarding house is defined as a house in which individual rooms are let out to short-­term tenants, who share common areas such as kitchens, living rooms and often bathrooms. This classification does not include backpackers’ accommodation, group homes, hotels or motels, seniors housing or serviced apartments. Given the multi-­income nature of the invest­ ment, boarding houses can offer a comfortable transition for residential investors seeking cash-­flow returns on a commercial scale. Keep in mind that this type of investment requires extensive and constant management owing to the transient nature of the tenant population. While the returns may look good on paper, the extra maintenance, management costs and vacancy issues can severely diminish the returns on the asset. Other types of commercial property will typically generate better returns than a boarding house.

34

What commercial property is (and isn’t)

Boarding house leases generally vary from one to 12 months, but average around six months. As an investor, key factors to look out for include business confidence in that particular sector, interest rates, and the general state of the economy.

What to look for Quality specialty commercial will:

•

be scarce to find; for example, if you are buying a childcare centre and there are three more under construction in the same suburb, the investment could present too many risks

•

have a strong lease backed by a secure tenant.

Next we will run you though a few more types of commercial properties that don’t fit into the four distinct types of commercial asset classes. They can almost be considered residential properties; however, the banks can treat them as commercial properties from a lending perspective. They include.

Unit blocks A block of more than four units on one title can be classed as a commercial property. For years, banks have treated blocks of four or more units on one title as qualifying for a commercial loan, which increases the minimum deposit to approximately 30 per cent. The yields are also higher than standard single-­ occupancy residential properties, given the multiple incomes involved. As with boarding houses, you will need to account for extra management and maintenance costs. A big difference, though, is that the units are fully self-­contained, so they tend to attract longer-­term tenants. Unit blocks can often allow value-­add plays such as strata titling, which involves changing the ownership structure of the building so you can turn a single title into a title on each unit. This means you can sell off the units individually, potentially at a higher per-­square-­metre rate. Unit leases, like most standard residential agreements, are generally six or 12 months. 35

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Land Land zoned for commercial property typically falls into three categories: brownfield land, which is land once zoned for industrial use and that may be impaired; infill land, which is land that has been developed but is now vacant; and greenfield land, which is completely undeveloped land. Land can be a useful investment if you are an owner-­occupier looking to build a premises for your business, mainly because you can build to your own specs, laying out everything exactly as you wish. In most cases there will be no holding income on vacant land, which rules it out for most investors. However, there are many examples where vacant land can be leased. For example, if you own land near a port, a logistics company may lease it to store shipping containers. In that case, rent will be payable, but at a lower per-­square-­metre rate than if it had a secure building.

Mixed-­use properties These types of properties typically involve a shopfront with a residential unit upstairs. This provides the tenant with the opportunity to work and live in the same location. There’s also the opportunity to rent out the unit separately in a multi-­income scenario. Something to consider is that they generally produce a lower yield because of the residential component of the property. As residential yields are lower, the residential floor space will bring down the overall net yield. They can also be located in relatively expensive metro areas, where there’s a lot of competition. This means vacancies can last longer and the unit itself isn’t often as desirable to live in compared to units in residential areas, because it’s located on a main road with other commercial properties. Prices for these properties generally start from $1 million. It’s important to always purchase the property for its leasable qualities first, before considering the strength of the tenant. One trick we always apply to asset selection is make sure you plan for a future vacancy. If you have confidence you will find a replacement tenant in a short period, then 36

What commercial property is (and isn’t)

you have a quality property. If you are buying a property just because of a good tenant, this is going to put you at potential risk. Because what happens if that great tenant leaves and you’re left with a long vacancy? It’s worth remembering that with commercial property you’re interested in owning the property itself, not the business. The business has nothing to do with it, although it does play a part in the property selection and tenant process, because the right type of business with a secure, reliable tenant will help the longer-­term performance of your commercial asset.

What commercial property isn’t You know the story. Couple at auction keep bidding to push the price up. They have their hearts set on their ‘forever home’. Couple ends up paying 20 per cent more than they had budgeted for, against another couple doing the same thing. Say goodbye to the emotional pull of the heartstrings and the stress associated with buying residential property, because in commercial property the transaction revolves solely around cold, hard numbers and contracts, not people — and not emotion. This is one of the main reasons I love commercial property. Because when you offer an amount on a property, the amount is dictated by the returns on the property. So for me it’s very easy to determine the value of a commercial property within minutes of seeing it, because it’s the net return divided by the capitalisation rate of the area. That’s how all good commercial investors operate. So you don’t get into that situation when you are rocking up to a residential auction hoping the price doesn’t shoot up 20 per cent above the agent’s guide. Well, not often, at least. Another thing: it isn’t completely unpredictable. There is more certainty over tenants and the consistency of cash flow and even growth. Let’s break this down. Things are often a lot more predictable when dealing with commercial than with residential tenants. For example, one of the most significant reasons we were drawn away from the residential property market was 37

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inconsistency of net income, mostly because you are responsible for the outgoings and often tenants don’t stay long term. When it comes to maintenance (which is almost always covered by commercial tenants), in residential portfolios the uncertainty of having to cover extra costs can become an issue, especially when you own many residential properties. We often seem to be paying thousands every month in following up maintenance problems — from a leaking tap, faulty air-­ conditioner or blocked toilet, to more major items such as leaking roofs, asbestos problems, replacing carpets and fences, and even structural issues. These items must be dealt with expeditiously and at your own expense. If your goal is to live off your rental income, uncertainty over maintenance costs can be a significant ongoing concern. This is something commercial property investors generally don’t need to deal with. Further to this note, understanding the true returns of residential property is very difficult. For example, I was looking up the average capital growth in a suburb in the eastern suburbs of Sydney. It was about 8.5 per cent for the last 10 years. I live in this suburb, and I have been noticing there was a never-­ending number of rebuilds and major renovations going on in this suburb since I have lived there. That made me think, people are spending millions on their builds and renovations. Is this factored in that 8.5 per cent growth? The answer is YES, renovation and rebuild costs affect the suburb average growth figures. If you have spent a significant amount on renovating your property, the growth rates may appear higher than they actually are. For instance, if you spent $1.5 million on luxury renovation after purchasing a $3 million property and then sold it for $5 million, the CoreLogic data would show a 66 per cent increase in value. However, the actual increase in value would only be 11 per cent before accounting renovation costs, and sales-agent fees. So, a lot of these amazing growth figures are off the back of people building amazing new homes or renovating their properties with their own money, which data figures should not confuse as capital growth. When data houses quote you these growth rates, they are missing the entire costs of the building. So, in reality, the figures are deceiving. Even more reason to focus on cash flow, in my opinion.

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What commercial property is (and isn’t)

Quoting gross rental returns is the other rather deceitful figure residential agents give. For example, I saw this guy on the internet seeing a property with a 9 per cent gross return! He was trumpeting this figure as the best thing on earth and all investors should rush to the deal because of the great cash flow. What he failed to disclose: there was a very high strata cost, plus the usual rates, water, electricity costs etc. Once all of this was taken out, the 9 per cent gross return turned into a 1.8 per cent net return. Commercial property doesn’t have this level of deception (intended or unintended) in the numbers. Another thing that is not generally found in commercial property is lower-­ quality tenants. This is what you will deal with more as a residential investor. Tenants generally sign six-­to 12-­month leases and might stay longer, but rents are very cyclical. Compare this to commercial property, where rental increases are generally fixed at an annual 3 to 4 per cent. Commercial tenants have their own brand and reputation, so naturally you will find they are more stable tenants. Growth, too, can be more predicable for commercial property. Why? Because rental growth is a good indicator of capital growth for commercial property. Residential is entirely driven by market and sentiment. Also, again, growth in residential doesn’t factor in capital costs owners have put in. When I first found this out, it really took the shine off the numbers for residential property. Don’t get us wrong: we love what residential property can do for you, but there comes a point in your investing career when commercial investments need to play a part. It’s simply more profitable in terms of cash flow and also more scalable, so you can build faster and more easily.

39

WHAT YOU NEED TO KNOW FIRST In a commercial property deal, the purchasing process is based on a simple mathematical formula plus market knowledge, which helps you value the correct yield for the offer. The offer is then turned into a contract, which is normally subject to a due diligence period. In this time window, you will have to review all the information on the property to verify if it’s exactly as expected. This includes building and pest reports, lease reviews, outgoing checks, tenant checks and much more. If it all comes together as expected, great; if not, either walk away from the deal or renegotiate the price. After settlement, one of the beauties of a commercial property deal is that you won’t have to deal with the day-­to-­day minor items that are common in residential. This is because in most commercial lease documents, it’s the tenant’s responsibility to keep the premises fully functioning. This is another part of the due-­diligence process. A solicitor or yourself must perform a full legal-­quality lease review to confirm assumptions, such as ‘does the tenant cover maintenance?’ or ‘how much should the rent increase per annum?’ and ‘who pays for other outgoings such as land tax or rental management?’. This bears repeating, because it’s a game-­changer: the tenant is responsible for the entire commercial space. That means no more maintenance phone calls and the unpredictability around income that comes with it. Furthermore, at the end of the tenancy, the tenant must hand back the property in the same condition as it was at the beginning of the tenancy, minus the usual wear and tear. There are normally allowances in the lease to compensate the landlord for the costs associated with cleaning the property and returning it to its original condition. This is called the ‘make good clause’, which basically spells out the tenant’s obligation to ‘make good’ the premises before handing back the keys. Understandably,

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it’s the most commonly contentious provision in the contract, as these provisions are not often well understood. Most commercial property tenants understand that the onus is on them to replace or repair anything on the site, while the owner’s responsibility ends at providing a watertight building. The bonus here is that tenants can upgrade or refurbish the space themselves, and many do this because it helps them to market their business. Another major point of difference: a commercial tenant is a business that has its own customer reputation to uphold, so by its nature it will be more self-­sufficient. It’s also worth noting that you must still manage your property managers but they are generally a higher level of manager due to their understanding of commercial leases and commercial businesses. When it comes to commercial real estate, property managers typically operate at a higher level than residential managers. They often possess a business background or a thorough understanding of business needs. Additionally, comprehending a commercial lease is a more complex task. Therefore, working with experienced commercial managers can provide a greater sense of security when investing in and holding property for the long term. For larger multi-tenant investments with common areas, a good property manager will manage the property in a similar manner to a strata company. This includes creating a 10-year maintenance plan for external works and common area management, as well as managing tenancy mix strategies and value-add strategies. We’ve now arrived at the best parts about commercial property investing. While we’ve already referred to some of these issues when discussing our personal experiences, here we’ll review the most important things you need to know. These are the fundamentals of commercial property investing. With a good understanding of them, you can start to get your head around how and why it differs so much from the residential property market. Essentially, you need to know about being cash flow positive and about yields. Let’s break it down.

42

What you need to know first

Cash flow positive Put simply, commercial property investment is designed to be cash flow positive for investors. You may have heard this referred to as positive cash flow or positively geared —­ that is, it puts actual money in your pocket even when you have high debt levels. Interestingly, cash flow positive investors are actually in the minority. In Australia, an incredible two out of three property investors claim a cash flow loss on their investments. Which means that the income you make from your property —­ rent —­ is less than your expenses, hence you make a loss. As some investors actively look to negatively gear property just to save tax, it becomes a tax position rather than a viable long-­term strategy if you plan to retire anytime soon. The bigger aim of negative gearing is for the capital growth to offset the cash flow loss. Many people feel compelled to engage in negative gearing due to the prevalent low net yields across various markets. The traditional perspective suggests that negative gearing is an essential yet temporary measure to counterbalance cash flow losses until capital growth is realised. However, it is our view that relying on potential future growth while enduring consistent losses is an ineffective strategy for success. Furthermore, it’s a widespread misconception that high-yielding properties are incapable of yielding substantial capital growth. A primary reason for negative gearing is the low net yields in the residential property sector compared to prevailing interest rates, leaving many with little choice. As illustrated in figure 1 (overleaf), a comparison of average net yields for each commercial asset class and residential net yields during Q4 2022 indicates that residential property net yields were a mere 2.66 per cent. This occurred during a period when average interest rates hovered around 5.5 per cent. Consequently, overcoming cash-flow challenges with these kinds of yields can prove difficult. Note: These figures represent average metrics for all capital cities.

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6.00% 5.00%

6.09%

6.23%

5.90%

4.00% 3.00% 2.66%

2.00% 1.00% 0.00%

Industrial

Office

Retail

Residential

Figure 1: Average net yields commercial versus residential net yields in Q4 2022 As you can see in table 1, of the 1 811 175 individuals who reported to the ATO in 2018 as having an investment property, 1 213 595 of them (or two out of every three investors) recorded a loss on their rental income. The total value of these losses over the year was $13.285 billion. Negative gearing of investment properties allows owners to claim a tax deduction on these costs. The average annual loss for these property investors with negatively geared properties was $10 947, or $210.50 a week. And many of those investors of held their portfolio for years. So that means even after years of rental growth the property is still negatively geared. We recognise that you need more properties to make more money, but when it comes down to what the average Australian is doing, it’s a different story again. Table 2 shows the average number of investment properties people own in Australia. What this table shows is that 74.7 per cent of investors never get past their second investment property, and that fewer than 5 per cent accrue more than six properties.

44

What you need to know first

Table 1: taxation summary of rental properties Gross rent no. 1 788 690 $30 730 421 999 Rent —­ interest deductions no. 1 459 530 $22 670 157 040 Capital works deductions no. 734 565 $1 920 663 564 Other rental deductions no. 1 795 705 $14 001 698 841 Net rent —­ profit no. 597 575 $5 422 999 805 Net rent —­ loss no. 1 213 595 –$13 285 087 251 Net rent no. 1 811 175 –$7 862 087 446

Table 2: individual investors’ interest in rental properties Property interests

2020-21 financial year

1

71.48%

2

18.86%

3

 5.81%

4

 2.11%

5

 0.87%

6 or more

 0.89%

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Why is this? Why don’t many people seek to achieve financial freedom through property? From our experience, this is because:

•

They have poor cash flow and lack of equity. Two out of three investors are negatively geared. The average annual loss for property investors with negatively geared properties was $5187 per property per year in 2019/2020.

•

They have no investment plan. They tend to:



–

–
–

–

–


buy based on emotion buy in ‘their own backyard’ follow the crowd rather than following markets closely sell at the wrong time select the wrong property.

•

The majority of people only consider residential property where they average net yield is 2.66 per cent.

•

They have the wrong advice, whether from:



–

–
–


spruikers friends and family people with vested interests.

Over the years, we’ve seen many novice property investors adopt the mindset that they just need to buy a property where they live. There isn’t much thought beyond just finding something they are familiar with. This often ends up in a negative cash flow investment that doesn’t grow as fast as they had hoped. In a way we view this type of investing as just trapping money in property and hoping for growth one day. Many of these investors simply do not prioritise the importance of deriving a good income from their investments. And they certainly are not trying to pick the best market in Australia for growth as well. They rationalise their poor returns by insisting that property is a ‘long-­term investment’, which means they may see many years of poor results.

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What you need to know first

This mindset is one we were determined to avoid. We wanted to invest without it hurting our day-­to-­day lives, which the negative gearing method would have done. From day one we sought to make a fast return, which is why higher cash flow properties have always been more attractive to us. Cash flow positive —­ we were certain this was the only way anyone should invest.

Better returns As previously mentioned, in residential property, the asset is typically negatively geared, meaning your income (rent) is less than your expenses so you make a loss. This is obviously not an ideal outcome, so why do people do it? One of the main reasons why people are more comfortable investing in residential real estate, aside from the fact that it is more familiar to them, is that they believe the capital growth prospects will be stronger, but this isn’t always the case. This brings me to one of the most important myths to bust. While preparing this book some statisticians and I have spent a lot of time and money coming up with figure 2 and tables 3 and 4 (overleaf). This table shows exactly how much capital growth each asset class in each capital city has achieved over the last 30-­odd years and the findings are amazing. I have observed, over the years, that capital growth from commercial property has been remarkable. However, it was not until I saw table 5 that I realised the capital growth since 1995 has been highly correlated to the capital growth figures for residential property in each capital city over the long-­term. As the numbers show, the average house price growth in our capital cities was 6.19 per cent per annum, while all commercial asset classes grew on average by 5.57 per cent. This is where it gets even more interesting for me as an investor. After we observed the close growth rates between residential and commercial, we then examined the average capital city yields for each asset class. As seen in the figure 4 (see page 52). 47

Industrial Office Retail Residential Industrial Office Retail Residential Industrial Office Retail Residential Industrial Office Retail Residential Industrial Office Retail Residential Industrial Office Retail Residential Industrial Office Retail Residential

CAGR

5.00%

0.00%

5.48%

Industrial 5.69%

Figure 3: Average CAGR per sector

48

7.13%

Perth

6.00%

4.00%

3.00%

2.00%

1.00% 5.63% 5.90%

Office

Retail

6.58%

6.51%

Adelaide

5.33% 5.17% 5.55%

5.66% 5.68% 5.45%

6.75%

6.69%

Melbourne Brisbane

5.97%

6.79%

6.51%

6.31%

6.03% 5.69%

5.27% 5.18% 5.12%

5.00% 5.40%

Sydney

4.66% 4.45% 4.76%

6.00% 5.68%

7.00% 6.35% 6.45%

Rethink Property Investing

8.00% Hobart Canberra

4.00%

3.00%

2.00%

1.00%

0.00%

Figure 2: Commercial vs Residential CAGR

6.19%

Residential

What you need to know first

Table 3: CAGR per sector Industrial

Office

Retail

Residential

Sydney

6.35%

6.45%

5.68%

6.31%

Melbourne

5.40%

6.51%

5.69%

6.79%

Brisbane

5.27%

5.18%

5.12%

6.03%

Adelaide

5.69%

6.69%

5.97%

6.75%

Perth

4.66%

4.45%

4.76%

5.66%

Hobart

5.68%

5.45%

6.51%

7.13%

Canberra

5.33%

5.17%

5.55%

6.58%

Darwin

5.10%

4.26%

Table 4: residential and industrial capital growth 1995–2022 RESIDENTIAL Capital value ($) 1995

2022

CAGR (%)

Sydney

$196 750.00

$1 025 684.00

6.31%

Melbourne

$129 000.00

$759 496.00

6.79%

Brisbane

$147 000.00

$715 130.00

6.03%

Adelaide

$111 500.00

$649 979.00

6.75%

Perth

$126 788.00

$560 789.00

5.66%

Hobart

$106 750.00

$684 828.00

7.13%

Canberra

$155 550.00

$869 235.00

6.58%

Darwin

$165 375.00

$510 105.00

4.26%

Average

6.19% (continued)

49

Rethink Property Investing

Table 4: residential and industrial capital growth 1995–2022 (cont’d) COMMERCIAL Industrial M2 RATE ($) 1995

2022

CAGR (%)

Sydney

$882.49

$4650.14

6.35%

Melbourne

$655.99

$2713.44

5.40%

Brisbane

$702.65

$2808.86

5.27%

Adelaide

$493.95

$2201.77

5.69%

Perth

$599.95

$2050.02

4.66%

Hobart

$659.72

$2935.74

5.68%

Canberra

$652.50

$2651.21

5.33%

Darwin

NA

$2170.25

NA

Average

5.48%

1995

2022

CAGR (%)

Sydney

$2201.51

$11 897.28

6.45%

Melbourne

$1104.05

$6061.72

6.51%

Brisbane

$1440.95

$5638.67

5.18%

Adelaide

$1003.05

$5763.56

6.69%

Perth

$1290.80

$4180.34

4.45%

Hobart

$1089.53

$4565.82

5.45%

Canberra

$1221.25

$4760.15

5.17%

Darwin

$1059.00

$4057.45

5.10%

Average

5.63%

Office M2 RATE ($)

50

What you need to know first

Retail M2 RATE ($) 1995

2022

CAGR (%)

Sydney

$2431.56

$10 812.86

5.68%

Melbourne

$1599.16

$7117.52

5.69%

Brisbane

$1790.82

$6898.89

5.12%

Adelaide

$1191.88

$5698.68

5.97%

Perth

$1543.03

$5419.18

4.76%

Hobart

$961.75

$5285.00

6.51%

Canberra

$959.86

$4127.90

5.55%

Darwin

NA

$3466.71

NA

Average

5.61%

For the analysis of changes in the Australian commercial property market, CoreLogic’s Property Information Monitor was utilized to extract relevant data from a comprehensive database of commercial property transactions. The dataset included M2 Rates, representing the price per square meter of commercial buildings, for the years 1995 and 2022. To address outliers, Winsorization was applied as a statistical technique. Extreme values above or below a percentile threshold were replaced with the corresponding threshold value, ensuring accurate insights while preserving the overall data distribution. This approach enhanced the reliability of the analysis without compromising data integrity. Additionally, a rigorous check for missing or erroneous values was conducted, with corrections made by referencing reliable sources such as Savills reports. This comprehensive data validation process further strengthened the accuracy and reliability of the analysis. To assess trends over the years, the Compound Annual Growth Rate (CAGR) was calculated. The CAGR compares the average M2 Rates from 1995 and 2022, providing insight into the average annual growth rate of the investment. The formula used for CAGR calculation is: / ) CAGR = (M 2 Rate ^ (1 / Number of Years) -­1 2022 M 2 Rate 1995 The CAGR enables comparisons between different investments or markets over time, representing the hypothetical growth rate if the investment had increased steadily throughout the specified period.

51

Rethink Property Investing Darwin 7.00% 6.60% 6.50%

Canberra

5.80% 6.25% 5.75%

5.80% 6.00% 5.50%

3.22% 2.06%

2.63%

3.08%

1.84%

2.00%

2.07%

3.00%

Hobart

3.67%

6.18%

6.80% 5.75%

5.50% 5.20% 5.62%

Perth

4.00% 2.70%

Net Yields

5.00%

5.10% 5.07% 5.54%

6.00%

6.20%

7.00%

Adelaide

6.50% 7.05% 6.32%

Melbourne Brisbane

6.80% 6.85%

Sydney 8.00%

1.00%

Industrial Office Retail Residential Industrial Office Retail Residential Industrial Office Retail Residential Industrial Office Retail Residential Industrial Office Retail Residential Industrial Office Retail Residential Industrial Office Retail Residential Industrial Office Retail Residential

0.00%

Figure 4: commercial vs residential net yields The net yields for commercial real estate are two to three times higher than those for residential properties, resulting in a substantial difference in overall returns. To illustrate this, we have compared the capital growth rates of each asset class with the net returns. Figure 5 outlines the total returns from 1995 to 2022. In conclusion, over the past three decades, commercial markets have yielded approximately 3 per cent higher returns annually. This is a noteworthy accomplishment, and one of the reasons why many affluent individuals and family offices around the world prefer to invest in commercial real estate.

52

What you need to know first

12.00% 11.57%

10.00%

11.85%

11.51%

8.00%

8.85%

6.00% 4.00% 2.00% 0.00%

Industrial

Office

Retail

Residential

Figure 5: total returns from 1995 to 2022

Yields Let’s revisit yields again in more detail. Net yield is another term you’ll need to get to grips with. In commercial property, the yield is everything. It is the calculation you will use to work out if a commercial property is worth buying or not. You can also use the yield to compare with other yields in the sale area. For example, if you are putting in an offer on a property that shows a 7 per cent net return, but the market yield for that specific type of asset is averaging 6.5 per cent, then your 7 per cent yield looks relatively good from a valuation point of view (as long as the rent is at market value, of course). A market yield can change over time too. Whether it goes up or down usually relates to good old-­fashioned supply and demand and interest rates, but it’s important to understand how it applies to commercial property. It’s also extremely important to understand the difference between gross yield and net yield. Residential property is always looked at from a gross yield. Which is the income before costs such as rates, water, maintenance, strata etc. As an example, a 5 per cent gross yield in residential could be lower than 2 per cent net by the time these costs have been extracted from

53

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the equation. This is where commercial is superior —­ because it always looks at the net yield. So when you find a commercial property with a net yield of 6 per cent, you can safely say the income is triple that of a 5 per cent gross yield in residential. (Remember gross yield of 5 per cent –­costs = circa 2 per cent net.) So let’s dive deeper into the yields as this is the true game-­changer for commercial investors. It’s the reason you can build a passive income.

How to calculate net yield It’s important to understand how to calculate net yield, because this should be the foundation for every commercial property decision you will ever make. It’s a formula we use in the office all the time:

Net income per annum NIPA = Total gross rent – Total outgoings

Net yield = NIPA / Purchase price ×100% Let’s break this down so you can fully understand how the formula works, starting with calculating the true net income per annum. You’re interested in buying an industrial property, and the purchase price is $1 million. The agent has listed the gross rent at $70 000 per annum and total annual outgoings at $7500. (This includes building insurance, maintenance and council rates. Please be careful to include all the outgoings, as agents often miss numbers. We’ll talk about this later in the book.) If we plug in the numbers, we can see that the rate of return is 6.25 per cent:

Total gross rent : $70 000

Annual outgoings : $7500 Purchase price : $1000 000 NIPA = $70 000 $7500 = $62500 Net yield = $62500 / $1000 000 ×100% = 6.25 per cent 54

What you need to know first

If other properties are selling at yields of 6.25 per cent or lower, then you could have a very good deal on your hands. To give you some basic philosophies about yield, let’s talk about our three main commercial types: office, industrial and retail. Historically, industrial properties usually offer the best yield but have lower capital growth. In recent times, however, industrial properties have achieved the fastest growth due to an increase in demand as more businesses move online and the need for storage space grows. In the office market, yields are lower than industrial in many areas. This is often due to higher-­quality finishes and higher per-­square-­metre values. Finally, retail yields vary greatly. For example, a national supermarket might demand a sharp yield of 4 to 5 per cent net, but the hairdresser next door might be valued closer to a 7 per cent net yield. In general, the lower the yield the higher the calibre of tenant. Historically, we’ve found yields are lower for retail versus industrial and office space in the areas we invest in. We attribute this to more people feeling comfortable with the idea of retail versus other types of assets, perhaps because people visit shops more than industrial properties. However, in recent times, post-­COVID, people have become more fearful of retail and more comfortable with industrial. Retail growth has slowed as a result of greater competition from online businesses. But, as everywhere, we can expect swings and roundabouts in yields for each asset class. Please note that these comments are general in nature and exceptions won’t be hard to find.

Yields are affected by the economy In a strong economy yields can drop. Remember that when people are confident, they can more readily justify purchasing properties at sharper yields because they see more potential for growth. When confidence is high in an area or in the economy as a whole, people will pay more for assets. This means commercial property values can rise because investors are prepared to pay more for the same value of rent coming in annually. This causes yields to drop, which is commonly referred to as yield compression. 55

Rethink Property Investing

When people ask us how commercial properties grow in value, we often refer to yield compression as a source of capital growth. On the flip side, where the economy looks weaker and demand is lower, investors generally seek higher yields to justify their purchases. This is one of the reasons why you will see higher yields in the country areas versus capital cities —­ because investors need a higher yield to justify purchasing in a higher-­risk market. So why are capital cities generally lower risk? Here’s how it works. If you take a busy city like Sydney, it has plenty of businesses in operation and a pipeline of new ventures driven by a large population base. This depth in entrepreneurship provides more choice of future tenants, which lowers the vacancy risk for investors. The result of this lower risk is that higher prices will be paid, hence lower yields are expected for these types of areas. Conversely, smaller cities that show less demand can have longer vacancy periods simply because there are fewer tenants seeking to lease the average commercial property. Longer vacancies mean more risk, which leads to higher average market yields. However, don’t make the mistake of automatically ruling out regional cities, as supply can sometimes be less, which can work in your favour on supply:demand ratios. It all comes down to local knowledge of the product, the demand and the supply, and then factoring in the yield as a measure of the deal’s quality. As you can see, the local economy is a huge part of the equation, so never make the mistake of looking only for high yields. You need to have a balance of quality and a good yield to make a wise investment choice.

Yields are affected by a property’s position Put simply, the best locations tend to attract the best-quality tenants. For example, KFC or McDonald’s occupy some of the busiest retail precincts in every corner of the globe. If they were located in areas where there was no foot traffic or highway traffic, it would be harder for them to succeed. As a commercial investor, we want the best locations too. Investors will pay premiums for better locations due to the added security of having a better-quality tenant occupy the property. The negative side is that paying this premium will lower your yield as the price you pay will be higher, as 56

What you need to know first

per the yield equation. Some will argue that this lower yield is worth it as there is more chance for capital growth with lower vacancy risk.

Yields are affected by interest rates Since the GFC we have seen interest rates continually fall. That was until we had the first interest rate rise in almost 12 years in 2022. See figure 6 for reference. 16% 14% 12% 10% 8% 6% 3.10%

4% 2%

5

99

g1 Au

0

00

g2

Au

g Au

05

20

010

g2

Au

015

g2

Au

g Au

20

20

Figure 6: Interest rates since the GFC As the price of debt gets cheaper, more people are encouraged to spend their money and commercial property is one of those spending targets. So a dropping interest rate environment is extremely positive for capital growth conditions. On the flip side, as interest rates rise, people are less likely to spend and that will slow down the demand for commercial property. In those periods you will likely be able to negotiate a better deal. However, your debt will cost more, and your returns will be lower. As this is a very important concept, I want to clarify it. As the cost of borrowing gets cheaper, this helps investors pay more for properties. To

57

Rethink Property Investing

illustrate this, see figure 7. It shows the price of an exact type of commercial product, in this case the Dan Murphy’s sales from 2009 to 2022. 8.00%

Manly Vale 7.34%

7.00% 6.00% 5.00%

Frankson 6.69% 6.70%

6.06%

Richmond 5.30%

5.60%

Wagga Wagga 5.23%

Burwood 4.59%

4.00% 3.00%

Mossman 4.85%

Pakenham 1.44%

Alphington 1.44%

Armstrong Creek & Orange 4.00%

2.00% Glen Waverley 1.44%

1.00%

0.00% 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Yield Linear (yield)

Figure 7:  Dan Murphy’s yield from 2009 to 2022 The reason yields have got a lot lower for this asset class can be due to a few reasons: 1. Interest rates trending downwards. 2. Increased investor interest in commercial properties since 2010 has led to a heightened demand for these assets. 3. The strengthening of the Dan Murphy’s brand However, the major theme would have been point number 1. As this is a very important concept, I want to clarify it. As the cost of borrowing gets cheaper, this helps investors pay more for properties. As rates have increased, yields have once again improved. This is due to investors requiring a greater return to counterbalance the higher interest rates. Notably, a large proportion of commercial buyers are cash purchasers, 58

What you need to know first

meaning they do not take out any form of loan when buying a property. Therefore, capitalisation rates on commercial real estate do not fluctuate as much as anticipated, particularly for properties where individual investors are involved.

The right yield Over the years we have fine-tuned plenty of techniques to build better passive income. We have found, for instance, that it’s better to have a high-­ grade 6 to 6.5 per cent net yield in a capital city or large regional centre than a 10 per cent net yield in a tiny regional town or higher risk market. There are of course exceptions to this rule, but as a general guide, high yields can equal higher risk. For example, if you bought an office investment in a small town of fewer than 5000 people and the tenant decided to vacate the premises, it might take years to replace the tenant. On the flip side, if you had a warehouse right next to an international airport, you might find it takes only a month or two to replace the tenant. Better-quality properties in good areas lower the risk for the investor. We also see better rental growth over the long term for higher grade areas. This will mean your long-­term yield will grow over time. One thing we always do when assessing a property is map out a 10-­year financial snapshot of the property. Table 5 compares a regional property with a high-­grade one in a capital city. Table 5: total 10-­year rental income forecast Purchase Yield Annual net Assumed price ($) (%) rent ($) vacancy (every 3 years)

Assumed Rent rental received growth over (p.a.) (%) 10 years ($)

Capital city

700 000 6.50

45 500 2 months

3.5

506 758.53

Regional town

700 000 7.50

52 500 6 months

2

487 913.99

59

Rethink Property Investing

The regional town property has a 7.5 per cent net yield versus 6.5 per cent in the capital city. Most people would assume the regional property would therefore offer a better cash flow. But this may be a false assumption when forecasting the total rental received over a 10-­year period. This is because the rental growth will be better and the vacancy period will typically be shorter between each three-­year lease for the property in the higher demand area. For this simple comparison we have assumed this higher demand area is the capital city example. Once you factor in the shorter vacancies and the higher rent growth, you can see that the capital city property will collect $506 758.53 in rent over 10 years, whereas in the same period of time the higher yielding regional property collects only $487 913.99. Let’s be clear: regional properties can make fantastic investments. In fact, we help clients purchase regional properties every month. You just have to be careful not to become fixated on the initial yield. It’s the yield after 10 years that is the big profit play for you as a long-­term investor. While we’re on yields, you can’t squeeze the yield too low as there will be a point where the cash flow is just not worth it. For example, we see some investors buying properties in Melbourne and Sydney at 1.5 to 3 per cent net yields. To us this is crazy because it defeats the purpose of choosing a commercial investment in the first place, which is to generate a passive income. Remember, the goal is to create strong passive income for your retirement, not just to trap money in bricks and mortar and hope for growth.

60

HOW DO YOU MAKE MONEY OUT OF THIS? There’s little point investing in any property if you’re not going to get a decent return. So let’s dig a little deeper into this.

Capital growth In residential property, the value of a property is set by comparable sales in that local market, and as we’ve described, these properties are bought differently and sold differently, based mainly on emotion and what price other houses of similar size have commanded. Furthermore, residential properties are usually bought with a view to capital growth and building equity rather than annual cash flow profits, which means that as an investor you have less predictability over your investment returns. After all, capital growth is inherently difficult to predict at the best of times. To illustrate this: every year, the banks’ economists come out with their annual property prediction figures. Every year they struggle to read the property market and their predictions can be way off. For example, banks were predicting 30 per cent property falls the year after COVID-­19 hit. Yet there were 20 per cent price gains. So the predictions were out by up to 50 per cent of the value of the medium house price. There are just too many variables to pin down something as complex as a property market. If every bank’s top economist gets it wrong, what hope does an individual investor have? This is why I believe time in the market is much more important than trying to time the right time to buy in. Commercial property, as we have proved, grows at a similar rate to residential. Also, a high percentage of the property’s value is derived from the rental income. As the rental income grows, so does the value 61

Rethink Property Investing

of the commercial property that holds that income. This can steady the ship where you don’t see the same level of rapid price falls or increases. Yes, there are still many variables that will influence capitalisation rates in a market: most notably, interest rates, quality of tenant and supply:demand ratios. However, there is simply less emotion in the market for commercial investors. Commercial property often comes with long leases and typically has scheduled rental increases built into the lease. These factors are crucial in the valuation process. The scheduled rental increases are a key contributor when making money in commercial property because each year, the rental increase built into the contract, which you can negotiate as the owner of the property, gives you more cash to grow your income. So you’ll know exactly how much rent you’ll be receiving per annum in year one, two, three and so on. This makes it easier to bank on your cash-flow returns, which should be significant when done right. Connected with this is the way the value of a commercial property is calculated. In residential property, value is set by the market comparable sales; in commercial property, value is directly proportionate to the income it generates.

Value-­add strategies Every time you increase the rental income or lease length on your commercial property you instantly create capital value. This is because longer leases make the asset more attractive to valuers and investors alike and higher rent increases the return so investors will pay more. To illustrate this, I have used an example of a recent client purchase.

• • • •

Asset type: Industrial property in Perth Price paid: $1 800 000 Net rental income at purchase: $117 000 per annum Cap rate: 6.5 per cent

62

How do you make money out of this?

This property was under-­rented at the time, which allowed us to increase the rent by $16 000 at end of the lease. So, the new rent was $133 000 per annum. Using the same cap rate for the market, this is the new value: New value : $133 000 / 0.065 = $2046154. Theoretically if you can double the rental income, you’d potentially double the value of your property. This for me is one of the most exciting things about commercial property. Finding upside in rental income is a sure way to create equity for future purchases. For example, strong rental growth markets, under-­rented properties, rezoning to get a higher use meaning higher rent potential etc. You can start to see why there’s no room for emotion in commercial property investment, because it’s purely a game of numbers. If you understand how to find properties that have a rental upside, you can create equity quickly by increasing the income. So maybe there is a little emotion after all, which would be excitement! Basically, the predictability of the lease and its inbuilt annual percentage increases helps you predict capital growth more confidently than with residential. And that’s why we love it.

Cash flow This is the obvious reason why most people start looking at commercial property. On a net percentage basis, the cash flow is roughly triple that of residential property. Instead of getting 2 per cent net returns (4 to 5 per cent gross) in residential, you would normally be looking at 6 per cent net or better for commercial. How this translates into cash flow really depends on how much debt you take on day one. Below is an example of the average price and yield property for one of my clients in 2022:

• • •

Average price 2022: $1935 000 Average yield 2022: 6.3 per cent net Average deposit needed : 30 per cent of asset value cash used

See table 6 (overleaf) for the average cash-­flow return each year. 63

How do you make money out of this?

As you can see in year one at the interest rates towards the end of 2022 (5.25 per cent) the passive income is $50 793.75. A decade later the passive income would be $143 533.21. Increasingly the capital value would be $2 754 108. That means you would have collected a total of $819 000 in capital growth plus $927 000 in cash flow for that period. Total return = $1 746 108 The simple cumulative calculation above is something very few investors ever do. Most just look at the year one equation to make decision. Imagine doing the same calculation on a negatively geared asset then comparing it to this. You almost need double the growth rate just to keep up with the cash flow of a commercial property. And remember, once more commercial and residential grow at similar rates. This was my aha moment when I first understood the numbers of comparing the two asset classes. Adopting these types of strategies makes the game more interesting. Testing the many tools, tips and techniques for increasing rental income is among the most enjoyable aspects of commercial property investing. We’ll dig into this in more detail later, but at this stage we just want you to get your head around the different mindset involved when dealing with commercial property. Add a few commercial properties to your portfolio and you will really start to see how you can build passive income into your lifestyle.

What is it going to cost? Buying property of any kind can be pricey, and for some unattainable. Overvalued residential property markets can make investing prohibitive for some in the housing sector, where a 20 per cent deposit can set you back hundreds of thousands of dollars. However, one of the great benefits for residential property is you can access it with lower deposits compared to commercial. Residential can be bought with as little as a 5 per cent deposit (with a LMI penalty), however in most cases you will need a 30 per cent deposit for commercial. This lower barrier to entry would be the second most common reason people choose residential over commercial. The first would be familiarity with residential, as commercial is still an unknown sector for most Australians. 65

Rethink Property Investing

In the commercial market, people often believe you need to be a multimillionaire to purchase a property. However, you can start off with a deposit as low as $150 000. We recommend kicking off at $200 000, which would cover your deposit and purchase costs on a commercial property purchase of around $57 000. This is the price point we believe will provide the quality you need in an asset. In many cases, if you already have built up some equity within an existing asset, such as your first house purchase, you can use that to secure your first commercial property investment. So it’s not as hard as you might think to get your foot on the ladder. Of course, a large retail space will have a larger price tag, but in this market there’s plenty of diversity, so there’s a wide mix of properties to choose from. For example, buying a car park could cost you tens of thousands of dollars, rather than the hundreds of thousands you’d be expected to outlay in the residential sector. Investors are flocking to look at small warehouses or ‘man caves’ as a good first investment. But we must stress that at these lower price points you should seek professional help to find the best quality possible, because the risk can be higher and the tenants may not stay as long as those for a larger property. Whether you have a lot of capital to spend or a smaller amount to finance, commercial property will offer you amazing diversity. The hard part is to pick the best type of asset for your budget.

Why is commercial property so important for investors? There are two main reasons:

•

High yields. In an investment world where high yields are becoming increasingly difficult to find, commercial property offers investors a cash flow high enough to generate a significant passive income even after bank debt has been taken on. This places you in 66

How do you make money out of this?

a much stronger position if you’re planning for early retirement. And for us, that’s the name of the game. Basically, commercial property can be a goldmine for investors looking to create a passive income for their retirement.

•

More flexible lending. It’s important to note that since the independent statutory authority APRA (Australian Prudential Regulation Authority) has made residential lending much more difficult, it’s no longer as easy for investors to build large portfolios. This is because it’s harder to meet the servicing requirements set by the banks. The more residential properties you buy, the harder it is to get another loan. Eventually, you will reach your lending limit — and it’s game over for growing your portfolio. Fortunately, there is another way: commercial lending.

Yes, you heard that right. It is still possible to secure loans for commercial property even if you can no longer meet the residential serviceability requirements. Commercial loans are assessed differently and comprise ‘lease doc loans’, ‘low doc loans’ and ‘no doc loans’ that you can potentially take advantage of if you have run out of lending steam on the residential side. For more details on lease doc loans, please listen to episode seven titled ‘How to succeed in commercial property’ from our podcast, Inside commercial property by Rethink Investing. In fact, hundreds of our commercial clients are investors with large residential portfolios who are now moving to commercial because it’s where the lending is. More about strategic investing later.

Why are commercial investors important? Businesses rely on investors to purchase their premises so they have the space they need to conduct their business. This is because most businesses won’t have the capital to purchase their own commercial premises outright. If you think about it, it’s no different from residential tenants needing landlords to provide them with housing because they haven’t yet saved up a deposit for a house.

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Additionally, commercial investors are good for the economy. Fewer investors underpinning commercial properties means fewer small businesses out there giving it a go. Many businesses rely on foot traffic and a high-­street presence, and an office is integral to their operation. They would face significant challenges if their only option was to buy their premises rather than renting it. So investors play a vital role in keeping the general economy in balance. Some jurisdictions have even waived stamp duty on commercial purchases to encourage investment. For example, in the ACT, no stamp duty is payable for commercial investments up to $1.7 million, and in South Australia, it has been completely abolished for commercial investments at any price point.

Why don’t more commercial tenants purchase properties? There is a huge owner-­occupier market for commercial properties. This is because many owners purchase their office, shop or warehouse through their self-­managed super fund (SMSF) or other structures to rent it back from themselves. Those who don’t become owner-­occupiers generally don’t purchase for two main reasons: 1. They can’t afford the outlay. The capital needed to purchase an entry-­level commercial property must cover around 30 per cent with a loan on top and the ability to service that loan. For a small business, this is a lot of money. 2. Businesses often prioritise capital expenditure on business costs rather than on property costs. They see that this money is better spent on marketing, stock, staff and other costs, rather than hundreds of thousands or even millions spent on property. So many large businesses still choose to rent from investors, as they prefer to spend their money on growing the business rather than keeping it tied up in the real estate they occupy. It’s a win-­win between tenant and landlord.

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BUSTING THE MYTHS Like any investment, there are risks in chasing returns on commercial property. But from our experience, some of these commercial risks can be blown out of all proportion, most often exaggerated by individuals who have little to zero experience in the commercial asset class. It’s probably not that different from other asset classes. For example, there are always crowds of people who are supremely confident that residential property is going to drop by 40 to 50 per cent, yet decade after decade that unlikely collapse never eventuates. Of course, the people who make these predictions are rarely property investors. That’s why you need to know the facts, and hopefully why you’re holding this book. Before taking investment advice from someone, ask them if they own any commercial properties or have any direct experience with commercial property. Nine times out of 10, you’ll find those warning you about various aspects of commercial property are not commercial investors themselves. Remember, residential investing is a very different game from commercial investing. Commercial property triggers a fear of the unknown in many people. It’s not as tangible as residential and harder to understand, which is why the myths are born. So let’s bust some of the biggest commercial myths out there.

Vacancies This is probably the main reason people won’t invest in commercial property. They assume you face a high risk of getting stuck with long vacancies, and they’re concerned about the risk of the property standing 69

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empty for a long period of time. They see vacancy signs outside commercial buildings, sometimes for months, and assume that any commercial investment will likely suffer the same fate. The truth is that vacancies can be long for poor-­quality assets but are generally shorter for high-­grade, well-­located properties. So investors need to carefully assess all relevant factors such as the quality of the building, the location, rent levels and the state of the general market around it. Getting the due diligence right will help ensure that the property won’t stay vacant for long. Never forget that properties in high-­demand, low-­supply areas will always be snapped up by tenants. If you purchase a commercial property in a poor location and the building is in disrepair, then of course the vacancy periods will be longer. It’s all about buying good-­quality properties with strong relettability potential. Another point to make is that many leases have minimum vacate notice periods in the contract. These state that the tenant must give the landlord notice of anywhere from three to 12 months before leaving the property. If you are notified by your tenant six months out, then you have six months’ rent coming in while you search for a new tenant. From our experience, tenants will often provide more than one year’s notice because their business needs more time to plan and accomplish their relocation. It’s also worth noting that the average length a commercial tenant stays in a property is around 10 years. This is a lot longer than residential length of tenure of just 17 months, according to Domain Australia. So if you factor in all the vacancies you get every 17 months in residential, I would argue there are actually more vacancies in residential. As you can see, commercial leasing is very different from residential, where tenants can just pick up and leave with a day’s notice. To reiterate, if you know what you’re doing and complete the proper due diligence ahead of time, you will have a much greater chance of reducing the risk of vacancy. The inevitability of long vacancies is a complete myth.

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Busting the myths

Only for the wealthy This is another myth we hear all the time. This is because people usually think of commercial property as commanding higher prices, which can be true, but there are thousands of exceptions to the rule. Did you know that you can find commercial properties for as little as $600 000 in capital cities? In fact, we regularly secure commercial properties around this price for our clients and will continue to do so until prices rise. Obviously, as you move into the higher price brackets you will have a lot more assets to choose from. Table 7 shows the amount of cash you would need for a $600 000 commercial purchase, assuming you could secure an 80 per cent commercial loan. As you can see, you would need only $120 000 — within the reach of most first-­time commercial investors as it’s similar to the deposit needed to buy an entry-­level residential property in our capital cities. Table 7: costings for a $600 000 commercial property 20% deposit

$120 000

Stamp duty

$22 400

Building report

$700

Solicitor’s fees

$6500

Strata report

$300

Bank valuation

$2000

Total

$151 898.40

We normally advise our clients to save upwards commercial investment, so they have a much wider from. If you don’t have this amount of money you’ll delaying the purchase for a little longer while you discuss this further in Part II.

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of $120 000 for a selection to choose get there simply by keep saving. We’ll

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Another alternative is to buy residential first, then move into commercial once you’ve built up sufficient equity. If you choose this path, you will first need to be confident of quick returns from residential property. .

Low capital growth As mentioned earlier in the book, this is one of the biggest myths ever to grace the commercial world. Capital growth for commercial property is as strong as, if not better than, residential. So many people incorrectly assume that commercial properties are no good for capital growth. While some markets remain flat, we have seen commercial properties double or even triple in value over a 10-­year period. So never assume commercial properties won’t achieve strong capital growth. The question is, how to improve your chances of buying a property that will get better growth than others? Let us explain. As in the residential market, plenty of factors can contribute to capital growth, including:

• • • • • • • • • •

good location scarcity factor infrastructure improvements population growth tightening vacancy rates strategic renovation potential loosening lending policies gentrification falling interest rates dropping unemployment figures.

Now guess what causes growth for commercial property? All the above! Of course, there is no way to predict precisely the capital growth amount of any property, as these triggers all move independently. 72

Busting the myths

Some will impact more than others at certain points in the property cycle. Just remember that, as in the residential space, the commercial market responds to these economic improvements. The one big difference is that commercial property has more of its growth attached to its rental income. So increasing or improving the lease quality will have a larger overall impact on the commercial asset value. And just like any investment, if you choose the property carefully, you’ll see growth.

Fewer value-­add opportunities We’ve also heard commercial naysayers argue that, unlike in the residential market, there are limited opportunities to create value-­add opportunities. Sure, they say, you can attract incremental growth through inflation, but you’ll gain nothing in the longer term from the property itself. Well, we wouldn’t be writing a book on commercial property if this were true. The fact is it’s completely possible to raise long-­lasting value on a commercial property if you know what to do. Unlike residential properties, where it’s all about improving the livability of a property, in commercial the numbers do all the talking. As mentioned, much of the value of a commercial property is tied to its rental income, so finding properties that are under-­rented can be the path to easy equity gains. For example, a 500-­square-­metre property renting for $100 000 per annum is valued at $200 per square metre. If the market rent is $240 per square metre, the property is under-­rented by 20 per cent. In that case, if you have a plan and the means to get the rent back up to market level, your income will be 20 per cent higher. And this could increase the value of the commercial property by 20 per cent, assuming you bought it at the correct yield from day one of course. Another value-­add is strata titling or subdividing the property. This adds value because you can sell or rent smaller sections at a higher per-­square-­ metre rate. For example, a 1000-­square-­metre warehouse might rent for $100 per square metre. But five 200-­square-­metre warehouses could potentially rent at $130 per square metre. Essentially, you are reversing 73

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the ‘economies of scale’ in your favour, and your value could increase by 30 per cent due to the higher rent per square metre. There are other value-­adds too, including renovating, lengthening leases, rezoning and developing. Just as with residential property, there are many opportunities to add value. You just have to be aware of the fundamental principles in play.

Commercial property investment carries a high level of risk (higher than residential) The higher-­risk myth is one I have found contributes to the most number of investors not choosing commercial property and defaulting to investing back into the residential markets. Even when they know the numbers are going to be much worse than commercial. Investors who see extra risk are generally those who are less educated on a topic. For example, they will combine all the myths above and see nothing but risk. Whereas I, who have invested in commercial for many years, see nothing but opportunity. I know I can make a better return in commercial property any day of the week; however, it’s due to experience and comparing the two asset classes. If you want to reduce the risk of commercial property, the easiest way to do so is getting confidence around the lease itself. The lease on a commercial property is what sets it apart from residential property and it’s also what accounts for most of the risk associated with commercial property. If you choose to purchase a commercial property and you want the lowest risk possible, I would recommend looking for assets with these types of leases and tenants:

• • •

five-­to 10-­year leases national, multinational, or highly reputable tenants or brands long-­standing tenants 74

Busting the myths

•

tenants with high-­value fit-­outs (means it’s more costly for them to move)

•

a full-­legal lease review to review existing lease conditions to ensure there are no surprises.

As with any investment, there’s always an element of risk with all types of property purchases; but, with the right education and by undertaking due diligence, you can minimise and manage your risk. If you can do this with commercial property you will reap higher rewards than the standard residential approaches.

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PART I SUMMARY Once you have reviewed our first commercial property purchase experience and explored the fundamentals of the commercial property market as outlined in Part I, you’ll start to connect the dots between theory and practice. And that’s exactly what it takes — practice. During our first few property purchases, we began to clock up thousands of hours researching and investigating potential property deals. We were starting to build some real intelligence around what it takes to become successful in this game. As you now know, there are many property types, each of them with their own levers. It can be hard to know what to buy and when, but once you get your head around the two key elements of commercial property — cash flow positive and yields — you’ll be streets ahead. We’ve busted some of the common myths. We’ve heard them so many times, but it’s only when you confront and get past these fallacies that you can start to see beyond your backyard and appreciate why we love investing in commercial property to build our wealth. To make money, you’ll need to aim for high-­grade but also high-­yielding commercial deals. But outside the numbers and details of the commercial properties themselves is another, perhaps even more important element you need to bring to the table — the right mindset. We’ll discuss this further in Part II. You’re now ready to move from theory to practice through our practical ‘8 Steps’ program. This will give you the ‘how’ when purchasing property, while also demonstrating how we ourselves work.

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PART II

THE 8 STEPS

In Part I we explored the theory and the ‘what’ of commercial property. We explained the ins and outs of the commercial property industry and shared with you our own personal journey of how we climbed that first rung of the commercial ladder, along with many lessons we’ve learned over the past decade. It wasn’t always easy, and looking back now we cringe when we recall some of the things we did —­ or didn’t do. Now it’s time to learn the practice of how to go about it. When we began building our portfolio, we soon discovered how some of the things we were doing were needlessly repetitive, following a similar path regardless of the property. We saw where our processes were duplicated and began to develop ways to systematise our approach. The more we invested, the more familiar we became with tools and techniques we could use to build our portfolio faster. This helped us fine-tune our approach. We found ourselves following a consistent pathway for every prospective property we became interested in, and subsequently when we bought it, which made our work easier and helped us determine whether the property suited our needs. Over time, we turned that pathway into a series of standardised steps and a clear process to help us buy properties faster once we were persuaded that the numbers made sense. Before long our seven eight became a crucial tool, and we began to use it with our clients too. So, without further ado, here are the 8 steps that we guarantee will help you become a successful commercial property investor: 1. Money habits. How much is enough? This is still one of the commonest questions we’re asked about property. It’s a question that’s fundamental to setting your path to success. For your initial deposit, we believe a good starting point is $100 000 for residential property and $200 000 for commercial. These amounts are based on an entry-­level $600 000 purchase price for both types of investment, though obviously the larger the deposit you can save, the more options you will have. 2. Investment mindset. It’s hard to do anything well without the right mindset. The importance of entering into any activity with the right mindset is written about endlessly, and for good reason.

Who you are as a person will influence the way you invest. Without a strong mindset, you’re going to struggle to see anything beyond your backyard. With the right mindset, you can better set goals that suit you. We are big goal-­setters at Rethink. It’s about setting the right priorities to get you where you want to be, and about setting your expectations around what you will experience when becoming a long-­term commercial property owner. 3. Assembling your expert team. When it comes to investing in commercial real estate, it is essential to have a specialised team of professionals to ensure success as the team that may have been successful in residential investing may not be suitable for commercial investing. This step outlines the team that has enabled us to invest in commercial property with greater efficiency and expertise. 4. Asset selection. There are numerous methods to identify the ideal property. Additionally, there are multiple asset classes that all respond differently depending on the current economic cycle. In the commercial real estate sector, it is essential to equip yourself with the necessary knowledge to uncover the best opportunities. By comprehending the growth drivers and other elements that affect the economy as a whole, you will be able to position yourself to acquire the most suitable property for your portfolio and objectives. 5. Method of sale. Once you’ve selected the right asset, it’s time to get to grips with the different ways to buy it. We recommend securing a property with a contract subject to finance approval and sufficient time for due diligence. This method provides the buyer with the greatest protection. It’s not the only option, though, and each has its own set of rules, all of which must be fully understood. 6. Finance. How are you going to pay for your investment property? You’ll need a bank loan, and it will require some effort on your part to come up with the information to secure the money. Luckily, you have a bunch of other financing instruments at your disposal to help you grow a larger commercial property portfolio and secure a better return on your equity.

7. The negotiations. All transactions are not equivalent. As you are the one in control, it is your responsibility to finalise the deal, so you must be ready to use your negotiating skills. Negotiations are not a battle, but rather a route to a mutual understanding. You must do your research and remove any sentiment that is usually associated with buying a home. If you collaborate with the sellers, they will collaborate with you. Negotiations are about forming a beneficial outcome for both sides. 8. Managing the property and understanding the tax. Will you manage it yourself or employ a property manager? Whether you own the property through a company, a self-­managed super fund (SMSF) or a discretionary trust, or as an individual, there are specific tax benefits that you need to be aware of. Get the ownership structure right, and you’ll become an expert in capital-­ gains tax, GST and negative gearing. Let’s kick things off by focusing on your money habits.

STEP 1

MONEY HABITS

Before you can become an investor, you must be a good saver, because without savings it’s almost impossible to do anything in property. (There are some rare exceptions to this, such as vendor finance and property options, but these are unlikely scenarios for high-­ demand assets, as vendors will always prefer to sell in the traditional way if they can.) Saving for a cash deposit is the number one barrier for many people seeking to get into the market. In Australia, the problem is exacerbated by the high price of housing. In many parts of the country it costs 10 times the average income to buy a mid-­priced house. So getting into good savings habits early on in life will give you a major advantage. Typically, the minimum cash deposit for residential real estate in Australia is 10 per cent of the purchase price. However, many people wait until they have saved 20 per cent to avoid having to pay lenders’ mortgage insurance (LMI) on top of the loan. There are also other costs such as stamp duty, solicitor costs and building or pest reports, and it’s always wise to have a contingency plan or buffer in place when buying a property. We’ll talk more about this in the next step. For now, table 8 (overleaf) shows the purchasing costs based on the national average house price in Australia in December 2022 — $708 613, according to the ABS. As this table shows, you will need to save about $182 712 to buy an average property in Australia. Given the average Australian annual income of $90 800, it can take a number of years for many income earners to break into the housing market. Luckily there are some shortcuts, which we’ll explore later in the chapter.

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Table 8: purchasing costs based on a $708 613 house House price

$708 613

Deposit (20%)

$141 722

Stamp duty

$27 289

Conveyancing

$3000

Building/pest inspections

$700

Contingency costs/buffer

$10 000

Total

$182 712

Savings strategies Before we continue, let’s look at Mina’s tips on saving, which helped us into our first property in Sutherland. It’s worth noting that these tips are not for everyone, but they worked for us and we think they’re worth sharing:

•

Set a savings goal. Set yourself a fixed-­amount target — a $100 000 deposit is our recommendation for commercial property. This will give you something to work towards. You can break it down into smaller, more achievable increments. For example, if you want to save $100 000 over three years, your goal is to put away $641 a week. If you want to create a saving target for your commercial property, we suggest $150 000 as your baseline number.

•

Save a percentage of your income. If a large-­figure goal like this doesn’t work for you, think about saving a certain percentage of your income. This percentage will vary, depending on your living expenses. For example, if you earn $1000 per week, aim to put away 20 per cent of your income or $200 per week. This amount will grow as your income grows. You could also open a savings account once you have your goals worked out. Use a dedicated online savings account to store and manage your money. Unlike with a transaction account, you can’t spend money directly from a savings account so it’s harder to dip into your savings. To grow your savings faster, look for an account with a high interest rate and no fees. 82

Money habits

•

Reduce unnecessary costs. It’s important to control your impulse spending. Focus on reducing recurring expenses as much as possible. Try to master the 30-­day rule. Waiting 30 days to decide on a purchase is an excellent way to give you a better perspective on whether you truly need it.

•

Be patient. It’s important to recognise that you’re going to need to be disciplined for a long period of time to save the equivalent of a deposit for a house. All too often people give up after six months and spend up big on a holiday because their friends are going overseas. Remember, you don’t need to ‘keep up with the Joneses’! You are denying yourself instant gratification for a more important goal — a bigger long-­term payoff for your future.

•

Pick jobs that pay well. This might not be possible for everyone, depending on your qualifications or skill sets, but it’s worth a mention. Picking a job that pays well may sound obvious, but some people choose jobs based solely on lifestyle or enjoyment. We see so many talented young people with a university education pursuing careers where their prospects and pay are below expectations. Scott would have preferred to be a ski instructor in Europe when he was 20, but he chose instead to become an engineer. Why? Because it was one of the best paying graduate roles out there.

•

Work hard from a young age. Obviously, most people who read this book will have been working for many years, but this is a good lesson to teach your kids. As we outlined in the introduction, we both worked while still at school and had many jobs before turning 20. Not only did these jobs give us a small savings base, but they also helped us to secure better paying jobs as adults. Scott remembers his engineering boss once saying, ‘I don’t really care about the school or university you went to. I liked the fact you worked at McDonald’s.’ So working from a young age can accelerate your job prospects and eventually help you save faster.

•

Make safe investments. Rather than simply leaving all of your money in the bank, try investing in reliable, long-term stocks. For instance, Scott began tracking the stock market from the age of 14. When he turned 18, he was legally allowed to own shares so 83

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he invested in companies such as Telstra, CBA, and BHP. Even though he was only investing small amounts (under $10 000), the returns were higher than the interest rates of term deposits. This allowed him to increase his savings over time, eventually leading to the purchase of his first property. So how did we save for our first deposits? We worked many jobs from a young age. Mina put every dollar she could into a savings account and never touched the money other than in an emergency. Scott disliked his engineering job, but it paid comparably well and set him up in his property career. Back then it was the only thing that got him through what felt like the wrong career choice, because he knew that something better was up ahead. So he used his salary to save as much as he could. More importantly, it helped him save quickly, which in turn enabled him to buy more properties at such a young age.

What buffers you need Once you purchase a property using most of your savings, you need to consider how much of a buffer you need to keep safe. To answer this, we need to consider individuals’ circumstances by considering all their financial obligations and income security. Since this can’t be done right now, I will leave you with some general rules for when you buy a property.

Residential property Allow for two to three months of your total rental income as your buffer. This is a baseline to cover the closes of leasing vacancies and minor repairs plus dealing with the usual outgoings like insurance, rates and land tax. If you own older properties, you also need to factor in upcoming major repairs. So in total, you need to allow for two to three months of rental income plus your next six months of major repairs. The more properties you own, the more diligent you need to be with predicting upcoming major works, as one or two of these maintenance jobs could eat into your buffer fast. For example, replacing a backyard fence, hot water system, gutters, etc. 84

Money habits

Commercial property Allow for four to six months’ rental income to cover potential vacancies. Note — as commercial property is positive cash flow, each month your buffer will grow. So you don’t necessarily need to keep building on your buffer as you would for residential. It’s worth noting that there isn’t the same need to have a buffer for outgoings or maintenance as your tenants will cover these costs. Buffers in commercial are all about being ready for a potential vacancy. If you own multi-­tenant investments or many commercial properties, your buffer can technically be lower as your exposure to a total portfolio vacancy will be much lower.

CASE STUDY A residential property To explain these numbers in more detail, first let’s break down the costs of purchasing a $495 000 residential purchase (summarised in table 9): • A 10 per cent deposit is based on a typically high lending ratio of 90 per cent for a residential loan. • Note that LMI (lenders’ mortgage insurance) will be added on to your loan for any loan over 80 per cent. • Stamp duty costs will vary between states. We have allowed for a buffer of $5000. Table 9: purchasing costs based on a $495 000 house House price 10% deposit (minimum) Stamp duty Conveyancing Building/pest inspections Contingency costs/buffer Total 85

$495 000 $49 500 $17 423 $3000 $700 $5000 $75 623

Rethink Property Investing

Here’s an example from our own experience. We purchased this property for a client in Brisbane in January 2023 for $495 000.

Fast facts • 4 bedrooms • 2 bathrooms • 2 car spaces • estimated rent of $495 per week • 5.04 per cent estimated gross yield • approximately 622 square metres • built in 2009

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Money habits

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Now let’s look at our cash flow. Table 10 shows the cash flow based on many different interest-­rate percentages and loan ratios. We also look at the impact the outgoings have on the cash flow. Residential purchases include the costs of council rates, insurance, rental management, plus landlord insurance and interest costs. Units and townhouses may have other costs such as body corporate and sinking fund expenses. Table 10: rental potential at $495 per week Price

$495 000

Property type

House

Rent

$495

Building insurance

$1211

Depreciation

$1500

Landlord insurance

$350

Capital gains

5%

Rates + water (approx.)

$2780

Rental mgt

8.8%

Repairs

$1500

Price

$495 000

Property type

Rent

$495

Building insurance

1211

Depreciation (approx.)

1200

Landlord insurance

350

10% deposit

$49 500

Capital gains

5%

Rates + water (approx.)

2780

20% deposit

$99 000

Rent mgt

8.8%

Further costs*

$35 762

House

Repairs

$1500

Pur­chase Annual Depre­- Capital price ($) rent ($) ciation gains benefit ($) ($)

Inter­ est ($)

Rent Re­ mgt pairs (8.8%)

Insurance, Cash water return bills, land ($) rates etc.

Total return including capital gains ($)

Cash buy

495 000

25 740

1200

24 750

0

2265

1500

4341

18 834

43 583.88

80 loan at 5.25%

495 000

25 740

1200

24 750

20 790

2265

1500

4341

-­1956

22 793.88

90 loan at 5.25%

495 000

25 740

1200

24 750

23 389

2265

1500

4341

-­4555

20 195.13

100 loan at 5.25%

495 000

25 740

1200

24 750

25 988

2265

1500

4341

-­7154

17 596.38

105 loan at 5.25%

495 000

25 740

1200

24 750

27 287

2265

1500

4341

-­8453

16 297.01

80 loan at 5.50%

495 000

25 740

1200

24 750

21 780

2265

1500

4341

-­2946

21 803.88

90 loan at 5.50%

495 000

25 740

1200

24 750

24 503

2265

1500

4341

-­5669

19 081.38

100 loan at 5.50%

495 000

25 740

1200

24 750

27 225

2265

1500

4341

-­8391

16 358.88

105 loan at 5.50%

495 000

25 740

1200

24 750

28 586

2265

1500

4341

-­9752

14 997.63

88

Money habits

80 loan at 5.75%

495 000

25 740

1200

24 750

22 770

2265

1500

4341

-­3936

20 813.88

90 loan at 5.75%

495 000

25 740

1200

24 750

25 616

2265

1500

4341

-­6782

17 967.63

100 loan at 5.75%

495 000

25 740

1200

24 750

28 463

2265

1500

4341

-­9629

15 121.38

105 loan at 5.75%

495 000

25 740

1200

24 750

29 886

2265

1500

4341

-­11 052

13 698.26

80 loan at 6.00%

495 000

25 740

1200

24 750

23 760

2265

1500

4341

-­4926

19 823.88

90 loan at 6.00%

495 000

25 740

1200

24 750

26 730

2265

1500

4341

-­7896

16 853.88

100 loan at 6.00%

495 000

25 740

1200

24 750

29 700

2265

1500

4341

-­10 866 13 883.88

105 Loan at 6.00%

495 000

25 740

1200

24 750

31 185

2265

1500

4341

-­12 351

12 398.88

CASE STUDY A commercial property Now let’s look at entry level commercial property for comparison. This investment uses a similar deposit amount as the previously mentioned residential property. As we’ve outlined, the deposit tends to be larger in commercial transactions. Commercial property generally needs a deposit of 20 to 35 per cent, depending on the type of property you are buying (among other factors). Table  11 (overleaf) shows the total numbers on a $308 000 commercial purchase: • 30 per cent deposit • 70 per cent LVR • stamp duty costs  — will vary between states You will see that we have allowed a buffer of $10 000, twice that for the residential property, to cover the worst-­case possibility of longer vacancies.

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Table 11: costings for a 70% LVR on a $308 000 commercial purchase Commercial property price

$308 000

30% deposit

92 400

Stamp duty

10 000

Conveyancing

2000

Building/pest inspections

600

Contingency costs/buffer

10 000

Total

$125 780

Here’s an example of a recent commercial property we helped one of our clients to purchase (see table 12). Table 12: commercial rental potential Price

$308 000

Rent

$22 464

Depreciation

$5000

Rental mgt

5%

(net of outgoings)

Fast facts • Style: industrial warehouse • Location: Brisbane • Price paid: $308 000 • Rental income: $22 464 p.a. + tenant pays 100 per cent of outgoings • Lease: 3 years + 3-­year option • Rental increase p.a.: 4 per cent • Other: purchased off-­market roughly $35 000 below the market value of others selling in the same complex.

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Now, if you compare the figures in our commercial cash flow table, you can see that the numbers stack up much more favourably for a similar deposit invested in commercial compared to residential property. On an 80 per cent loan, the residential property in the first example is going to give you a negative income of $1957 per annum. For a similar cash deposit, invested on 70 per cent loan this time, the commercial property will produce an annual passive income of roughly $15 022 (see table 13, overleaf). Which is considerably better cash flow! And there are other benefits, for example, the tenant pays 100 per cent of the outgoings, which means no nasty unanticipated maintenance bills, not that much would ever go wrong with a concrete built warehouse, and a comfortable three-year lease. For years, investors have asked me whether it is necessary to begin investing in residential real estate prior to commercial real estate. The response is not a definitive yes or no. As one can observe, the cash flow from an entry-level commercial property is significantly higher than that of a residential property, but residential real estate offers more advantageous leveraging opportunities and requires less capital. Therefore, I often advise my investors to start with residential. However, if they have access to larger down payments, commercial real estate can be a great starting point, with the assistance of a professional.

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Table 13: rental potential Price

$308 000

Net Rent (pw)

$432

Depreciation

$5000

Capital Gains

5%

Rent Mgt

5% Annual Rent

30% Deposit =

$92 400.00

Further Costs* =

$33 380.00

30% Deposit =

$125 780.00

Depre­- Capital Inter­est Rent Re­ Insurance/ Cash ciation Gains Mgt pairs Water Return Benefit (5%) Bills/Land Rates/etc

Cash Buy

$308 000 $22 464

$5000

$15 400

70 loan @ 5.25%

$308 000 $22 464

$5000

$15 400

80 loan @5.25%

$0

Total Return Including Capital Gains

$1123

$0

$0

$26 341

$41 740.80

$11 319 $1123

$0

$0

$15 022 $30 421.80

$308 000 $22 464

$5000

$15 400 $12 936 $1123

$0

$0

$13 405 $28 804.80

100 loan @5.25% $308 000 $22 464

$5000

$15 400 $16 170 $1123

$0

$0

$10 171

$25 570.80

105 Loan @5.25% $308 000 $22 464

$5000

$15 400 $16 979 $1123

$0

$0

$9362

$24 762.30

70 loan @ 5.5%

$308 000 $22 464

$5000

$15 400 $11 858 $1123

$0

$0

$14 483 $29 882.80

80 loan @5.5%

$308 000 $22 464

$5000

$15 400 $13 552 $1123

$0

$0

$12 789 $28 188.80

100 loan @5.5%

$308 000 $22 464

$5000

$15 400 $16 940 $1123

$0

$0

$9401

$24 800.80

105 Loan @5.5%

$308 000 $22 464

$5000

$15 400 $17 787 $1123

$0

$0

$8554

$23 953.80

70 loan @ 5.75%

$308 000 $22 464

$5000

$15 400 $12 397 $1123

$0

$0

$13 944 $29 343.80

80 loan @5.75%

$308 000 $22 464

$5000

$15 400 $14 168 $1123

$0

$0

$12 173

$27 572.80

100 loan @5.75%

$308 000 $22 464

$5000

$15 400 $17 710 $1123

$0

$0

$8631

$24 030.80

105 Loan @5.75% $308 000 $22 464

$5000

$15 400 $18 596 $1123

$0

$0

$7745

$23 145.30

70 loan @ 6%

$308 000 $22 464

$5000

$15 400 $12 936 $1123

$0

$0

$13 405 $28 804.80

80 loan @ 6%

$308 000 $22 464

$5000

$15 400 $14 784 $1123

$0

$0

$11 557

$26 956.80

100 loan @6%

$308 000 $22 464

$5000

$15 400 $18 480 $1123

$0

$0

$7861

$23 260.80

105 Loan @6%

$308 000 $22 464

$5000

$15 400 $19 404 $1123

$0

$0

$6937

$22 336.80

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What can we learn from this? You need more savings to successfully invest in commercial property because of the lower lending ratios offered by commercial loans. Remember, though, that most residential investors wouldn’t want a 90 per cent loan on a property just to avoid the LMI costs. So if you factor that in, the required savings amounts are almost the same for commercial versus residential. Something else to consider is that, like many looking to move into commercial investing, you probably already own a property — your own home — and you can use the equity in your home as a springboard into investment property at sometimes much higher price points. In fact, about half our clients are homeowners using equity out of their principal place of residence. Depending on their equity levels, they can consider commercial properties at much higher price points. Just one or two such purchases can create significant passive incomes, essentially fast-­tracking their retirement. Here are a few other tips and tricks you have up your sleeve if you want to buy while putting less money down:

•

Using a higher LVR. It is possible to borrow up to 95 per cent of a property’s value. But it does trigger extra LMI costs, so you need to be careful. Generally, the higher the lending ratio the greater the perceived risk. The cash flow from your property will be weaker due to the extra repayments you must make to the bank to cover the higher interest costs. The 95 per cent loans are not available in commercial lending, but as mentioned it is possible to borrow 100 per cent of the property’s value if you are drawing the deposit and subsequent loan from another asset, such as your home equity. (Side note: in recent times, as the RBA raised interest rates, the more highly leveraged residential investors fared worse; hence there were greater price falls across 2022. Commercial investors are on average much lower leveraged, so when the market goes down, you will find stock levels go down with it, because commercial owners prefer to hold on to their properties rather than sell in a weaker market. So having lower LVRs can make the

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commercial market less volatile, as commercial investors are less likely to sell at a time that doesn’t suit them due to better cash flow and LVR positions)

•

Joint ventures (JV). You may consider attracting a partner to sponsor the upfront costs of the purchase, then splitting the proceeds. Most important in any JV is total trust between partners. You also need to make sure all partners are on the same page. Of course, the catch is you’ll end up with only half the proceeds of the deal. There are two types of partners in a typical JV — equity partners and finance partners. Equity partners pay the deposit and buying costs, while the finance partner gets the loan from the bank.

•

Buying off-­the-­plan. You may choose to buy a property before it’s built and, provided it increases in value by the time it is constructed, you can borrow against the new value to fund your deposit. However, buying property off-­the-­plan is highly risky, so be careful. Yes, it can be a clever way to purchase with little funding, but it only works when purchased at a good price and in a growing market. The development also needs to have a long lead time. For example, buying commercial off-the-plan can be a good strategy to consider when you’re buying industrial strata property. For example, the property might be ready in six months’ time. So that gives you six months of extra savings time to get ready for the purchase.

•

Option agreements. This one isn’t so great for first-­home buyers, as it involves a higher level of skill and sophistication. The idea is to find a vendor who will agree to an option agreement by which you have the right — but not the obligation — to buy their property. The aim of many option agreements is to push settlement long into the future. As the potential buyer, you will look for ways to increase the value of the property and on-­sell it for a profit. But it’s not easy. Not many vendors are willing to enter into this type of arrangement, in which they must be prepared to delay settlement, sometimes by years, while you enjoy the capital growth and benefits, and whatever value you can add to it. Such agreements are more common in weak markets with distressed sellers.

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YOUR TAKEAWAYS Having additional savings significantly influenced our attitude; without the security of our savings, we would have been less likely to take the risks we did. We felt secure in the knowledge that if something went wrong, we had our savings to rely on. We could still cover our daily expenses and we could recover and reinvest without drastically reducing our current lifestyle. This outlook certainly provided us with the opportunity to think beyond our immediate environment and to approach things differently.

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INVESTMENT MINDSET It’s hard to go the distance with building a decent size property portfolio without the right mindset. An important part of this is understanding who you are as a person, because this will ultimately impact the way you invest. As we’ve stressed, this book isn’t about knuckling down and saving for a home and being ‘comfortable’. It’s about making your money work for you as effectively as possible, and over long periods of time. This can only be done by taking educated risks and getting uncomfortable, which can lead you to pursue your investment goals in a bold but informed way. Our own goals as property investors were never complicated and could be summed up as:

• • • • • • • •

following the numbers, not being emotional investors being efficient with time not following the crowd spending more time with family having the ability to travel overseas as often as we like living comfortably in a home we love having the flexibility to work when and where we want. simply being happy

Whether investing in commercial or residential properties, keeping these goals front and centre has ensured that we remain focused and on track.

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We switched to commercial property investing because we wanted to diversify our portfolio by putting some of our eggs in a different basket, instead of focusing purely on residential properties. Commercial property addressed our goals much more directly and quickly, and we also looking for new challenges by pushing the boundaries. Residential is perceived as a safe way to get into investing, but we found there were more pros than cons to investing in commercial property. We were first attracted to commercial investing for the following main reasons:

•

The tenancy agreements are most often three to five years, where residential terms are generally three, six or twelve months.

•

Business owners are generally easier to deal with than residential tenants.

• • •

All outgoings are paid by the tenant. Less touch points compared to residential properties. Better income/returns.

Confident of these benefits, we anticipated ‘easier management with fewer touch points’. This was important because at the time we were working very hard keeping on top of our residential properties. And the bigger our portfolio grew, the more we seemed to be moving away from the goal of ‘buying back our time’. Moving to commercial early on was a hard switch, as we had nowhere near as much knowledge of the topic. But as an asset class, it felt so much more in tune with our goals of getting better results from high-­quality properties with business tenants. Looking back at this moment shows us it was one of the best moves we ever made with investing. There were no shortcuts to our success in this asset class. We learned simply by putting thousands of hours into searching, teaching ourselves, and eventually buying and managing our investments ourselves. However, at many points in our journey we had our own doubts. Especially when our experience in the asset class was still in its infancy. Our investment mindset got us through the bad days, such as a tenant leaving or dealing with a large capital expense item we needed to work through. 98

Investment mindset

This next section delves into the mindsets we believe helped us through the ups and downs of our journey.

The fear mindset Once you know what drives you, you will be able to make decisions with the right mindset. Because, as already noted, being in the right mindset when approaching property, whether it’s commercial or residential, is the key to good investing. When it comes to choosing between residential and commercial property, a lot of people fear what they don’t know. People know more about residential property, less about commercial investing. Fear blocks us from doing many things. For evidence of that you need look no further than the sheer number of investors in residential as opposed to commercial. Relatively, there aren’t that many in our neck of the woods! Which seems crazy to us when the returns are superior for commercial property. This fear of the unknown is the reason why commercial property has better returns and less competition! If you’re really determined to achieve your goals, which we’re guessing is why you picked up this book, you must get past the fear of exploring the unknown. The best way to fix that fear mindset is through education.

Opportunistic mindset Year after year we see articles in the mainstream media telling to us how the property market is going to crash, that people are losing money, that the world is ending, and so on. For us, these articles represent an opportunity to get a better deal. Many inexperienced investors try to find excuses to justify that it is a poor time to invest. They then sit on the sidelines for long periods of time, waiting for that elusive bottom of the market. But the truth is there will never be a perfect time to invest as, if there was, everyone would know it and premium prices would be paid. Inexperienced investors 99

Rethink Property Investing

prefer the media to influence their investment decisions rather than their own research. This really ties into their own lack of understanding of the market and the media’s role in trying to get article engagement. In contrast, the most experienced investors generally look to double down on their investing in weaker markets. This is simply because they can negotiate a better deal and hold for the long term. This is the opportunistic mindset which is something we have always taken advantage of. For example, look at some of the years when we purchased properties:

•

2010. We purchased a house in Sydney when the media wrongly claimed the market would crash by 40 per cent. Instead, prices tracked sideways for around 12 months before a strong growth phase in Sydney.

•

2018. We purchased our largest property at the time: a family home. This was the same year the media incorrectly predicted a property crash of 30-­40 per cent due to APRA lending changes and the ‘interest-­only cliff’. Instead, Sydney recorded 5 per cent price gains over the October 2019 quarter, the biggest property price increases in a decade.

•

2020. We refinanced many of our properties which put us in a position to purchase multiple larger assets in 2021. At the time, the media were quoting 20-­30 per cent crashes, but instead the prices increased 20 per cent in the 12-­18 months that followed.

As you can see, if you listen to the media and let the fear override your opportunistic mindset, it could make an immeasurable wealth difference to you in the long run.

Rolling with the punches mindset Another point to consider is how you handle it when things turn sour. Because let’s be honest, over time you will have to deal with problems, such as losing a tenant at a bad time or copping a large unanticipated maintenance bill. These issues are part of property ownership and you must have a plan of how to handle them. 100

Investment mindset

Vacancies can be challenging, and we have had our fair share, but you have to stay positive and work out solutions. Remind yourself, ‘Well hang on, I’ve made my money back already via growth,’ or why not take advantage of the vacancy by doing minor fix-­ups and renting it for more? In other words, you need to be able to roll with the punches. Property can generate amazing long-­term wealth, but some people expect results without hiccups. Investors must be ready for some adverse events or they can become pretty discouraged. You need to be prepared for:

• • • • • • • •

unexpected maintenance bills tenants trying to exit a current lease long vacancies market downturns poor rental managers complaints from tenants or neighbours roof leaks interest rates rising.

Some of these events can come as a big shock if you’re new to investing. But we’ve developed a trick over the years to help put things in perspective. It involves looking at the total return on investment, which helps put the day-­to-­day problems in context:

•

Work out the cost of the issue. For example, if the air conditioner blew up and needs replacing, it might cost you $10 000.

•

Work out how much money you could make from the investment over a 10-­year period. For example, a $1 000 000 property with 6 per cent compounding growth per annum for 10 years will equate to $689 479. It’s always good to remind yourself of your long-­term results or projections when you have a bad day with expensive items. Adopt this perspective, and suddenly that $10 000 seems inconsequential (especially when you can claim it as a tax deduction).

•

Remember that the long-­term leases often outweigh the vacancies. For example, if you have a 6-­month vacancy with a commercial 101

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property, it might be the only vacancy you have for the next 10-­15 years as most commercial tenants are long-­term tenants. In the middle of one of these longer vacancy periods it is stressful as you feel like your finances are going backwards. However, it’s important to remember that once you fill the vacancy the capital value of your commercial property will likely go up as new, fresh, longer leases will be valued higher in the market. If you have the mindset that recognises sometimes things go wrong, and that you just have to roll with the punches without the punches getting the better of you, then congratulations, you’re already a true investor! Part of the mindset is recognising the importance of removing all emotion when investing in the commercial market. You must have the stamina and the stomach to be an investor, because it is a never-­ending rollercoaster with new surprises around every corner. And —­ surprise! Not everyone is cut out for it. For some, fear or frustration overwhelms them, and that’s understandable. When we invest, we take the plunge only once we’re satisfied with all our calculations. We do our research and our checks to ensure we enter into the negotiations with a clear mind, knowing it’s the right choice. We know that with any property there will be highs and lows, and we ride the wave. And we encourage all our clients to adopt a similar mindset.

Profit mindset —­ short and long term As we’ve mentioned, this type of investing is for those who don’t want to sit on their negative or neutrally geared assets while hoping for growth over the long term. For us that model was too slow, nor was never going to produce a worthwhile passive income for our retirement. We’re guessing you’re reading this book because you’re the type of investor who wants faster results and you’re not afraid of plunging into something new to achieve them. When it comes to property, it’s important to see beyond what everyone else sees. We’re not here to purchase the ‘prettiest’ property to make us feel happy and nice, we’re here to make money from our investments. 102

Investment mindset

Time and time again, we’ve found that the surest path to success is to plan to make money in both the short and the long term. It sounds incredibly basic, but I promise you a large percentage investors don’t think about exactly how they can profit at both levels. They buy for different reasons —­ having ‘a good feeling’ about the area or because the house presents well, or for some other arbitrary reason. Residential investors also often conclude that’s it’s okay to spend years losing vast amounts of cash flow from negative gearing before turning an income profit. We like to challenge this notion. Rather than relying on such thinking we recommend you follow our tried and tested procedure on profit goal setting —­ a three-­year view for profit and a 10-­year-­plus view for long-­term wealth.

Three-­year view for profit When we invest in property, it’s for the long term. However, we also plan to profit in the short term in what we call the three-­year window from purchase. For example, there is no point buying into a property market that will decline for the next three years, or if you will be losing cash flow year after year. It’s important to gain profit in this time frame if you plan to go onto subsequent purchases. There are many ways to do this, but at a high level you need to gain profit in both capital growth and net-­positive cash flow in this initial three-­year period. If you can do this, you will be ahead of most investors. In terms of profit via cash flow. Take this recent example of a commercial property we helped one of our clients purchase in Queensland. Note, this shows a property income over three years with an annual rental increase of 4 per cent per annum. Purchase price: $2 200 000 (net yield: 6.86 per cent).

•

3-­year cash flow profits:


–


3-­year net income before mortgage costs: $471 361.59 ($157 120.53 per annum average)


–


3-­year cost to hold: 70 per cent finance at 5.25 per cent interest $230 990.91 ($76 996.97 per annum average)



–

3-­year cashflow profit: $240 370.68 ($80 123.56 per annum average) 103

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•

3-­year capital growth profits


–


Factoring in capital growth, this $2 200 000 purchase will be worth $2 379 520.00 ($179 520 more based on the 4 per cent per annum growth in rent over the three year period).

• •

3-­year total profits

•

As this $2 200 000 property could be purchased using a 30 per cent deposit plus costs totalling $802.365, this represents more than a 50 per cent cash-­on-­cash return in just three years (see table 14). Not bad considering we only considered a 4 per cent capital growth rate!

$419 890 which more than half of the profits coming from the month-­to-­month free cash flow.

Table 14: three year profit on a $2 200 000.00 purchase Commercial purchase price

$2 200 000.00

Deposit (30%)

$660 000.00

Stamp duty

$115 365.10

Valuation

$4000.00

Solicitor costs

$8000.00

Other purchasing costs

$15 000.00

Total cash required

$802 365.10

Year 1 net rental income

$151 000.00

Yearly review

4%

Term of ownership

3 years

Loan interest rate

5.25%

Debt reduction (1=true, 0=false)

1

% of profit used for debt reduction

100

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Investment mindset

Year 0

Year 1

Year 2

Average

Rent received

$151 000.00

$157 040.00

$163 321.60

$157 120.53

Yearly yield

6.86%

7.14%

7.42%

7.14%

Interest paid

$80 850.00

$77 167.13

$72 973.80

$76 996.97

Cash flow (rent less interest)

$70 150.00

$79 872.88

$90 347.8

$80 123.56

Comparing apples with apples, imagine you purchase a house or unit for the same money at a cost of $20 000 per annum to hold (this is a typical Sydney or Melbourne house), that would mean there is a $60 000 negative cash flow position in just three years, putting the two assets almost $300 000 apart in a cash flow profit sense. So unless the residential property grows by more than $300 000 in just three years and the commercial property doesn’t grow at all, then the commercial investment will bring greater profits. Let this sink in and you will start to see how you can make considerably more money out of commercial investing. Many investors who negatively gear look only for a tax benefit in the short term, while hoping the property will grow in the long run. This lowers their chances of making a short-­term profit because the returns are much reduced once they take account of their negative cash flow. Or they might overpay for a property just to get into the market. So how can you plan to make money by adopting the three-­year view for profit? You may purchase a property under market value, achieve exceptional cash flow or purchase into a market that is rising in value quickly. In each case, your goal is to make money in the short term. And all three of these methods can be applied to commercial property.

10-­year-­plus view for long-­term wealth On the other hand, some investors concentrate only on short-­term results. For example, to buy a property with the goal of flipping it for a quick profit, especially when you take into account the major costs of buying the

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property (stamp duty) and of selling it (sales agent fees plus capital gains tax). You might also end up selling too early. Focusing on trying to make money only in the short term adds a great deal of risk to the process, which can impact their long-­term investment return results. Smart investors in Australia look to hold their investments for at least 10 years, because in a country with an economic track record as strong as Australia’s, it makes sense to hold property for the long term. It’s also important to purchase in a market with a good long-­term growth forecast. For example, we’ve never been fans of mining towns or other markets that can quickly go from boom to bust. These types of markets are too difficult to predict over a 10-­year-­plus period. We do, however, like strong regional markets, especially since more people have moved to the regions since COVID-­19. It’s important to see a consistent pattern of population growth to feel confident in the 10-­year investment window. Adopting a 10-­ year-­ plus view for long-­ term wealth could include purchasing quality assets in built-­out capital city suburbs where supply is limited and tenant demand is high. Or purchasing a property with a good-­ quality land component, because this land will appreciate over time and may lead to long-­term development upsides. Again, all these elements can be found in commercial property, with the bonus of high cash flow, which makes holding such investments for long periods a whole lot more fun. Be sure not to chase all-­out yield and neglect the fundamentals. As illustrated in table 5 (see page 59), having an initial higher yield in a lower growth market can actually result in less cash-­flow over a 10-­year period. It’s important to have a good yield but also strong capital growth prospects.

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YOUR TAKEAWAYS Property investors are a special breed of people. They are optimistic yet calculated in their decisions. If you are the type that sees risk as the driving emotion when you invest, the key is to get educated. The more you learn, the less risk you will see. If you have a bad day with your property, remember that there is always a solution, and you are working towards a greater long-­term goal. Keep this in mind to avoid making a bad short-­term decision, such as selling simply because your tenant causes a problem for you. The goal is to make money from your investment ventures. This needs to happen within three years (short term) as well as 10+ years (long term). You need both good cash flow and growth to achieve this.

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STEP 3

ASSEMBLING YOUR EXPERT TEAM Do you think of property investing as something you can handle yourself, or as better left to professionals? We think of it as a trade. Ask yourself this: Would you install an air-­conditioning system yourself to save paying contractors, at the risk of your own time and a potential disaster? Or would you just hire professionals to complete the job? Of course, you wouldn’t unless you had years of experience in that field. This is the same for designing a web page, doing your tax return or getting your car serviced. You turn to someone who knows their stuff really well. Sometimes, even if you are a highly experienced investor, consulting an expert will bring a new dimension to your decision making. Yet, strangely, in Australia so many inexperienced investors choose to trust themselves with their investments. This occurs in both share trading and property investing and this ‘can do’ attitude often results in years of poor investment returns. There’s sure to be factors you’ll miss if you try to invest in a new asset class yourself, because there are a lot of moving parts. For example, working in various states can be tricky, and you need to find experts who understand the different legal jurisdictions, because cooling-­off periods and other regulations can vary from state to state. On the other hand, a professional who understands the complexities of investing inside out can do the groundwork for you. You’re paying for their expertise and experience. We seek advice only from people who know more than us and have already achieved what we want to achieve. Finding your expert team requires lots of research. Use your professional networks and word of mouth. It may be a bit hit and miss, as we have

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experienced over the years, but the more exposure you open yourself up to, and the more you are willing to get involved in the industry, the more people you will meet. But you must be willing to dedicate time to start building your network. Your team members must be organised and pay attention to detail. They need to act fast and never delay a process. A property sale doesn’t wait around for someone to finish their dinner! You have to move fast for a good deal. The right team understands that the process of investing (the way we do it) is critical to our success. Surrounding yourself with experienced players who understand the investing process and the reasons why you are investing is also a must. Let’s meet the most important people on your team.

Mortgage broker A broker understands the lending process and how to maximise your borrowing capacity as your portfolio grows. They shop around many providers in order to offer you:

• • • • •

the best deal with the lowest fees on accounts the lowest interest rate the longest loan terms to help extend your serviceability sound advice on what will best fit your borrowing needs. a comparison of up to 40 different banks for the best of the above items.

Brokers are paid by the banks when you settle successfully. If you stay with that bank, they also receive a trailing commission over time, so it’s important to choose a broker you trust. Many will keep you with the same bank, even if there are better deals out there, because it saves them time  —­  and they can get extremely busy. So it’s very important to have a good relationship with your broker, which means you can call them up and have them regularly review your loans. Shopping around every 12 or 24 months will often pay off in gaining you a better deal on your loans. Brokers who 110

Assembling your expert team

are keepers do what is needed to accommodate all the changes required to refinance with the banks, even if it means losing their commission. It’s important to note that if you go down the commercial property route, you will need an expert commercial broker. For years we have worked with residential brokers who are also part-­ time commercial lenders. However, these part-­timers simply can’t move at the same speed, nor do they have the connections to get the best commercial lending deals in the market. As a result, we suggest always working with a full-­time specialist commercial broker.

Buyer’s agent A buyer’s agent can make the biggest difference as they can deliver investment-­ grade properties you would have never before seen or considered. The main benefits of a buyer’s agent include:

• • • • • •

Identify the best markets and asset classes to invest in. Source properties on and off market. Negotiate the best possible deal. Complete all the due diligence on the property. Help you walk away from a bad deal. Provide 100 per cent commitment to you as the buyer.

Similar to a mortgage broker, it’s important to work with a commercial buyer’s agent who specialises in selling commercial property. There are many residential buyer’s agents who say they do commercial property yet they rarely dabble on this side of the fence. A full-­time commercial buyer’s agent will have access to far more quality off-­market deals. If they are not sufficiently experienced, though, they can also get it horribly wrong. A commercial buyer’s agent knows and understands the market in depth and will deploy this understanding on your behalf. With many years of investment experience across multiple property cycles, a good agent can guide you towards the outcomes they have achieved for themselves. 111

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It is therefore vital to choose an agent who is already in a position you aspire to be in. It’s also important that they follow the investment strategy that works best for you and the current economy. There’s no point in working with a buyer’s agent whose strategies aren’t aligned with your appetite for risk or who promotes dated strategies that worked 20 years ago, such as negative gearing. Your buyer’s agent will provide you with strategic advice and source the properties for you. The cost of using a buyer’s agent ranges widely. Generally, they are paid at settlement (although companies vary and some expect to be paid before settlement). The price will depend on the property bought. Some are fixed and others are based on a percentage. Some charge a sign-­up fee and some expect one lump sum. Sign-­up fees can range from $1000 to $5000, and the commission can range from $12 000 to $18 000. For larger value purchases, percentage charges are more common than fixed amounts. A percentage rate can range between 1.5 and 3.5 per cent.

Property manager Once you’ve reached settlement, you need to make sure you have a good property manager who understands that this is an investment, so doesn’t waste money on things that don’t align with the bigger picture. There’s nothing worse than a neglectful agent who fails to do the right thing, especially when the investment is in a different state from where you live. It’s important to work with property managers that are experts in the investment class you have invested in. For example, if you own an industrial property, you need a property manager who specialises in leasing and managing industrial assets in the local area where your property is located. Property managers take a monthly commission according to the number of tenancies they manage. The rates vary between different cities. Table 15 gives you a rough idea of the different fees for rental management that apply in each state. 112

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Table 15: rental management fee comparisons Residential(%)

Commercial1(%)

Sydney

4–6

2–5.5

Melbourne

5–7

4–6

Brisbane

7–8.8

3–6

Perth

7–10

5–9

Canberra

6–8

4–6

Adelaide

7–9

5–7

Hobart

7–11

5–8

Darwin

6–9

5–8

 Depending on your lease agreement, you may be able to on-­charge the cost of rental management back to the commercial tenant.

a

Accountant Before making an offer to buy a property, obtain advice from a property tax expert (such as an accountant) about the best structure to use for your offer. The popular tax structures available for property investors are:

• • • • • •

individually in your name jointly with a partner or spouse joint venture (JV) family discretionary trust unit trust self-­managed super fund (SMSF).

Most people have their own trusted accountant they’ve used for years, but it’s important to use an accountant who is an expert in property tax. If you use a non-­specialist, you may end up purchasing the property under the

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wrong structure, which could cost you tens or even hundreds of thousands of dollars in the long run. All the above structures have different tax implications that must be properly taken account of. Only an accountant who understands your long-­term property investment strategy will be able to provide the best advice for you. All too often we see accountants advising investors to purchase negatively geared property. As we have noted, this can be a big mistake. Focusing purely on saving some tax is the opposite of setting up a self-­sustaining positive cash flow property portfolio. So if your accountant is not on board with your long-­term investment strategy, it might be time to look for a new one. We are pleased to report, though, that nowhere near as many accountants push clients towards the negative gearing model these days compared to 10 years ago. We like using accountants who are also property investors because they understand the wealth-­creation mindset, not just the tax-­ saving mindset. Accountants charge an annual fee that depends on a few factors, such as how much the company charges, how many properties and loans you have, and whether they also manage your super. Their services can range between $300 and more than $5000. It really depends on the complexity of your personal and business finances.

Solicitor/conveyancer Solicitors need to be quick-­thinking, detail-­oriented professionals who can add value to your due diligence process when transacting on a property. We like using solicitors who have been in the game for a while. The more experience they have, the better they can manoeuvre around problems that crop up during the purchase process. Solicitors need to be tough, but still be able to make smart commercial decisions rather than putting up unnecessary road blocks to a negotiation.

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We have seen many solicitors representing either the buyer or the seller get too demanding. This can cause conflict and make the transaction more difficult. Remember, we are just trying to purchase a property. It’s not a litigation process. Time and time again we have seen this happen, and it can actually hinder the negotiations if one side of the transaction starts to get frustrated or aggressive. When everyone works together amicably there is more flexibility for buyers. For commercial purchases, we recommend that you use a qualified solicitor rather than just a conveyancer. This is because if you ever need to chase something up legally, you have an experienced solicitor ready to stand up for your rights. Their costs will be anywhere from $1500 to $4500, and higher value commercial properties will attract higher fees. It’s good practice to ask your solicitor for an estimate of the conveyancing transaction costs, so you know the total cost. Why are lawyer’s fees for reviewing leases so varied? In short, you get what you pay for. If you are price conscious, your decisions are unfortunately limited by what you can afford. However, if you are not price conscious, is it really worth taking a short cut of $1500 or $2000, only to find out that your make-­good clause has cost you $50 000 more than it should have at the end of your lease? Understanding the factors that contribute to the variances in pricing can help you make informed decisions when choosing the right legal representation for your needs. Some of the key factors include the experience and expertise of the lawyer, the complexity and length of the lease, and the urgency of the matter. Additionally, some firms may offer bundled services or different pricing structures, so it’s important to carefully review all the options before making a decision. A final word of advice: don’t always go with the cheapest. It may all look similar, but the devil is in the detail. Whether you’re a tenant or a landlord, finding the right legal support is crucial, so make sure to do your research and choose wisely.

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Insurance Broker In addition the contacts above, it is essential to have an insurance broker as part of your team when embarking on your journey as an investor. In most cases when I carry out due diligence on properties, I find that the owners current insurance policies are generally not accurately covering the owner. For example, the property might be under-­insured with the building valued at far less than the actual replacement value, or they might not have the current tenant activities updated with the insurance companies. This would put the owner in a high-­risk situation if something ever went wrong. Ideally, you want to find a broker who is an expert within the commercial property space. An experienced broker will have an understanding of the risks that different types of commercial property are exposed to, and how to best insure them. A quality insurance broker will:

•

conduct a thorough analysis to establish the most suitable structure for appropriate coverage of your asset

•

gain an understanding of the tenancies and their business activities and advise how to minimise your risk exposure as a landlord

•

contact a panel of leading insurance companies and underwriting agencies to negotiate favourable terms on your behalf

•

work in conjunction with your finance broker, accountant and buyer’s agent to maximise efficiency during the settlement process

•

conduct annual reviews to ensure the details of the property remain up to date and are accurately reflected in your coverage

•

perform an annual remarket (where applicable) of your asset to ensure you are getting the most competitive terms

•

submit and manage any insurance claims on your behalf, as well as insurance surveys and reports.

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At a minimum, you want your property insurances to provide the following cover:

•

Damage to your physical property from events such as fire, storm, cyclone, etc.

•

Loss of rental income in the event your property is damaged and your tenant is unable to trade from the premises.

•

Liability in the event of personal injury to tenants or visitors while on your property.

Additional coverage to consider for your asset include:

•

Machinery breakdown: Cover for the financial loss incurred from the breakdown of your machinery, such as air-­conditioner units, generators and elevators, to name a few.

•

Flood cover: the covering of normally dry land by water that has escaped or been released from the normal confines of a natural water course, think 2011 Brisbane floods. It is important not to confuse flood with storm damage, which covers damage as the result of a storm.

YOUR TAKEAWAYS It’s easier and wiser to outsource to people who know their stuff. But you should still do the legwork, so you understand fully what’s happening within your portfolio. Imagine managing tax time for 30-­ odd properties and even more tenancies! If you don’t know everything that’s going on, it’s going to be hard to move forward, especially if things go pear-­shaped. Like any business or investment venture, a good team around you helps manage this risk. Don’t be afraid to move on from your long-­term accountant or mortgage broker if you think another more experienced operator will help you reach a higher level. Remember, you might outgrow your previous contacts, so it’s important to keep moving with experts who will continually add value.

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STEP 4

ASSET SELECTION

Let’s recap where we’re at on your property journey. You have your deposit, and you have developed good money habits, including a buffer to cater for unanticipated costs that often crop up. You have sharpened your investment mindset and developed the right strategy and headspace so you dedicate the time needed to wheel and deal in the commercial property market. You are now ready to take the next step — choosing the right property. At this point, your priority is to understand the market, because as with any investment, success is all about buying the right type of asset at the right time and price. Luckily, you have a mountain of great resources at your disposal. Scan the newspapers for economic news, read investment magazines and the paper’s property sections so you get to know what’s happening in the market. If you’re developing a passion for property, chances are you are already doing this, but we can’t emphasise enough how important it is to do your research and get to know the market well before you do anything further. Of course, this is easier said than done. The amount of information available can seem overwhelming. But you need to understand the whole picture so you can work out what drives the market. There is one side note: it’s much more important to buy the best-­quality investment, rather than trying to time the market and buying an average investment. It’s worth noting that most of the properties advertised on the web won’t stack up once you have carried out all your due diligence. It takes time, energy and dedication to pick out the good opportunities and the right commercial investments. For example, at Rethink Investing we review and reject about 40 properties for every single one we present to our clients. To help you understand the market better, we recommend breaking down your research into smaller chunks. 119

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Macroeconomics — the big picture Macroeconomics is concerned with the broader aspects of national, regional or global markets and economic projections. When sourcing our properties, we first consider the big-­picture stuff — including interest rates and government policies — because this gives broader context to our decisions. Then we drill down to developments at the micro level, such as infrastructure and local and state authorities’ plans for the region. Your best sources of all this information are online global and economic data, daily newspapers and property publications. We also spend a fair bit of time researching the ASX these days to keep our finger on the pulse. Here are a few of the larger macro-­level forces that impact on the commercial property market:

•

Population. For example, Australia’s ageing baby-­boomer generation has increased demand for healthcare services such as aged-­care facilities and medical centres, which will require increased federal government expenditure over the next few decades. It’s worth considering how this may affect the market. Which suburbs will require more healthcare amenities and retail provisions? What are the main characteristics of the local population? Is it a relatively wealthy demographic with a high p­ er-­capita discretionary spend profile? Will strong population growth in areas undergoing gentrification require new services such as shopping centres, financial-­service companies and restaurants?

•

Infrastructure. Are there government plans for new infrastructure? Infrastructure spending is an important growth driver. Big infrastructure projects can boost demand for commercial property. For instance, the development of the M7 in Sydney generated demand for warehouse properties in the surrounding precincts. We predict that over the next decade we will see the largest infrastructure boom we have ever seen. This was one of the government’s responses to stimulate growth in a post-­ COVID world.

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•

Supply and demand. You can look at the total number of building approvals nationwide as an early indicator of future supply. However, supply and demand is both a microeconomic and a macroeconomic driver of growth. For example, an increase in property within a specific suburb may create a threat, since the existing tenants may look to upgrade or expand, which might cause you to lose your tenant and replace them at a lower rental rate. So, in general, you don’t want a lot of new building in the precinct unless vacancy rates are very tight. Keeping on top of vacancy rates is one way to measure the health of the supply and demand ratio.

•

Interest rates. This is one of the most important drivers for price valuations. When interest rates drop, investors are encouraged to take their money out of their bank accounts to seek higher returns elsewhere. By investing in commercial property, investor cash-flow returns improve as the costs of lending drop. So what does this mean? Essentially, prices for commercial property increase because it’s viable to pay more for the same rental return. This is called yield compression, which is how asset appreciation happens on a macro level. This can also go the other way when rates increase. Note: it’s important to understand that the impact on rates rising or dropping is very similar in the residential, commercial and the stock markets.

To examine yield compression in a little more detail, let’s look at the following example. Let’s say interest rates are 5 per cent and you purchase a $1.5 million property using a $1 million loan. That means an annual interest cost of $50 000 per annum. If that $1 million loan is used to purchase a 7 per cent net yielding property, there will be a $55 000 net income after the cost of the debt has been accounted for (see table 16). Table 16: yield compression Debt on Cost of Net income property debt p.a. for a $1.5 ($) ($) million asset ($)

Net income Cash flow after debt improvement repayments (%) ($)

Interest rate 5% 1 000 000 50 000

105 000

55 000

0

Interest rate 3% 1 000 000 30 000

105 000

75 000

36

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Now let’s look at the same situation if the interest rate dropped to 3 per cent. This would improve the net income on the commercial property from $55 000 to $75 000, which is a 36 per cent improvement in post-­interest cash flow. Logically, therefore, investors would be encouraged to pay more for the property as the interest cost drops. This is called yield compression.

Vacancies Understanding vacancy levels is very important, because it will help you secure a good deal on your commercial property. Your best preparation is to do your research. Consider how many vacant shops, offices, warehouses and factories there are in the precinct you are looking at. Also consider the exact length of the vacancies so you can work out how long it would take to relet your property. It’s important to determine if they offer a true comparison to the property you’re buying. For example, if you’re looking to purchase a 500-­square-­metre warehouse and there are seven other properties available to rent of more than 2000 square metres each, this probably isn’t an immediate threat to your property, because different tenants need different assets. If there are many similarly sized, directly comparable vacancies, it could mean finding a new tenant will be difficult. If there are no vacancies, this is a good sign that the precinct is in high demand from businesses and that you are more likely to relet your property quickly. My advice is never to buy with vacant possession unless you are sure you can find a tenant quickly. However, buying a property without a tenant may be viable if you can persuade the owner to guarantee at least 12 months’ rent. This will give you time to find a tenant and might also allow you to buy at a lower price.

What to invest in One of the beauties of commercial property is there are multiple asset classes to consider. So, if you do your research you will be more targeted 122

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into where the growth areas are in the economy. Some tips on how to choose what to invest in:

•

Research the local market and look for properties that are in high demand.

•

Consider the location, size, and condition of the property, as well as the potential for future growth.

•

Consider the cost of renovations and repairs, and the potential for rental income.

•

Look for properties that are in high-­traffic areas and have good visibility (retail and office properties, only).

Where to invest It may seem that we property investors have a knack for ‘discovering’ hidden gems that yield real-­estate gold. But the truth is, we have access to the same information you do; we’re just across higher volumes of it. We know what to do with it too, and we have the contacts built up over years of experience to help us uncover the gold. It’s also true that no one method delivers the best results; there are many. And it’s worth knowing them all so you can use a good mix when you’re ready to purchase. It’s also worth remembering that different types of commercial properties need different locations, so while there are opportunities all over Australia, I have always opted to invest in prime commercial locations. If you don’t sacrifice on quality, you will always be able to attract the best tenants. This is because the best tenants always prefer the high-­demand positions that attract the most foot traffic, access and prestige. For us, there is too much risk in heading to a sleepy little town just because the yield is good. As mentioned, however, large regional centres can be good investments as long as they are located near important infrastructure such as an airport, hospital or major highway. Location can make or break a business so, depending on your asset choice and your tenant type, you need to do a full market analysis on the viability of the tenant’s business and the relettability of the property. 123

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When considering location, it’s important to try to understand the growth drivers behind it. During an economic downturn, demand for certain types of commercial property generally falls due to sluggish economic growth and low business confidence. It’s important to consider whether the investment may be susceptible to major economic downturns. Let’s drill down to understand more about the best reasons for choosing a property.

Visibility In our eyes, highly visible equals highly attractive. And understanding the fundamentals of each asset class and their associated market is key. So what constitutes good visibility across the various asset types in commercial property when it comes to choosing a location?

•

Office. These spaces must be centrally situated and well serviced. It helps to have offices near retail amenities and transport networks, and to have adequate onsite car parking. Natural lighting and functional floor plans or tenancy areas are also important considerations; offices with only artificial light may be cheaper. Another value-­add could be an aesthetically pleasing setting. For example, any Sydney office space with views of the harbour will demand a premium rent. Office investments can become riskier as they become dated, so make sure the aesthetic appeal is great enough to attract your tenant.

•

Industrial. For these properties it’s all about location and great access. The ability to transport materials and goods in and out of a site saves significant extra logistical costs. So industrial sites close to major arterial roads and rail access are highly attractive. Proximity to an airport or seaport will also increase a property’s attractiveness to prospective tenants.

•

Retail. The most important factor to consider when investing in the retail market is foot traffic. Look for places where people regularly congregate in high volumes, because more people means more opportunities for business and generating sales. You also need to consider the tenant mix of the area. For example, you wouldn’t 124

Asset selection

want too many Thai restaurants close to one another. Also, look for exposure to passing traffic, anchor tenants such as supermarkets, and a good customer car-­parking ratio.

Parking Adequate parking is important for both customers and staff, especially when you are buying in built-­out urban areas where space is scarce. For example, if you buy an office space a high ratio of parking spaces to total square metres will add significantly to the property’s value. This is because it makes the property more attractive to tenants and you’ll be able to fill the property faster while also chasing a premium rent. Car parking is particularly important in the retail sector where customers need to carry purchases to their cars. Retail businesses or those with a retail component also need exposure, so main-­ road frontage within an established commercial precinct can be critical to the success of a business — and to your chances of securing a tenant. You can also rent car parks out separately for a secondary revenue source.

The building layout Consider the structure or ‘bones’ of the property and whether the layout can be easily changed to suit different types of tenants. It’s important to consider properties that can be configured differently, because a multipurpose space can help you attract a wider pool of potential tenants by marketing the property to many types of tenants. And you won’t be left with an inefficient floor layout if you sublease the space. Industrial sites require great onsite access, plenty of space in which large vehicles can manoeuvre, good clearance height into the warehouse or factory and the right office-­to-­warehouse ratio. A good tip is to find an industrial site where the proportion of office space can easily be changed. Check the build costs per square metre in the area and compare it to your building. Look for areas where you can buy a building below its replacement cost, as this means there will be less future competition for you from developers — until prices rise, that is! 125

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Keep in mind that larger commercial properties may be more difficult to lease than smaller properties and will typically be more expensive to hold.

Get personal If you can, walk around the area and call the commercial property agents who work in the area to check on rents. Meet up with them and ask them about their property listings. Read the newspaper property sections, search the web and subscribe to local agents’ mailing lists. And investigate the health of the business sector you expect your tenant to come from. Get familiar with this asset class. Expand your knowledge by talking to experts in the field. Ask them about the deals they’ve done in the past, and the type of properties they’ve bought. The agents in the areas are a fantastic source of information, and they are usually passionate about property. Ask them about recent sales and the listings they have coming up. It’s also helpful to speak to other investors to help build your knowledge about the good and bad side of investing. Ultimately, this will give you the confidence to choose the right property. If you don’t have the time or ability to carry out this local research, this is where a buyer’s agent can help fast-­track your results.

The tenant Finding the right tenant is an important part of the property deal. We only purchase and recommend leased investments, meaning the property is sold with the tenant already in place. In simple terms, having a tenant in place mitigates your risks and improves your chance of a good return as you can complete your due diligence on the tenant. This creates a lot more certainty when buying. And it makes financing easier. We advise you to look for a strong corporate or blue-­chip tenant, or any tenant with a long successful trading history, that has the financial resources to meet the rental payments and is unlikely to default on the rent, particularly when it is already in the location you are purchasing. Review the tenant’s business model, brand assets, annual statements, resources and even industry trends to better assess their viability as a long-­term tenant. 126

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Other factors you should consider in relation to tenants include:

•

Who are they? How long have they occupied the premises and is their rent up to date? We like to ask for bank statements that have the tenant’s payment history clearly displayed, so we can see whether they have paid their rent on time each month. It’s important to note when the lease expires. For example, some multiple-­tenant assets may have all their leases expire in the same year. Although not a deal-­breaker, it adds to the risk.

•

Best tenants. They have a good track record in business or are the type of business that has good growth potential. For example, solicitors and accountants have shown substantial durability over the years and have a public image of reliability and responsibility. Check out Property Play 3 for more details on the types of tenants we recommend.

•

Lease length. Leases are typically for three to five years, with tenants paying all the outgoings, often including the managing agent’s fees. Sometimes you can buy shorter leases to secure the property for a lower price (due to the extra risk). Once you increase the lease, you can then create value on the asset you purchase — extra risk plus extra upside.

•

Rent price. Make sure the tenant is paying a fair market rent. This is extremely important as the commercial property can be valued from its rental income. If the rent is inflated, then you might be offering too much, and you will have little upside potential for rent reviews and therefore increased capital values.

•

Below-­market rent. Finding below-­market rent is also a way of identifying future value-­add properties, because you can potentially raise the rent at the next rent review to match it to market level. When done correctly, this will increase your equity.

•

Lease structure. This includes the length of the lease, the frequency and methods of rent review, and who pays the operating costs. Of course, it’s preferable to have a long lease with regular rent reviews to market with a minimum of CPI increase and a tenant who pays all the outgoings.

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•

Relettability. Many investors forget the importance of the property’s relettability. No matter how good or secure your tenant looks, it’s prudent to consider how you would go about finding a new tenant, because you never know what the future will bring.

Where are they? Finding a suitable new tenant can be challenging. And just as with valuing a property, working out a vacancy period is vital. But we’ve been doing it for years, and over time we’ve developed some great tactics, including:

•

CoreLogic. Find the leasing history of similar properties in the area by searching the extensive CoreLogic property website. For example, if you are looking at a 300-­square-­metre warehouse, research vacant units sized between 200 and 400 square metres, and see how long it took to fill them. If in most cases the vacancy was between two and three months, we would allow for a three-­month vacancy when looking for a tenant.

•

Local rental managers. If you don’t know the area well, speak with local rental managers to confirm your findings. A local leasing specialist who is active in the area and experienced in your particular type of asset not only knows what tenants are new to the area and actively looking, but knows the tenants who are already operating, when their lease expires and their requirements. So if their current premises no longer meets their demands, they may be able to move them across to something bigger, smaller or more suitable — such as your property.

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YOUR TAKEAWAYS It’s hard to know where to start when searching for the right property. There’s such a lot of information out there! We have invested tens of thousands of hours in studying the art of real estate in order to learn what works and what doesn’t. In the search for the best commercial properties, nothing beats knowledge combined with experience. Whether it’s reading printed and online resources, or carrying out on-­the-­ground research, your best strategy is to research and understand the key drivers and influences on the market and the broader economy, and the way they impact specific properties and tenancies.

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STEP 5

METHOD OF SALE Lining up your finance and completing your due diligence are huge steps towards securing your commercial property, but you also need to know how the property will be brought to the market. There are different ways to buy a property, depending on how it’s marketed, and you need to know what boxes to tick when it comes to your due diligence. Your first step is to learn the different methods of sale of commercial property. As touched on earlier, most of us are familiar with the different ways to buy a residential property. It’s not too different for commercial property, but there are more variations in sales methods. Generally, these assets are sold through expression-­of-­interest campaigns, auctions and (increasingly) off-­market sales. Your competition may include individuals, trusts, companies or even syndicates. In the commercial market, the range of methods of sale are: 1. auctions 2. Expressions of interest (EOIs) 3. fixed-­price listings 4. off-­market sales. Let’s break these down.

1. Auctions As in the residential sector, auctions are usually preferred for properties that are likely to be in high demand, especially in the capital cities. Commercial properties with long leases are often pushed through to an 131

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auction, because the agent knows that demand will be high and active bidding will push the price up for the seller. In an auction, the seller may allow for some flexibility in the bidding and purchasing terms, which the auctioneer will announce prior to the auction. Keep in mind that purchasing terms at an auction are usually dictated by the seller rather than the buyer in a hot market. All of this reduces your control when buying and is more likely to lead you to overpay or lead to a costly oversight. This is why we advise you to avoid this type of auction scenario. In our general business, we prefer to stick to other methods of sale where you’re more likely to get value for money and the sort of profit that will be harder to achieve for highly attractive and highly competitive properties. In Australia, auctions for commercial properties typically account for about 20 per cent of sales. We dislike them when representing clients mainly because we can’t negotiate favourable due-­diligence or finance terms. Most auctions also demand an unconditional contract, which can be risky. But there is a bit of a silver lining: if you rock up to an auction where there is little interest, it will really show you where the market stands. You might then try to purchase the property after the auction with all your due-­diligence and finance conditions covered. One of the biggest pieces of advice we can give you as an investor is that it is difficult to get a good deal at a commercial auction. Over the years we have seen many novice investors get unknowingly ripped off by paying too much for properties with long leases, mostly due to their perceived low risk. This could include the standard childcare, fast-­food or service-­station auctions. If you want a good deal, it’s best to avoid an auction.

Our auction top tips If you decide you still want to participate at an auction, make sure you do your homework, because in the heat of an auction you need to know exactly what you’re doing. We’ve bought properties at many auctions and have learned to keep a cool head. This will probably be nothing you haven’t heard before, but what’s critical is that you have all your ducks lined up properly. This means having your finances in tiptop order, because when 132

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you buy a commercial property at auction, you’ll need to organise your bank’s unconditional approval beforehand. This can take a few weeks to arrange and cost several thousand dollars, so if you don’t win at the auction it’s a bitter pill to swallow — and potentially a big waste of money. You’ll have to have your 5–­10 per cent deposit ready to go if you win it. If you don’t have it, you might be able to negotiate a lower deposit with the seller’s solicitor even before the auction. Be aware that if you have to use other properties as security, you may be stung with higher interest rates for those borrowings until the finance is settled. Once the hammer comes down and you’ve still got your hand stuck in the air, the property’s yours. And that means making sure you’ve done all your due diligence before the day of the auction.

2. Expressions of interest (EOIs) An expression of interest is generally far less of a pressure-­cooker situation for many than an auction, mainly because you don’t have to look your competition in the eye and there is more time to work with. With an EOI, you simply submit your offer, which isn’t binding. EOIs allow buyers to specify their preferred purchasing terms, then it’s up to the seller to decide if they are acceptable or if they want to negotiate further. Note that an EOI is still bound by its own rules — notably, that you’ll have to enter a bid by a certain due date and you’ll need to abide by the closing date. So in a way you’re just putting off the inevitable price war, only it’s invisible because you won’t know who you’re up against. If you’re headed down this path, you’ll be asked to fill out a standard EOI form. It’s only one or two pages and is pretty similar across the various commercial property agencies. The most important point made in the form is that you don’t need to do all of your due diligence straightaway, as you have to in the auction process. You are required only to indicate how much time you’ll need to get this done, because at this stage you’re simply registering your interest in the property. Once the closing date arrives, which could be up to six weeks down the track, the agent will call you to chat about the next step — the wheeling and dealing. 133

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Our EOI top tips At this point, the vendor’s agent hasn’t yet had to work for their money. They’ve let the expressions of interest roll in, and they’ve had time to sort out the wheat from the chaff. You’ll most likely hear one or more of the following lines, which they love to trot out to up the ante and drum up excitement:

•

‘You’ve made a solid start, but you’ll need to come up a little to be in line with the vendor’s expectations.’

•

‘Another, similar offer has come in. I recommend you put your best foot forward on price.’

•

‘The owner is still considering the offers. All I can say is you will need to be over the XX price.’

•

‘The vendor will be making a decision over the weekend. I recommend putting in your best price before 5 pm Friday.’

One great thing about EOIs is that you can negotiate on things other than price. You might be able to offer a better deal on the settlement conditions, so it’s worth making sure you have some wiggle room in your first offer so you have some bargaining power during the negotiations. Our offers will vary depending on the type of property. Some vendors will be won over on price, some on settlement conditions, some on both. Here are a few examples of these conditions:

•

Most commercial offers are made with a 21-­day due-­diligence or finance condition. If you are prepared to shorten this, it will give you more leverage on the offer.

•

Most commercial contracts are for 42 to 60 days. Again, if you can go shorter, this will give you more leverage.

•

Larger deposits help. If you are feeling super-­confident in the property, you might even offer a non-­refundable amount (but this is not something we often do).

•

Find out if the vendor has any other preferences you can work into your offer. (In some cases they may even want a longer settlement.)

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3. Fixed-­price listings In this method, what you see is what you get. Pure and simple. The owner knows what price they want, the agent lists it, and it’s there in black and white for the market to buy or pass on. The process is open and transparent too. To get to this point, there’s been a significant amount of research into the listing price, and for many investors buying this way saves a lot of time and energy stuffing around with banks and other institutions. Think of it as a bit like the opposite of an auction. Properties that are sold under this method are usually listed because the demand isn’t high. They may have been passed in at auction or listed with another agent. Developers often use fixed prices to lock in a certain amount of profit margin, otherwise it’s not worth selling. Do your due diligence to find out if there’s any existing selling history so you don’t pay more than you should. It’s also worth remembering that when an agent lists a fixed price, the owner has not had to outlay much on a marketing campaign. Reading between the lines, this is usually because they don’t expect interest to be that high. For an informed investor — which you will be — there’s gold to be found in these listings, so don’t dismiss them!

Fixed-­price top tips The key is to make sure you still complete your due diligence on the price. Look for comparable sales and back yourself in valuing the property without being influenced by the listing price. If the deal stacks up at their asking price, then great. If not, on you go to the next deal. Before you move on, though, it’s always worth trying to offer a lower price where you see value. Try to find out as much as you can about the property, so you have some bargaining power. Again, offer a quicker settlement if it’s possible and see if you can find out if the vendor has other motivations for selling. In fixed-­price sales, don’t wait too long if you are hoping the owner will hold out for you. 135

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4. Off-­market sales This one’s our favourite. The longer you’re in this game, the more likely you’ll be the person agents call when they have a property that isn’t going to be listed on the market. And you can catch a great deal this way! Because they know you, trust you and appreciate that you’re a professional, you’re more likely to get a deal when something good comes along. With an off-­market sale, the owner doesn’t list or advertise the property and may be in a hurry to sell. The agent will use their networks to see who might be interested to buy and will go about marketing it privately between prospective buyers. There are a few reasons why a seller chooses to sell off-­market:

• •

Privacy. They might not wish anyone to know they are selling.

•

Cheaper. Discreet advertising campaigns are the cheapest (no professional photos, costly auctions and so on).

•

Speed. Sometimes an agent needs to approach only one buyer to make the sale. This can mean much faster results compared to a drawn-­out marketing campaign.

Protect tenants. Fewer inspections and questions can help keep their tenants happy.

How do you access off-­market properties? For the investor, it’s all about building your networks. It can take many years to reach a point where you are regularly alerted to high-­quality off-­ market opportunities. We’ve completed literally thousands of commercial purchases for ourselves and our clients, which results in reaching out to countless numbers of agents and regularly improving our relationships with them. The consequence of this is getting to know the main players in the game, to understand who’s who in the zoo, and that means knowing who has access to the best off-­market stock. One of the most valuable assets a professional investor can have is their network.

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Different types of off-­market properties

•

Non-­advertised. This is when the agents don’t spend money to advertise the properties on the major websites such as realestate .com.au or domain.com.au. However, they are often advertised on their own agency websites and the properties are passed around their agents. On some occasions the owner may or may not sell, which is why they haven’t committed to a full campaign. We don’t consider these a true off-­market sale, although many agents would call this an off-­market deal when they speak with you.

•

Pre-­market deal. This is where an agent brings you a property before it is listed anywhere online. This is closer to a true off-­ market deal because if you act fast, you can technically purchase the property without any external competition.

•

Silent listing. This is a true off-­market deal when only you, the agent and the owner know the property is for sale. There are no fancy IMs or professional photos for these types of properties. The sales agents involved often haven’t even completed all the information needed to complete the contract for the property. These can represent some of the best opportunities you will find but be careful to do your due diligence, due to the lack of information available at the time of sale.

Our off-­market sales top tips This process follows much the same path as we’ve covered, but this time you’ll likely be under time pressure to buy the property before it is presented to another buyer or listed online. As with any sale, the vendor’s agent will try to negotiate the best deal for their client. They may point out how very lucky and privileged you are to have been given this opportunity, which may sometimes be true, but in other cases, where the quality is poor, be ready to walk away if it doesn’t meet your standards. Remember, being an off-­line deal doesn’t necessarily mean it’s going to be a good one. So, as always, do the numbers and calculate what you need to secure a good deal. Over the years, about 60 per cent of the properties we have bought have been off-­market deals. This is one of the key ways we position ourselves 137

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as experts. We have access to properties before they hit the market, giving us first dibs on the best ones. You need to act with confidence on price and be ready to justify your offer by understanding the market, the property, the rent and the rate of return. Your access to off-­market properties will increase if you complete sales regularly. Unfortunately, this is a privilege reserved mainly for buyer’s agents who purchase frequently on behalf of their clients. If you purchase many properties from the same agents, you become their ‘go to’ buyer for quick sales. This is something we have perfected over the years in our business. If operating only on your own behalf, you need to give the agent confidence you are a legit buyer, someone who can navigate the transaction smoothly and easily. If you sell yourself as a buyer in the right way, the agent will keep you in the loop with other off-­market deals. If this is something you would like to shortcut, then engaging a buyer’s agent with good contacts will allow you to leverage off their networks without having to build your own from scratch.

YOUR TAKEAWAYS There are several ways to buy property, but if we were to leave you with just one tip, it would be to try to take back control from the selling agent. It’s in the agent’s best interests to control as much of the process as they can, so the more you can see what is happening during the sales process, the more likely you are to walk away with a good deal. Being educated about the market and the property itself is the best way to gain confidence and hence control over the negotiations. Of course, you might not always like the selling method, but as long as the numbers stack up, and you are happy to proceed within the agreed parameters, then go for it! Build good relationships with commercial real estate agents and you’ll be in their thoughts when the best properties hit the market. Ultimately, this is what you want to aim for. Get the deals before they reach the online listings and you’ll know you’re onto a good thing. 138

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FINANCE Property investing is often described as a game of finance. When financing property deals we believe investors should always use loans, even if they have the cash to buy the property outright. Why? A simple reason: you can maximise your returns better by using bank finance. It’s called leveraging. Leveraging has the additional advantage of allowing you to front up with less cash when buying a property. This puts you in a great position to buy multiple properties, which translates into more income sources and more diversity as you grow your portfolio. We wouldn’t be in the position we’re in without using loans! Let’s look at how your returns can be increased by using the bank’s money rather than buying a property outright.

CASE STUDY Cash versus bank loan A client of ours, Peter, came to us with approximately $870 000  in cash savings. He was set against taking out a bank loan as he viewed lending as riskier than using cash, and he believed he had enough to purchase a small commercial property outright. We compared the numbers for buying a property outright versus splitting his $870 000 between two commercial properties, using 70 per cent bank loans. Let’s see how it pans out.

Scenario 1: Peter purchases a $800 000 property outright • $45 000 covers purchasing costs (stamp duty, legals and so on) • $25 000 leftover cash/buffer.

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Potential result when purchasing an asset with a 7 per cent net return: • $56 000 per annum rent (tenant pays 100 per cent of the property’s outgoings) • Bank loan = $0 • Total return = $56 000 per annum + capital growth.

Scenario 2: Peter purchases two properties using leverage off the cash deposit with a 70 per cent loan • Purchase two properties for $1.2 million with a 70 per cent loan • $360 000 for each 30 per cent deposit (total $720 000) • $65 000 to cover purchasing costs for each property (total: $130 000) • $20 000 leftover cash/buffer

Potential result when purchasing an asset with a 7 per cent net return: • The two properties rent for a combined amount of $168 000 rent (tenant pays 100 per cent of the property’s outgoings) • Bank loan = $1 680 000 • Interest rate = 5.25 per cent interest only • Total return = $79 800 per annum + capital growth. As you can see, leveraging your money will increase your cash flow returns much more for commercial property. It’s also important to note that owning $2 400 000 in real estate (Peter’s two properties) will increase your chances of accumulating better capital growth over a long period than owning only $800 000 worth of property. For example, if your $800 000 property grows 5 per cent per annum for 10 years, its value will increase by $248 097.70. But taking that same growth rate, your $1 200 000 portfolio will grow by $661 593.86 —­ a whopping $413 496.16 difference. And that’s simply because you took out a bank loan 10 years earlier. Table 17 compares the growth (assumed at 5 per cent per annum) over 10 years for the two scenarios. 140

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Table 17: growth comparison over 10 years of two investment scenarios Assumption of 5% $800 000 property ($) p.a. growth

2 × $1 200 000 properties ($)

Value Year 1

$800 000

$2 400 000

Value Year 2

$840 000.00

$2 520 000.00

Value Year 3

$882 000.00

$2 646 000.00

Value Year 4

$926 100.00

$2 778 300.00

Value Year 5

$972 405.00

$2 917 215.00

Value Year 6

$1 021 025.25

$3 063 075.75

Value Year 7

$1 072 076.51

$3 216 229.54

Value Year 8

$1 125 680.34

$3 377 041.01

Value Year 9

$1 181 964.36

$3 545 893.07

Value Year 10

$1 241 062.57

$3 723 187.72

Total growth

$441 062.57

$1 323 187.72

Difference

$882 125.15

There are other benefits to leveraging. In this case, Peter will have three assets with three different tenants in three different suburbs or areas. This diversity reduces his vacancy risk, because the chance that all three tenancies would be vacant at once is probably slim. Also, the flexibility in scenario 2 means Peter can sell one of the assets if he needs to while still receiving an income, and he can cash out for whatever reason. If, however, he owned only one commercial property and had to sell, he would lose all his income there and then. This case study illustrates how important it is to get the finance right from the start, and how the game is to get the best result possible for your personal situation.

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Starting out Of course, as a skilled investor, you must consider many other factors when borrowing. You need to be across a bunch of rules too. Understanding them, and knowing where and when you can take shortcuts or give yourself a better chance, will allow you to get ahead of the game, legally and credibly. Without this knowledge, it will be harder to build a large, self-­sustaining property portfolio. One of the reasons we’ve been able to generate such a large portfolio is that right from the start we were very good at maximising our lending capacity. But first, to get you on your way, here’s what you need to do.

Save a deposit We covered this in Step 1, so we won’t spend too long on it here. Suffice to say that every property deal, whether residential or commercial, starts with a deposit. In Part I we talked you through recommended deposit amounts if you’re buying commercial property; if you’re in this boat, we suggest you aim to save a ballpark $100 000. Of course, if you’re pulling equity from other properties you won’t need to save as much, but you will need cash, so you should still aim for this amount. If you came into this thinking that you’re nowhere near the ballpark figure, don’t worry. Our best advice is simply to turn around: focus on saving and bringing that figure a little closer. If you don’t, you’ll simply waste your time at the bank trying to justify finance, and they’ll tell you exactly the same thing. Alternatively, if you’ve done the hard yards and got your savings in order, then read on. Saving up for a deposit is usually the hardest and most time-­consuming part of the game. Once you’re there you’re ready to start shopping. Table 18 illustrates the deposit you should aim for commensurate with the property price.

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Table 18: deposit needed per property value Property value ($)

30% deposit + 5% costs ($)*

300 000

105 000

500 000

175 000

700 000

245 000

900 000

315 000

1 100 000

385 000

1 300 000

455 000

1 500 000

525 000

1 700 000

595 000

1 900 000

665 000

2 100 000

735 000

2 300 000

805 000

2 500 000

875 000

* A 5 per cent allowance for purchasing costs will cover stamp duty, solicitor fees, building/ pest report and so on.

Give yourself a buffer There’s nothing worse than feeling pleased that you’ve saved your deposit only to be slugged by unanticipated extra costs. That’s why we recommend giving yourself a buffer, so when those extra costs pop up —­ and they will —­ you can cover them from your reserve. Here are a few examples of extra fees and charges to keep an eye out for:

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Bank costs. Banks may charge fees you aren’t expecting. They might even ask for a larger deposit at the last minute before settlement, in some unlucky cases.

•

An early, unexpected vacancy. For example, when COVID-­19 hit, gyms were forced to close, which meant tenants couldn’t pay the rent in full, leaving owners with a short-­term cash-flow problem. 143

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•

Valuation shortfall. If the bank valuation comes back lower than the purchase price, you will have to pay the difference. For example, if you have a valuation returned at $50 000 below the purchase price, you can challenge the valuation, pay the difference or try to renegotiate the price with the vendor.

•

Maintenance. Although in most cases the tenants are required to pay for the maintenance of the property, it’s still good practice to have a buffer in place.

Remember, your best defence is to plan for the worst. Get that buffer up and you’ll be more likely to breeze through these little interruptions. We recommend adding a cushion of 10 per cent. Don’t even think of it as a buffer; imagine it’s just part of your deposit and you won’t even notice the little extra you need to save. Trust us, it’s much better to factor this in than to stress about having to scrounge around for money you don’t necessarily have, especially when on a deadline.

Loan structure and application process The loan structure for a commercial property is different from that for a residential property. Given that you probably won’t be buying your commercial property outright, understanding this is important. But how do you know what to look out for? If you’re just getting started in commercial property investment, it might look daunting. In essence, the banks will be looking at a few key criteria, including:

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your ability to repay the loan, considering all your income, which will include what you’re expecting to receive from the commercial property

•

how much deposit you have, and if you have any equity to use from another property

•

what type of commercial property you wish to buy, its location and the valuer’s report

•

the commercial property lease and its conditions. 144

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If you have all the above in order, you’re ready to hit the banks. But how do you choose between them? What do you look for? Here are our tips on getting to grips with the application process and loan structure.

Big banks versus specialised lenders Things can be easier if you engage a mortgage broker with commercial lending experience, rather than securing the loan yourself from one of the big four banks. That’s because a broker will have access to a wider range of lending options, including non-­bank lenders. Often these lenders are more competitive than the big banks, which means you’ll find a better deal.

Shorter loan terms Residential loans are typically for 25 to 30 years. Commercial loans can range from short-­term loans of one to 10 years, all the way up to 30 years. It’s important to note that the shorter the term the faster the loan must be paid back. As a consequence, you’ll need to be able to convince the lender that you can service the loan, because the repayments will be higher. A rule of thumb is the longer the loan terms, the better the serviceability. This is because the buffering test of repayments will be stretched out over a longer time period. So if you can get longer-term loans, this will be a better result for your serviceability.

Lender’s policy The rate, terms and structure are similar across all lenders. Where they differ is in their policies and varying tools, and the way you can make them work in a deal. Let’s go through a few of them, because understanding these can mean the difference between securing a great deal or missing out. Here are some examples to look out for:

•

Some banks can do standalone deals, which can help with serviceability.

•

Rental shading: some banks only consider 70 per cent of the income instead of 100 per cent. In some cases it can be even less, 145

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such as 65 per cent or 50 per cent. The stronger the rental shading the harder it is to get a loan, because the figures show you have less income to support your loan.

•

Lenders that allow interest addbacks for servicing, net profit addbacks.

• •

Postcode restrictions can result in the loan being denied.

•

Retail, office and industrial types of commercial properties can have different LVRs, reflecting their differing risk levels.

•

Loan size limits may come up as you borrow more and encounter different policies for different levels of debt. This is one reason why many larger investors spread their loans across multiple banks.

First-­time use is a new one I’ve just started to see pop up. Basically, the banks offer different loan terms for new properties than for older ones.

The property The property itself can be a factor when it comes to commercial finance. Its location, security, tenant and lease terms are major determinants of the maximum LVR (loan-­to-­value ratio) and in some cases the actual rate for the borrower. It’s worth keeping this in mind when you’re searching for your property, because it can make the difference between good finance and great finance. Given that the LVR is generally lower for commercial properties (70 per cent, compared to 80 to 90 per cent for residential property), you’ll also need a bigger deposit or more equity.

Strategic lease terms You might be in a better position to secure your loan by playing around with the lease terms. This is something we often do for Rethink Investing clients: when we put offers on properties, we make them subject to a lease negotiation. Commercial leases offer much more flexibility than residential leases, which means there’s plenty of room for negotiation. For example, a typical residential lease is six to 12 months. A commercial lease, on the other hand, is usually longer. This might include an ongoing 3+3 years or 5+5 years with options to extend for another three to five years. Tenants 146

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usually pay their own outgoings. Basically, all these items are negotiable, but the better the negotiation goes for you, the more favourably the lease is for the lender. If the lease is strong enough you might be able to get a lease doc loan —­ that is, a loan on the property purely from the income on the lease without taking into account your personal income. This is a good type of loan for those who have reached their serviceability limits.

Property valuation You’ll need to pay for a lender’s valuation on your commercial property. If you’ve bought residential property, this cost is usually covered by the lender, but in commercial loan applications, it’s up to you to foot the bill. To give you an idea of the cost, anything under $1 million will cost around $800 to $1500. If the property is valued at over $1 million, the cost will be higher. There may also be an additional GST cost. The good news is these detailed valuations are an important part of your due diligence. Although they are often based on the most conservative of views, they can still give you great market insights to boost your confidence in your commercial purchase decision.

Principal and interest (P&I) or interest-­only loans You will need to work out whether P&I or interest only is better suited to your circumstances. Personally, we choose P&I on our home loan but interest only on our investment loans. It’s worth remembering that investment loans are tax deductible, but your home loan isn’t. So it’s better from a tax point of view to maximise your investment loans and reduce your home loan. Let’s look at an example. If you choose P&I, you’ll be able to secure higher lending because the stress testing of repayments is based on the remaining loan term. So if you have a 20-­year commercial loan with five years interest only, the remaining P&I term will be 15 years. The lender will then say that the balance is to be repaid over 15 years on the stress-­tested rate. This commonly kills a lot of deals. However, if you opt for P&I, it’s 20 years stress test on the balance instead of 15 years. 147

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One positive advance in recent times is that banks are offering much longer loan terms for commercial loans. Most of our clients secure 25-­to 30-­year commercial loans these days. This helps their serviceability, so they can keep buying!

Other options There are a few reasons why things don’t work out when financing. If all of the above fail, you can look at a lease doc or a standalone approach. For a lease doc loan, the lender only looks at the commercial property you are purchasing for servicing and ignores all your other financials. For a standalone loan, the lender only looks at the financials of the entity you are purchasing. For example, if it’s a family trust entity, only the financials of the family trust will be considered; if it’s a company, then the financials of the company will be the lender’s only concern.

YOUR TAKEAWAYS In commercial property, the interest rate is only one consideration. Borrowers have a bunch of other factors at their disposal to help them grow a larger commercial property portfolio. Sometimes it’s worth paying that higher rate to secure the investment. Sure, it might cost a little more (which is tax deductible), but in the longer term the investment will pay dividends and provide growth that will quickly outstrip that small cost. The best advice we can offer here is that you make sure you have an expert commercial broker on your team. Once you do, you can basically automate all the advice and information in this chapter.

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STEP 7

THE NEGOTIATIONS If you’ve got this far, well done! You’ve done the searching and due diligence, and you’ve sorted out your finances. All that’s left to do is to seal the deal. You are now ready to start the negotiations to secure your commercial property.

In residential property, this is relatively straightforward. Head to the auction, stick up your hand and the property’s yours. Or negotiate a private sale. One title, one sale. In commercial property, things can be trickier. What if the property sits on several titles? There may be multiple leases too, with various tenants on different terms and agreements, plus potential vacancies to deal with. It can sometimes take weeks or even months before agreement is reached and the contract of sale is signed. This is because from your first, non-­binding expression of interest, you will need to negotiate the terms of the deal and be confident enough to deliver your best offer. There’s a great saying in real estate investing: ‘You make your money when you buy, not when you sell.’ Your purchase price is the main determinant of your ultimate profit. So how do you secure the right purchase price? Three important factors:

• • •

understanding how the sales process works understanding the current market conditions understanding your real estate agent.

Get these factors right and you’ll be signing on the dotted line in no time.

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Negotiating a good deal Being a good negotiator is key to getting the best results. How do you negotiate the best deal? After personally negotiating over $1 billion in completed sales, and losing many more, here are our best tips when going into any negotiation.

Do your homework You need to make sure you know the market, the value and the vendor’s expectations before putting down an offer. Don’t throw in a ridiculously lowball offer, as the only thing this will achieve is make you look uneducated on the market. Commercial sellers don’t respond well to crazy lowball offers either, so it might hurt your chances of being taken seriously in the negotiations. When you know the real value of the property, you’ll be able to bid with confidence and respond to the seller with authority. This will fast-­track the negotiations in your favour. A quick starting point on how to value a property is knowing the market rent value. If you’re negotiating with the selling agent yourself, here are a few questions to ask about the current rent that will help you value the property:

• • •

What is the current rent for the property? What is the rent for comparable properties nearby? What is the median market rent in the area as a whole?

By now you’ll be aware of the value we place on doing your homework. Maybe not in school, but definitely in real estate! To set the baseline of any negotiations, we want to know as much as we can about the property, who’s selling it and their motivation for selling it. The best way to do this is to draw on your experience of that market or, if you are new to the area, to quickly fill in any knowledge gaps you may have. If you can manage it, a site visit can prove useful. For a retail property, this is easy, because you can walk into the shop and have a chat with whoever is behind the register. If it’s a building with 150

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several tenants, you can pop in and have a chat with the people who work there. Whether it’s the owner or an employee, try to find out as much as you can. The question you really want answered is why are they selling? They may be reluctant to answer directly, but you’ll get better at this with practice. If, for example, you learn that the owner is relocating overseas, this will open up your negotiating options, because they’ll probably be under pressure to sell before they leave. Here are a few other questions you might ask:

• • • • • • •

How long have you been running your business here? When are your busiest times? What maintenance has been done to the property over the tenancy? What is the area like? What other businesses are operating in your building and/or area? Are there any vacancies nearby? Do you think you will be here for a while? (That one can be a little direct so make sure the conversation is going well before asking it.)

Have a look around the area too. Check out any other shops or businesses nearby. What sort of condition is the building in? Every scrap of information is useful and adds to your negotiating power, so dig around.

Take emotion out of the equation We talked about this earlier in the book, but it’s worth reiterating. Far too often we see people fall in love with a property and pay too much. Or worse, we see people get frustrated on a personal level with an agent, vendor or prospective buyer, and want to walk away on ‘principle’. (I confess this is also one of my personal weaknesses, which I have had to learn to control! —­ Scott.) Emotions are not helpful to your efforts and have no place in negotiating a good deal. This is where a buyer’s agent can be invaluable because they have no emotional connection to the property or the principals. This means the negotiations will come down to the last $5000 or $10 000, and an expert negotiator will hold out and not pay the difference. 151

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Become a good listener Being a good listener has served us well over our 3500-­plus successful property negotiations. This means listening closely to what the vendor says. Sometimes a faster settlement may be needed, and we can work with that. Sometimes the vendor needs help understanding the true market value, and we can also help with that by showing them comparable sales. Sometimes the vendor needs more time to consider the offer as they are not yet ready to accept a lower amount —­ yep, that too. Always listen to what they have to say, because your next move may well depend on it. Good communications may also help you in the future with the same vendor, especially if they remember you were great to work with. Remember to always keep your cool. When it looks as though the deal is done, but not in your favour, don’t lose your temper. Settle down and think about a solution that might benefit everyone. The great thing about commercial deals is that you can negotiate on a range of factors. Consider, for example:

• • •

the interior of the premises

• •

the number of years on the lease

the number and location of car parking spaces whether the lease could include extra spaces on the premises for the tenant’s use how many extra years you could add on at renewal.

But more on that later.

Don’t give anything away without getting something in return Whenever we give something away, we expect to see some sort of compromise from the vendor. Think of it as the give and take of business dealing. If you give something away without any matching flexibility by the vendor, there’s the risk that 152

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they will feel entitled to your concession and will not be satisfied until you have given further ground. On the other hand, if they’ve had to work a little bit to earn their return, it’ll give them a greater sense of pride and satisfaction than if they had earned it without having to do anything.

Negotiate in good faith This is a big one for us. We like investing with the goal of creating a win-­win solution. After all, a deal will never be made if both parties don’t agree on a final position. This is why we like to make sensible offers that work for us, and then make sure we understand what the sellers need for the deal to work for them. With no emotional distraction, no-­one is offended or frustrated with the process. If you can work like this, more deals will go in your favour. Someone who wants to ‘crush’ the sellers into submission with a very lowball offer is a poor negotiator. Trying to defeat the other party is not the attitude you should go in with. Negotiations are not wars; they are pathways to a mutual agreement. Work with the sellers and they will work with you. This is how we have negotiated all our best deals.

The deal structure You can play many angles during negotiations. Think carefully about how the components of any deal will affect your longer-term outcomes, then come up with a solution that’s a win-­win for everyone. Think, for example, of a sale negotiation and leaseback scenario (which can occur when the tenant and the owner are the same person). Should you reduce the rent to help lower the asking price? On the face of it, it might seem as though dropping the rent would be a good option, because you’re not losing any money from your own pocket if you are getting it back in the sale price. But the lower rent may also lower your valuation for years to come.

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With this in mind, here is a list of the most common aspects of a deal that can be negotiated:

• • • • • •

rental income (for leasebacks) rental guarantees shorter or longer settlements maintenance and repairs allowances a discount on sale price works undertaken (for example, if you attach a physical mezzanine level to the building).

These are all items we regularly seek to bring into a negotiation where applicable.

CASE STUDY Client purchase in 2020 This investment, which settled for one of our clients in mid-­2020, is an example of how many layers there are in some negotiations.

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We were presented with this property off-­market in February. The vendor sought offers of more than $1 300 000. Although this was a pretty decent deal, we knew we wanted it for around $1 250 000. We offered $1 200 000, which was a pretty big lowball offer by our standards. It wasn’t received too well, and the negotiations stalled there. The owners really wanted $1 350 000. Weeks later the property was online, then COVID-­19 hit Australia. Most of us in the industry took a back seat in March to wait to see what would happen. By mid-­April the signs were looking better than expected and most states saw buyer demand increase sharply. We were back, and still interested in this property. Now there was more economic uncertainty, though, and we wanted more out of the deal. So we offered the same money ($1 200 000) with a 12-­month rental guarantee on top of the lease. Again this was rejected, but interestingly the vendor’s expectations had softened. Now they were at $1 275 000 with a six-­month rental guarantee. Another few weeks passed and after a lot of back and forth we finally agreed on terms: • Purchase price: $1 250 000 • Terms: 21 days for due diligence and 21 days for finance approval • Settlement: 35 days • Extra: 12-­month rental guarantee. So after a long couple of months we were under contract with a property we saw a lot of value in, especially as a 5+5-­year lease with a 12-­month rental guarantee was included, which meant double-­backed rent. But the deal was not yet done. The next part was to complete a building and pest inspection, and we discovered that the build had issues. There was a leak in the roof, which was a body corporate issue. So we asked the vendor to fix the problem. They said they had fixed it. Then it rained, and we reinspected it. And guess what? It was still leaking. We asked again, and this time it was harder to get proof that the leak had been fixed, as it would need to rain hard again to confirm it. So, rather than

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leave it to Lady Luck, we asked for a 12-­month maintenance guarantee on the roof leak. The vendors graciously agreed, and the solicitors drew up the legal paperwork. The property settled a month later. As you can see there are many things you can negotiate, but you can also take advantage of the market conditions at the same time. It was all about getting the best result for the buyer, but the vendor was also happy with the result.

Use incentives When it comes to locking in a good lease, you have a card up your sleeve — a lease incentive. This is a common practice between office landlords and tenants. You’ve probably seen examples on the drive to your local shops: ‘$10 000 fit-out incentive! Two months’ free rent!’, and the like. Incentives can take several forms, such as rent abatement, a rent-free period or a fit-out contribution, but basically they’re a sweetener to attract tenants. If you’re looking for tenants in a market with high vacancy rates, you’ll need to offer whatever inducements you can, with careful consultation with your team, to lock in a tenant. You can also use incentives that fluctuate depending on the market, and you can adjust the incentive a little if there’s less competition, or more if the vacancy occurs during a period of high demand. Finally, incentives are used to offset fit-out costs. It’s common for tenants to be able to afford the rent but not the fit-out, so adding in a fit-out incentive can help secure a great tenant. The better the quality of tenant, the more your commercial property will be worth in the long run, so it’s important to remember that incentives are an important part of securing high-quality tenants.

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YOUR TAKEAWAYS If you’ve made it this far, you’ve just about sealed the deal. Understanding how to do this is a fine art, and you’d better be ready to put on your negotiating shoes, because in commercial property there’s plenty on the table to negotiate. To get the best deal, you need to do your homework thoroughly. Be sure you know what you’re getting yourself —­ and your money —­ into, and that you’re not entering the negotiations with any emotional baggage. The good thing about commercial property is that it’s all about numbers, so it’s a lot easier to be logical and clinical around decision making. Next, learn to be a good listener. Don’t give away anything without insisting on something in return. And always negotiate in good faith. If you’re a serious investor, chances are you’ll do business again with the same agent. Treat them with respect, and they’ll return it in kind in the future.

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MANAGING THE PROPERTY AND UNDERSTANDING THE TAX This last step is very exciting. It marks an important milestone in your property journey. You have made your property purchase. You’ve done the hard yards, and now it’s time to watch the rent roll in. But before that happens, you need to work through the options for managing the property. Basically, you can either manage the property yourself or pass the job on to a property manager, for a fee. As we’ve outlined, each option has pros and cons. The big positive is that you will learn on the job. You will be able to see for yourself exactly what is involved when it comes to property management, and this knowledge will be useful when you next invest. Now you’ve learned how the system works, you’ll be able to make a much more informed decision on whether or not to engage a property manager. Going solo can be stressful, time-­consuming and expensive. Of course, this is something you can only learn through experience, but from our side of the fence, engaging a property manager is the only way to go. Full stop. However, if you do decide to save some money and try doing it yourself, a few fundamental elements you’ll need to account for are:

• • •

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• • •

repair costs day-­to-­day management tenancy gaps.

Still sound appealing? A good rule of thumb is that the better the lease, the easier the property management. Also, one of the good things about commercial property is that a high percentage of leases allow you to pass 100 per cent of the management costs onto the tenant. This also means you could charge for your time if you self-­manage, effectively increasing the yield. It’s also important to set up the ownership structure correctly before you even sign the contract to purchase a property, so that you can reap the benefits of reducing your tax obligations. We thought about including this in step 3 or 4 of the book; however, it’s all part of the long-­term management of your property. This is because, depending on your purchasing structure, you will have a different method of calculation in each year’s tax return.

How to manage your property portfolio Managing a property portfolio may not be an easy task sometimes, especially as your portfolio grows. It can be challenging to be across all the details and unless you have structure to be able to understand the intricacies of each property you own —­ whether it is residential or commercial —­ things can fly under the radar easily. To have growth in your portfolio, I found you must handle it like you would a functional thriving business. Your portfolio cannot grow to its maximum potential without giving it what it needs —­ if you don’t have the right amount of input with the correct experts to back you up, things can unravel quickly. This happened to us on two occasions, which we will cover below. So how do we know how to manage such a large-­scale portfolio? What are the questions I should be asking myself if I was managing this for

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someone else? What advice would I give? These are questions I will ask myself if I want it to be managed properly. In the following breakdown, we will see a step-­by-­step process and thought pattern of what it takes to make your property portfolio thrive, and for you to be in complete control of where you decide to steer it.

Professional management Unlike residential property management, which can be managed by less experienced staff, commercial is much more complex. Therefore you need more experienced property managers to do the job right. Unfortunately, this makes it harder to find a good manager. Especially in this high-­staff-­ turnover industry. Anyone can claim that they are a specialist in their field but in reality, may not have, or think they have, the experience to manage large volumes of complex and intricate leases in commercial or retail properties. I found that when managing my own portfolio, it was difficult to weed out which property managers had experience in the field and understood commercial property management. There is also one more thing to consider. That is, you need to pick a commercial manager who is an expert in the specific sector in which your commercial property sits in. For example, if you own a shopping centre, I recommend seeing a manager who has a lot of experience in retail management. It also helps when they have contacts in the space so they can find your tenants faster. Here are the main advantages and disadvantages of engaging a professional property manager: Pros:

• • •

They save you time. They organise everything for you. They help you at tax time (monthly statements are great for tax returns).

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• • •

They deal with the tenants directly. They help minimise vacancy. They can help supervise minor and potentially major rectifications to a building (such as building a duplex).

Cons:

•

Their services cost you approximately 4 to 6 per cent of your rent. However, as mentioned, some leases can have management as an outgoing that is covered by your tenants. This is more common for single-­tenant properties.

• •

Managers can change, leaving you exposed. Experience in commercial management can be limited or hard to find.

Our errors and tips for success with management Here are a few issues we have encountered in managing our property portfolio. ISSUE ONE —­ SELF-­MANAGEMENT GONE WRONG

We used to personally manage nine different properties in NSW and Queensland while still working full-­time jobs. Many of our weekends were filled with meeting tenants onsite for interviews, managing trades and dealing with all the rental paperwork. We were collecting and submitting bonds and doing some of the renovations and maintenance ourselves. This situation quickly got out of control and caused us to have longer vacancies than necessary. Our goal was to save money, but trying to do everything ourselves ended up costing more in lost rental income. We were also restricted to doing things outside work hours as we had full-­time jobs at the time. So rather than trying to do it all yourself, we now recommend managing it closely through various trustworthy and experienced experts in their field such as:

• •

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•

solicitors (only at the time of purchase for residential and commercial investments or renewing contracts for commercial investments only)

•

most of all, property managers.

These are key to having a well-­rounded, functional and self-­sufficient portfolio. Just like a business, having a good team is the key to success. ISSUE TWO —­ NOT AUDITING OUR PORTFOLIO ENOUGH

Our second issue with managing our portfolio was more recent. We had just recently purchased several larger multi-­tenant commercial properties. At the time our residential properties were ticking along smoothly; however, our commercial properties were not. We found that unless we were auditing our own portfolio once a month, various items can most certainly fly under the radar, which can have immense implications to the success and development of your portfolio. Implications may include loss of cash flow and missed lease renewals at the correct market rate. We found that the managers had not been passing on the scheduled rental increases, allowed maintenance items to be ignored and some of our expired leases were renewed at below-­market rents. Some of the rent wasn’t ever collected or chased up in time. One property was not managed correctly, to the point where for two years no rental increases were applied. As we have 63 tenants, it was easy to let things slide. However, even if you have a few, you might fall into the same trap, which was trusting the agents would do this for us. If a property is not closely monitored for a lease renewal, your manager might just renew the lease at the same market rate. If the rental market is strong, you may have lost tens of thousands of dollars in cash flow on potentially hundreds of thousands of dollars in equity. This is a big issue if this happens, as once the leases are locked in you certainly cannot go back in time to gain that money back! The property manager never mentioned anything, we did not manage it closely due to just trying to stay afloat due to multiple project work happening at the same time (Airbnb management, building a new home, 163

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being a new mum during COVID, expanding our Rethink group), and therefore we lost out on a fair amount of cash flow, which could in turn fund other investments in time. The issue from the property managers was a shortage of staff in the rental companies we worked with. To fix this, we had to move managers and they did their best to clean up the mess. However, it was our fault for not paying close enough attention to our portfolio. Our lesson here was to always be across the leases when they are due for expiry. Also, never let a manager renew a lease unless you evaluate the market rent. For if there is a market review built into the lease and you miss the opportunity to bump the rent up, you might be missing out on a lot of extra cash flow and equity growth. Although you have property managers, you must do your own research. Lease renewals are as important as cash flow. For commercial properties, it is essential to comprehend the terms of the lease. Does it include an option to extend or is it a gross lease? If it is a net lease, are you certain that all outgoings are included? Leases can have a variety of outcomes, so it is important to understand your outgoings and assess your financial situation when the end of the financial year approaches. For residential the right rent at the right time of the market is just as important as securing a ‘good tenant’. We always ask property managers to provide rental appraisals; however, we then do our own. Again, this is for both residential and commercial. Just remember: the implications of rental increases are more important for the capital value when it comes to commercial property. IN SUMMARY

Your property managers will deal directly with your tenants on all matters. They should be able to manage multiple complex leases and give financial summaries every year and help you understand options and outgoings. This can be very useful if you are a busy professional, a caregiver or even if you plan to retire and spend time away from your portfolio. Knowing a manager is responsible for your tenants and your property can be a burden lifted. However, it will always be your responsibility to audit their work. Having said this, you could possibly pass this onto your 164

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accountant to help, but then they would need the full understanding of your portfolio. Also, a manager can find you new tenants faster than you could yourself, because they will usually have a large database of other rentals from which they can seek tenants. However, their fees are significant. (Note that in some cases you can pass on the cost of rental management as an outgoing to your tenant.) It’s also worth noting that many people prefer to self-­manage, which leads us to the next section.

Self-­management Here are the main advantages and disadvantages of managing your own investment property. Pros:

• •

It saves money (no management fees payable).

•

You may put more care into your property than a rental manager.

Some people like being closely involved with their investment property.

Cons:

• • •

You don’t receive monthly statements. You need to invest time and effort to manage the property. Some tenants can be difficult to deal with.

You may have to fly to and from locations to see certain properties or be on the ground for certain decision making (for example, court). If you do want to go down the self-­management route and solely manage as a full-­time job, then you may need to have the correct network of experts to help you do so. These experts may include but are not limited to:

• • •

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• •

solicitor (who specialises in all states)

•

yourself.

assistant (networking to get the relevant trades and people on the ground in each state)

When your portfolio becomes large enough that self-­management is becoming overwhelming and stressful, taking up most of your time, this is how you know that you need to have a platform that can help contain all the important information —­ such as renewals of leases or rental income per month —­ all in one location to review once a month. Alternatively, you may need to hire help (assistant) to help with the workload, travel and platform management. Remember that managing this portfolio will need to be done correctly by not dropping the ball. Sometimes missing items can have a negative effect on your income and the whole direction of the portfolio in its future, which can make you fall back in years instead of moving forwards. There are a few different ways to manage a commercial property. While the ideal set-­up for your situation is best left to the professionals to decide, it’s useful to understand what your options are, because the best structures offer significant tax benefits. Following are some general guidelines for self-­managing:

• • •

Ideally you will have some experience with managing people.

•

You will need to deal directly with the council, tenants, maintenance contracts and so on.

• •

Have a list of the local tradespeople in case of an emergency.

It’s much easier if you live locally to your investment property. You need to be willing to be involved in the day-­to-­day activities of your property.

Make sure you’re on the ground and available in the correct time zone (for example Perth and Sydney have a three-­hour time difference).

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How to manage and understand your tax obligations as an investor Generally speaking, commercial investors pay tax on the net rental income they earn from an investment property, plus tax on any profits they make from the sale of that property. However, the government offers commercial property investors numerous discounts, deductions and exemptions to encourage investment. The way that the tax is calculated depends on the type of entity that owns the property. The great thing about an investment property is that you can claim tax deductions for most expenses incurred while operating the property, including:

•

interest paid on a loan used to buy the commercial investment property

• • • •

travel costs incurred during visits to the commercial property advertising fees repair, maintenance and management expenses depreciation of the building structure and the assets within it.

While each ownership structure is obliged to pay a different rate of tax, each structure can also claim different types of deductions. In addition to the deductions mentioned above, each ownership structure is often entitled to claim a credit for the GST included in the purchase price, as well as the following discounts and deductions. Commercial property also has the added benefit of being able to claim a larger amount of depreciation benefits than residential property. We will explain in more detail below. But first, let’s walk through the different ownership structures.

Individuals If you are the legally recognised owner of the commercial property, the rental income is incorporated into your assessable income and taxed at the individual’s marginal tax rate. 167

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It’s similar for properties with multiple owners. The proportion of rental income attributed to each owner is equal to the size of their legal interest in the property —­ regardless of any agreements between the owners that state otherwise —­ and each portion of the rental income is taxed at the rates that apply to each individual owner. As with residential property, individuals must also pay tax on any capital gains made from the sale of a commercial investment property. The capital gain is added to the individual’s assessable income. Owners will also add goods and services tax (GST) on the sale price if the ‘going concern assumption’ isn’t satisfied. The going concern assumption basically means that both the buyer and the seller are registered for GST, that there is a current lease in place on the property, and that everything necessary is being done to support the continued operation of the business. This means they pay GST on one-­eleventh of the sale price and claim GST credits on purchases that relate to selling the property. But there are exceptions: for example, when you use the margin scheme to work out the GST on the sale of a commercial premises or sell the property as part of a GST-­free sale of a going concern.

A company If you own the commercial property through a company, you’re liable for 30 per cent tax to be paid on the property’s net rental income. This is the same as the current corporate tax rate and is often a lot lower than an individual’s marginal tax rate. The highest tax rate sits at 45 per cent alongside a Medicare levy of 2 per cent (for FY2022–23). Capital gains are also taxed at 30 per cent, unless the company is eligible for one of the four small business capital gains tax concessions offered by the ATO. Like individuals and trusts, companies must also pay GST on one-­eleventh of a commercial property’s sale price if the going concern assumption isn’t satisfied, but they can claim a few GST credits on purchases that relate to selling the property.

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A discretionary trust You can also choose to purchase your commercial property through a discretionary trust. This means the trustee can apportion the rental income from the trust’s property to the beneficiaries however they like, on a discretionary basis. The bonus is that you can get smart about tax. You, or the trustee, can apportion the most rental income to the beneficiary with the lowest marginal tax rate. The beauty of this is that only the beneficiaries who receive an income pay tax; the trust itself doesn’t pay any tax as it is a flow-­through entity. However, the trust must pay GST on one-­eleventh of the sale price if the going concern assumption can’t be satisfied, but it can claim GST credits. This is a no-­go when it comes to negative gearing, though. A discretionary trust can only distribute income to beneficiaries, not losses. But capital losses can be carried forward and offset against future capital gains. And beneficiaries that receive capital gains can apply whatever discount their specific ownership structure entitles them to. Land tax thresholds also need to be considered when using a discretionary trust to purchase properties. Some states, such as NSW, don’t allow any land tax threshold for property owned through a discretionary trust. Fixed or land tax unit trusts can be used in this instance to obtain the land tax threshold; however, these types of trusts don’t offer discretionary distribution to beneficiaries. Distributions need to be made in line with the unit entitlement.

A self-­managed super fund Another popular way to fund a commercial property investment is through your self-­managed superannuation fund (SMSF). It’s tricky, time-­ consuming and expensive, but for the informed investor it offers excellent tax benefits. This is because rental income funnelled into an SMSF is taxed at just 15 per cent during the accumulation phase, which is a lot lower than most investors’ personal tax rate. Better still, it drops to zero once the fund moves into its pension phase. 169

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A couple of things are worth noting. An SMSF pays tax on capital gains, but there are discounts that can be claimed. Furthermore, an SMSF in the pension phase is exempt from capital gains tax. An SMSF is also required to be registered for GST if it owns a commercial property and its annual turnover exceeds $75 000. This means that it will need to pay GST on one-­eleventh of the sale price if the going concern assumption can’t be satisfied, but it can claim GST credits on purchases that relate to selling the property. An SMSF can also acquire commercial property from a member of the fund or a related party, which is not the case with residential property. The transaction needs to be at arm’s length, which means the transfer needs to be made at market value. This is a capital gains tax event for the vendor, but the small business concessions may be applied to help reduce any tax payable. As for capital gains tax, SMSFs are eligible for a capital gains tax discount of 33 per cent during the accumulation phase, as long as the asset is held by the fund for more than 12 months. This means that the fund pays 15 per cent tax on two-­thirds of the capital gain, which is equal to 10 per cent of the total capital gain. And they are eligible for a complete capital gains tax exemption during the pension phase as long as each member’s total super balance is under $1 900 000 from July 2023, meaning they don’t need to pay tax on capital gains made during this period.

How depreciation works on commercial property Property depreciation is a powerful tool that commercial property investors can use to both reduce their taxable income and pay less tax. As such, investors can also increase their cash-flow position by claiming depreciation on their investment properties, making them more profitable post tax return. While depreciation is paper expense and provides taxation benefits, this actually increases the after-­tax net yield.

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As an example, say: A  new purchase —­ $1 000 000 Say net yield is 6 per cent, i.e. $60 000 Say the depreciation for the year is $15 000 Let us utilise the company rate of 30 per cent (for investment entity) and 25 per cent (for trading entity) Hence, tax benefit is $4500 (30 per cent of $15 000) This tax benefit is 0.45 per cent ($4500/$1 000  000) Hence, net yield after tax benefit is 6.45 per cent (i.e. 6 per cent actual and subject to tax as well as 0.45 per cent from taxation benefits from depreciation) We note that 6.00 per cent net yield is pre-­tax return and will be subject to tax, however the depreciation is an additional taxation benefit of 0.45 per cent, which is a true value.

Is depreciation the same for residential and commercial investors? In short, the answer is no. There is an essential difference where commercial investors can claim more in deductions than residential. To explain why, it is worth noting that depreciation deductions apply to investment properties in the following two methods: Deductions will be claimed for the depreciation of building structure popularly known as capital works deductions. Capital works deductions are available for any commercial property that was constructed after 20 July 1982; this includes the period of time when construction commenced. This differs to the residential date, which is 15 September 1987. The other difference is the rate of capital works deductions, which can change across commercial industries, though it remains at the same rate of 2.5 per cent for residential property.

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Deductions can also be claimed for plant and equipment assets available inside the property. This is generally not the case for residential, as in 2017 there was a legislation change meaning that when a residential property is purchased with existing fittings and fixtures with depreciable value, you cannot claim deductions; however, you can with commercial property

YOUR TAKEAWAYS Managing your commercial property is a role you can take on yourself, or you can choose to engage a professional property manager to do it for you. While a property manager will save you considerable time and effort in the long run, it’s also a useful experience to manage one or two properties yourself so you can learn about the pitfalls and mitigate them later as you grow your portfolio. Make sure you understand when all your commercial leases are up for renewal. Also understand what the fair market rent is before agreeing to any new leases. This could make you $100 000 if you can implement fair market review increases. You’ll need to work out the best ownership structure for the property well before you purchase the asset. The costs of unravelling an incorrect structure can be enormous. For example, how does double stamp duty liability sound? Not ideal. It’s important to minimise your tax obligations and set up your finances appropriately, depending on your goals. This should go without saying, but make sure you have a highly qualified property accountant on your team before you purchase a property. Also, understanding the depreciation benefits of a commercial property from day one will allow you to see your post-­tax yield. In many cases your yield will actually improve due to the high number of tax benefits on offer, especially for newer commercial buildings with a high building ratio to land component

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PART II SUMMARY Having completed our eight steps, let’s reflect on our journey so far. Whether you are a seasoned professional or just starting out, there’s always something to learn from seeing how others approach the same challenges. And we love it when others use our guidance to help them achieve property success. You now have all the tools you need to buy a commercial property with confidence. For us, commercial property investment is a measured and informed game of numbers. We’ve learned the hard way that emotion doesn’t help when navigating this world, and neither does trying to do it all ourselves. The stakes are higher in commercial investing, but so are the rewards. Here are the key takeaways for each of our seven steps: 1. Money habits. Don’t forget to build strong saving patterns as you save for your first entry-­level deposit of $100 000 for a residential property and $200 000 for a commercial property. 2. Investment mindset. Developing the right mindset can make the difference between frustration and becoming a higher level of investor. Once you have the right mindset, you can set your goals and confidently work towards realising them. 3. Assembling your expert team. Put simply, commercial property is different and more complicated than residential property. Therefore, consider taking on a new team of experts who focus solely on commercial property. 4. Asset selection. Understanding how the market moves will give you a better foundation on which to make informed decisions. Read up, listen and learn whatever you can. 5. Method of sale. Learn to adapt to each sales method according to the property you’re interested in, so you won’t be let down because you’re unfamiliar with a particular sales technique.

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6. Finance. Your bank is about to become your best friend. Without it, you’re hamstrung, so it’s worth making sure that you understand thoroughly how to finance your property. 7. The negotiations. We have learned through practice that good negotiation is not just about trying to beat a competitor, you need to create win-win situations. It’s also important to walk away from deals. It takes careful management, timing, and of course not letting emotion get in the way. 8. Managing the property and understanding the tax. Understanding the key to the right ownership structure can make a huge difference to your portfolio. It’s always worth investing in professional advice. It takes years of investing experience to truly understand what makes the market tick, but a solid grasp of what happens when, and how best to respond to it, provides a fantastic learning tool. How do you really accelerate in the commercial property market? What do you need to know that goes above and beyond what you read about in the newspapers? In the next part, we’ve done the heavy lifting in order to reveal our Top 5 Property Plays. These are the strategies you can use to get ahead of the game and start building your wealth. As you’ll expect by now, they’ll take you far outside your own backyard.

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PART III

OUR TOP 5 PROPERTY PLAYS

If you’ve made it this far, you’re already miles ahead of the game. Most people don’t understand how the property market really works, and they’re especially uncertain about taking that next step from residential to commercial property. The eight steps we worked through in the previous chapters are the template we use every day, with every deal, so it’s safe to say you now possess some real-­world, informed knowledge and information. You have also neatly sidestepped those who claim to be experts, like Uncle Bob talking about why you shouldn’t invest in commercial property but instead concentrate on buying that house down the road. Which, as we all know, could be a big opportunity cost for your financial future. So what’s next? You need to know when to climb down off the fence and when to sit it out. But if you can’t recognise a good deal, how will you know when to act? The enduring topic of Australian property always makes headlines. Wouldn’t it be nice to be the one telling the story? But to be the storyteller, you must stick to one strategy and become extremely good at it. When it comes to strategies, everyone has their own play. Whether it’s a renovations, developments, high-­yielding assets or just a long-­term capital growth strategy, some deals will yield better results for your personal situation. Picking the correct path is critical for you to reach your financial goals. You need to be informed enough to make sure you’re the one who gets to pull the right trigger. And the way you do that is by learning what works and what doesn’t. Normally this would come down to experience —­ trial and error —­ when working to get a deal over the line. But we’ve been there, and after being involved in more than $3 billion in real estate purchases, we’ve learned a lot about the best property plays. Of course, this didn’t just happen. Our insights have accumulated over many years. They helped us to become extremely astute in our investment decisions and secure great deals because we know precisely what we’re doing. This book is about ‘buying your time back’ through building substantial passive incomes with property. For us, the fastest and most efficient way to do this was though high-­yielding commercial real e­ state.

We continue to fine-tune our approach to make sure we’re investing only in the properties that suit our longer-­term goals, and while this will inevitably change, we know what we want, where we want it and how much we are prepared to pay for it. In this final section of the book we share with you our Top  5 Property Plays to show you how best to use commercial property to your advantage. Following are our Top 5 Property Plays: 1. How to build a $200 000 passive income. Without a doubt, this is the most common question we are asked. How do you do it? 2. How a property can pay itself off in 10 to 12 years. Sounds great, doesn’t it? We’ll take you through the numbers so you can see for yourself how this strategy works. 3. How to increase capital growth with value-­adds. We’ll show you how to identify a value-­add opportunity and how to execute it. 4. How to check the numbers so you don’t overpay. This is a good one. It’s easy to get seduced by the agent’s sweet talk. But never forget they’re not working for you. 5. How syndication can work for you. You’ve heard of syndicates, but how do they work and why should you sign up for one? Let’s get started!

PLAY 1

HOW TO BUILD A $200 000 PASSIVE INCOME Of all the property questions we’re asked, this is one of the most popular. Building a passive income large enough to retire on is the ultimate goal for most investors. Everyone has a different figure; however, a $200 000 per annum passive income is a common objective. It seems to be the magic number for many, whether they are seeking early retirement or the flexibility to work or not as they choose. For early investors this goal may seem all but unattainable, but we can tell you it’s not. At the time of writing, 13 years after we purchased our first property, we have built a portfolio that produces a seven-­figure passive income. We also have 100s of clients that have fully retired from our help through our commercial buyer’s agency Rethink Investing. Within a few years this number should be in the 1000s. Proof, if needed, that time, smart investment decisions and constantly taking action pay off. Creating a passive income should be one of the main goals for any property investor, because without an income from your investments you’ll find it very difficult to pay for your retirement. Which is why we chose this strategy as our top property play. So what does it take?

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Hopefully by now you’ve gained valuable insights into what it requires to build up a portfolio like ours. But there are of course thousands of variations on how to attract a $200 000 passive income through commercial property. For example, you might:

• • •

purchase multiple smaller properties or one larger asset take on more or less debt draw on a residential property to loan into a commercial asset.

As little cash as possible What interests us is creating a $200 000 passive income using as little cash as possible. Table 19 offers a simple demonstration. Table 19: cash-­flow returns based on different debt levels and interest rates (commercial) Based on interest rates at the start of 2023 Commercial purchase price $5 000 000.00 Deposit: 30%

$1 500 000.00

Stamp duty

$285 488.40

Building report*

$1500.00

Solicitor costs*

$8500.00

Valuation*

$5000.00

Total cash required

$1 800 488.40

Purchase price + purchasing costs

$5 300 488.40

Net annual cash-­flow return

$385 000.00

Net yield on property

7.70%

Net yield on property accounting for the purchasing costs

7.26%

* approximate numbers 180

How to build a $200 000 passive income

Now —­ let’s look at the cash-­on-­cash return. Deposit needed: 30% + costs

$1 800 488.40

Cost of loan (5.25% p.a. on 70% debt)

$183 750.00

Cash flow after mortgage costs

$201 250.00

Return on equity (pure cash-­flow return)

11.18%

Return on equity with a 5% capital growth rate

25.06%

Return on equity with a 7% capital growth rate

30.62%

Return on equity with a 10% capital growth rate

38.95%

Based on interest rates in 2019 Commercial purchase price

$5 000 000.00

Deposit: 30%

$1 500 000.00

Stamp duty

$285 488.40

Building report*

$1500.00

Solicitor costs*

$8500.00

Valuation*

$5000.00

Total cash required

$1 800 488.40

Purchase price + purchasing costs

$5 300 488.40

Net annual cash-­flow return

$385 000.00

Net yield on property

7.70%

Net yield on property accounting for the purchasing costs

7.26%

*approximate numbers

Now —­ let’s look at the cash-­on-­cash return. Deposit needed: 30% + costs

$1 800 488.40

Cost of loan (3.25% p.a. on 70% debt)

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Table 19: cash-flow returns based on different debt levels and interest rates (commercial) (cont’d) Cash flow after mortgage costs

$271 250.00

Return on equity (pure cash-­flow return)

15.07%

Return on equity with a 5% capital-­growth rate

28.95%

Return on equity with a 7% capital-­growth rate

34.50%

Return on equity with a 10% capital-­growth rate

42.84%

As you can see, the interest rate at the time of writing our first book was a lot different for this scenario —­ around $70 000 per annum in passive income different, in fact. However, even with the rapid increases in the mortgage rates, this hypothetical $5 million property still clears more than $200 000 per annum in passive income. In this example, the purchase is a $5 million commercial property, with a net yield of 7.7 per cent. This doesn’t have to be one property, either. It may be two or three commercial properties totalling $5 million in value. It’s the value of the portfolio that is important, not the number of properties. Here, we focus on the 70 per cent debt level at a 5.25 per cent and 3.25 per cent interest-­only amount. After 100 per cent of the outgoings were taken out, the commercial asset will return a passive income of $201 250 at the higher interest rate of 5.25 per cent or $271 150 per annum at the 3.25 per cent rate. Sounds good, right? You might now be thinking, how do I come up with $1.8 million in cash to purchase this hypothetical property? This is where we must be real with you. It takes time and a lot of saving and other investing to come up with this much cash. We are not spruiking some zero-­cash-­down strategy that never works in reality. You need equity and/or cash to retire from property. We did it from starting in residential, saving from our jobs and reinvesting passive income and equity in properties at every chance. It took us about eight years to reach this number. What happens if you invest the same $1.8 million into residential property? 182

How to build a $200 000 passive income

Commercial versus residential Let’s look a little deeper and put those numbers in perspective. Say you owned six residential properties worth $833 000 each with the same debt levels —­ that sounds like a retirement-­grade portfolio, right? Table 20 shows the numbers on a single property with the 70 per cent debt at the same interest rate as above. (Note: commercial mortgage rates are basically the same as residential interest rates, if not better.) Table 20: single property with 70 per cent debt Commercial purchase price $833 000.00 Deposit: 30%

$249 900.00

Stamp duty

$32 000.00

Building report*

$600.00

Solicitor costs*

$4000.00

Total cash required

$286 500.00

Purchase price + purchasing costs

$869 600.00

Gross annual cash flow return

$33 320.00

Total costs (rates, water, insurance, management etc)

$10 500.00

Net yield on property

2.74%

Net yield on property, accounting for the purchasing costs

2.62%

* approximate numbers

Now let’s look at the cash-­on-­cash return. Deposit needed: 30% + costs

$286 500.00

Cost of loan (5.25% p.a. on 70% debt)

$30 612.75

Cash flow after mortgage costs

$(7792.75)

Return on equity (pure cash flow return)

-­2.72% (continued)

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Table 20: single property with 70 per cent debt (cont’d) Return on equity with a 5% capital growth rate

11.82%

Return on equity with a 7% capital growth rate

17.63%

Return on equity with a 10% capital growth rate

26.36%

Now let’s turn this into a $5  million portfolio to compare apples with apples. Table 21 represents six of these properties combined. Table 21: six properties combined Commercial purchase price $4 998 000.00 Deposit: 30%

$1 499 400.00

Stamp duty Building report

$192 000.00 $3600.00

*

Solicitor costs*

$24 000.00

Total cash required

$1 719 000.00

Purchase price + purchasing costs

$5 217 600.00

Gross annual cash-­flow return

$199 920.00

Total costs (rates, water, insurance, management etc)

$63 000.00

Net yield on property

2.74%

Net yield on property accounting for the purchasing costs

4.20%

* approximate numbers

Now let’s look at the cash-­on-­cash return.

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How to build a $200 000 passive income

$1 719  000.00

Deposit needed: 30% + costs Cost of loan (5.25% p.a. on 70% debt)

$183 676.50

Cash flow after mortgage costs

$(46 756.50)

Return on equity (pure cash-­flow return)

-­2.72%

Return on equity with a 5% capital-­growth rate

11.82%

Return on equity with a 7% capital-­growth rate

17.63%

Return on equity with a 10% capital-­growth rate

26.36%

As you can see, the circa $5 000 000 pure residential portfolio shows a total passive income return of negative $46 756 after outgoings and mortgage costs. Clearly you could never retire from this income. Some residential experts might then tell you that you must sell down some properties to pay the others off. Table 22 looks at this situation to see if it’s any better if you just did a straight cash purchase on two properties totalling $1 700 000. Note: this uses the same $1 800 000 cash after purchasing costs as the two previous case studies. Table 22: straight cash purchase of two properties Residential purchase price $1 700 000 Deposit: 100%

$1 700 000.00

Stamp duty

$84 000.00

Building report*

$1200.00

Solicitor costs*

$8000.00

Total cash required

$1 793 200.00

Purchase price + purchasing costs

$1 793 200.00

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Table 22: straight cash purchase of two properties (cont’d) Residential purchase price $1 700 000 Gross annual cash flow return

$68 000.00

Total costs (rates, water, insurance, management etc)

$21 000.00

Net yield on property

2.76%

Net yield on property accounting for the purchasing costs

2.62%

Now let’s look at the cash-­on-­cash return. Deposit needed: 30% + costs

$1 793 200.00

Cost of loan (5.25% p.a. on 0% debt)

$0.00

Cash flow after mortgage costs

$47 000.00

Return on equity (pure cash-­flow return)

2.62%

Return on equity with a 5% capital-­growth rate

8.53%

Return on equity with a 7% capital-­growth rate

10.43%

Return on equity with a 10% capital-­growth rate

13.27%

The numbers don’t lie. Even with a debt-­free $1 700 000 asset base, you are only creating a $47 000 passive income. This is without having the leveraging benefits compared to the versions with debt. As you can see, as soon as you apply growth to the equations you get a much better return on equity. Don’t forget, leverage is one of the single greatest benefits of investing in property in Australia. It’s how you amplify your returns over time. Table 23 makes this crystal clear for each scenario. To sum up, there is no possible situation where you could build a $200 000-­ plus income out of residential unless you used multiple times more cash deposits. Even then, the low yields and the fact you have to pay for all the outgoings in residential property makes it a highly inefficient way to invest.

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Table 23: commercial vs residential cash-­flow returns Interest ($)

Total LVR (%)

Annual rent ($)

70

385 000 183 250

Total Out­goings ($)

Pre-­tax cash return ($)

Property

Current value ($)

Total loan ($)

Commercial property (with 70% loan)

5 000 000

3 500 000

6 houses at 4% gross yield (70 debt)

4 998 000

3 498 600 70

199 920

183 676.5 63 000

-­4 6  756.5

2 houses at 4% gross yield (no debt)

1 700 000

0

68 000

0

47 000

0

0 tenant pays

21 000

201 250

The numbers always tell the true story. But you already knew that, right? We’ll leave you with that thought  …  You can see why we prefer commercial property.

YOUR NEXT MOVES • Commercial property is the most efficient way to build a retirement-­ grade income. However, like all property, it’s a cash-­intensive investment class. You need to generally work off 30 per cent deposits, so it can take time to be able to afford the right types of properties. • You can use equity in your houses or residential properties to move into commercial properties. So you don’t just have to rely on cash savings. • Always compare apples with apples. As you can see above, have a look at the income your deposit can generate for you.

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PLAY 2

HOW A PROPERTY CAN PAY ITSELF OFF IN 10 YEARS In a perfect world, we’d have our investment properties lined up in an easy set-­and-­forget format. We’d sit back and pay them off effortlessly every month until the debt disappears. To most investors the idea that a property could pay itself off, without any external help, seems far-­fetched. However, when it comes to commercial property, this is a genuine strategy that has worked for 1000s of investors over the years. The only reason it can work is because of the high-­income nature of the asset class and the fact that outgoings can be absorbed by your tenants. Unfortunately, this paydown strategy will remain a pipe dream if you haven’t set up your investments the right way. Obstacles have a habit of cropping up when you least expect them, and you’ll need to be able to cover them. You could end up having to shell out more than you thought, and this could easily chew into your cash reserves, especially if your goal is to follow us over the fence and pay off your property in 10 years. What we want to impress on you is that the best way to pay off property is through solid financial planning. And a strong part of this is due diligence. Don’t think you can avoid it, because ensuring you have done your homework is your insurance when you seek to pay down debt faster. Full stop. While there is more due diligence to do for a commercial property than a residential property, it’s worth every cent to get it right. The returns are larger, and you’ll also benefit from the capital growth and built-­in rental increases. 189

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For this property play, good financial planning involves three key factors: great asset selection, a high yield, and a strong continuous lease. This will give you a better chance of uninterrupted cash flow over a long period of time, which in turn will increase the chances of your being able to pay your properties off faster. In Part II we outlined the best ways to choose your commercial asset. Let’s consider two of the most essential aspects of asset selection now.

Higher net yields Yields must be high enough to produce a positive income from day one —­ even with 100 per cent debt. Why 100 per cent debt? I like using this rule as many people look to refinance their house to access a deposit for a commercial purchase. Since you are increasing the debt on your home, you need to work from 100 per cent debt calculations, so you have all of the interest rate costs covered in your cash flow equation.1 You may remember that earlier in the book we talked about hitting a yield ceiling in the residential market, which is what prompted us to hop over the fence into commercial. When writing the first edition of this book, interest rates were in the 3 per cents, but with this second edition, they were in the 5 per cents. However, if you take a long-­term view of where rates are likely to be, changes in interest rates will be less important to you as an investor. We play the game of averages and don’t ride on every RBA meeting results. What follows is a guide to the yields we have applied for investor clients and ourselves.

The 100 per cent debt is from borrowing the deposit from your home. For example: you have a $1  million home with $500 000 debt. You might increase your loan on your home to 80 per cent. This means your new home debt is $800 000. However, because the debt is higher you have access to a cash loan amount of $300 000. You can use this as a deposit on a commercial property. This $300 000 can be used to buy a $1 million property once a new loan is written. So your $300 000 is a loan and the $700 000 amount to buy the $1 million property is also a loan. Hence, 100 per cent debt. 1

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How a property can pay itself off in 10 years

•

Net yield less than 5 per cent. These properties don’t interest us. We see this to be below the long-­term expected interest rate. So, you wouldn’t cover a 100 per cent debt scenario unless there was instant rental upside.

•

Net yield 5–­6 per cent. These properties do interest us, however, they are at the lower end of our acceptable yield so we would want to be compensated by other investment strengths. Such as:



–

–

High quality tenant (such as, global brands, medical tenants).


–


Long leases (5–­10 years gives investor great security which can compensate you the yield).


–


Upside in rent (if the property is under-­rented on a square meter basis, then it’s okay to accept a lower yield because eventually you can push the rent higher to match the market).


–


High rental growth scheduled (many leases have CPI increase or 4–­5 per cent fixed increases per annum. A few years of these high rental increases in the lease will make your yield look better over time).

High growth corridors (such as, areas undergoing major changes for the better. This will give you an upside in the future, just like a residential growth strategy).

•

Net yield 6–­7 per cent. Over the years this is the range where most of our best deals have been purchased. A yield in this range often gives you the best of both worlds: growth and income. They are generally high-­quality capital city type properties or regional properties with global brands.

•

Net yield 7–­8 per cent. Mostly found in regional areas. Great income returns but can often be associated with lower long term rental growth.

•

Net yields 8+ per cent. Do your due diligence with these properties. There is generally a reason for a yield over 8 per cent. These could be:



–

–

A shorter lease. A small town. 191

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–

–
–


Tougher to finance. An older building needing maintenance. Riskier tenants.

In summary, we don’t think that a higher yield better. But don’t go too low on the yield spectrum, otherwise the asset will never ‘wash its own face’ and clear its debt in time. You need a balance of both good yield and stability. This will ensure you have the best chance of receiving an uninterrupted passive income over a long period of time.

Strong debt reduction strategy Once you’ve selected your asset with a good yield in place, your next aim is to reduce the debt faster. A great method of achieving this is to use the high net incomes from your commercial properties’ rent to pay down the loans 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 13 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 your 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. So, it’s very important to focus on rental growth as an investor, as this over time is more important than your day-­one yield. Interest rates come into play too, and over the last decade they have averaged out in the 5 per cents. Using the handy debt reduction calculator on our website (www .rethinkinvesting.com.au/property-­investment/calculator/), as illustrated in table 24, you can plug in the numbers on a commercial property to discover how long it would take to pay off your debt. 192

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Year 0

Year 1

Year 2

Rent received $70 000.00

$73 150.00

$76 441.75

Yearly yield 7.00% Interest paid $38 500.00 Cash flow $31 500.00 (rent less interest) Return on equity 8.99% (pure cash flow return) Principal paid $31 500.00

Year 4

Year 5

Year 6

Year 7

Year 8

$79 881.63 $83 476.30

Year 3

$87 232.74

$91 158.21

$95 260.33

$99 547.04

7.32%

7.64%

7.99%

$36 767.50

$34 766.46

$32 474.32 $29 866.92

8.35%

Year 9 $104 026.66

Year 10

Year 11

Year 12

Year 13

Year 14

Average

$108 707.86

$113 599.71

$118 711.70

$124 053.73

$129 636.14

$96 992.25

8.72%

9.12%

9.53%

9.95%

10.40%

10.87%

11.36%

11.87%

12.41%

12.96%

9.70%

$26 918.40

$23 601.12

$19 885.48

$15 739.86

$11 130.46

$6021.17

$373.40

$-­5854.04

$-­12  705.16

$-­20  226.90

$15 817.27

$36 382.50

$41 675.29

$47 407.31

$53 609.38

$60 314.33

$67 557.09

$75 374.85

$83 807.18

$92 896.20

$102 686.69

$113 226.31

$124 565.74

$136 758.88

$149 863.04

$81 174.99

10.38%

11.89%

13.53%

15.30%

17.21%

19.27%

21.50%

23.91%

26.50%

29.30%

32.30%

35.54%

39.02%

42.76%

23.16%

$53 609.38

$60 314.33

$149 863.04

$36 382.50

$41 675.29

$47 407.31

$67 557.09

$75 374.85

$83 807.18

$92 896.20

$102 686.69

$113 226.31

$124 565.74

$136 758.88

Principal remaining $700 000.00 (start of year)

$668 500.00

$632 117.50

$590 442.21 $543 034.91 $489 425.52 $429 111.19

$361 554.10

$286 179.25 $202 372.06

$109 475.86

$6 789.18

$-­106  437.13

$-­231  002.87 $-­367  761.76

Principal remaining $668 500.00 (end of year)

$632 117.50

$590 442.21

$543 034.91 $489 425.52 $429 111.19

$286 179.25

$202 372.06 $109 475.86

$6 789.18

$-­106  437.13

$-­231  002.87 $-­367  761.76 $-­517  624.80 $206 411.68

$361 554.10

$81 174.99 $287 586.67

Value at same $1 000 000.00 $1 045 000.00 $1 092 025.00 $1 141 166.12 $1 192 518.60 $1 246 181.94 $1 302 260.12 $1 360 861.83 $1 422 100.61 $1 486 095.14 $1 552 969.42 $1 622 853.05 $1 695 881.43 $1 772 196.10 $1 851 944.92 $1 385 603.62 cap rate as when you purchased

Purchase price $1 000 000.00

Total cash required $350 500.00

Total loan (assuming 70%) $700 000.00 Deposit (30%) Stamp duty

Year 1 net rental income

$70 000.00

Yearly review 4.5%

$300 000.00 $40 000.00

Term of ownership

Valuation cost

$3 000.00

Loan interest rate 5.5%

Solicitor cost

$6 500.00

Other purchasing costs $1 000.00

15 years

Debt reduction (1=true. 0=false) 1 % of profit used for debt reduction 100

Table 24: Rethink Investing debt reduction calculator

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In this example the property has a 7.5 per cent net yield and 4 per cent annual increases in its rent. The property is completely paid off in 10 years, without the owner having to inject any of their own funds. In this scenario, the passive income at the end of year 10 would be $109 750 without any debt remaining. So that’s retirement for most people with one property! Table 25, also drawn from the RI calculator, shows the numbers for the first 10 years. Note: If this particular property had a lower yield or lower rental growth figure it would take longer for the property to pay itself off. We don’t see this as a big issue as the quality of your investment is more important than trying to take a risky yield. 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 lead to longer vacancies should your current tenant ever leave, and longer vacancy periods would obviously lengthen your loan payback timeframe. These types of returns can only be gained from commercial property, 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. In fact, commercial property is one of the best asset classes for the handling of reducing tax. This is because you can claim on many aspects of the property (building, fixtures, fit outs, capital works, etc.). 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! 194

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Year 0

Year 1

Rent received $75 000.00

$78 000.00

Yearly yield 7.50% Interest paid $35 000.00 Cash flow(rent $40 000.00 less interest) Return on equity 11.30% (pure cash flow return) Principal paid $40 000.00

Year 2 $81 120.00

Year 3 $84 364.80

Year 4

Year 5

$87 739.39

$91 248.97

Year 6 $94 898.93

Year 7 $98 694.88

Year 8

Year 9

$102 642.68

Year 10

Year 11

Year 12

$106 748.39 $111 018.32

$115 459.05

$120 077.42

Year 13 $124 880.51

Year 14

Average

$129 875.73

$100 117.94 10.01%

7.80%

8.11%

8.44%

8.77%

9.12%

9.49%

9.87%

10.26%

10.67%

11.10%

11.55%

12.01%

12.49%

12.99%

$33 000.00

$30 750.00

$28 231.50

$25 424.83

$22 309.11

$18 862.11

$15 060.27

$10 878.54

$6 290.34

$1 267.43

$-­4  220.11

$-­10  204.07

$-­16  718.14

$-­23  798.08 $11 475.58

$45 000.00

$50 370.00

$56 133.30

$62 314.56

$68 939.86

$76 036.81

$83 634.61

$91 764.14

$100 458.05 $109 750.89

$119 679.16

$130 281.49

$141 598.66

$153 673.81

$88 642.36

12.71%

14.23%

15.86%

17.60%

19.47%

21.48%

23.63%

25.92%

28.38%

33.81%

36.80%

40.00%

43.41%

25.04%

$45 000.00

$50 370.00

$56 133.30

$62 314.56

$68 939.86

$141 598.66

$153 673.81

$88 642.36

$76 036.81

$83 634.61

$91 764.14

$100 458.05 $109 750.89

$119 679.16

$130 281.49

$377 242.28

$301 205.47

$217 570.86

$125 806.72 $25 348.67

$-­84  402.21

$-­204  081.38 $-­334  362.86 $-­475  961.52 $229 511.66

$377 242.28 $301 205.47

$217 570.86

$125 806.72

$25 348.67

$-­204  081.38 $-­334  362.86 $-­475  961.52 $-­629  635.33 $140 869.30

Principal remaining $700 000.00 $660 000.00 $615 000.00 (start of year)

$564 630.00 $508 496.70 $446 182.14

Principal remaining $660 000.00 $615 000.00

$508 496.70 $446 182.14

$564 630.00

31.00%

$-­84  402.21

(end of year) Value at same $1 000 000.00 $1 040 000.00 $1 081 600.00 $1 124 864.00 $1 169 858.56 $1 216 652.90 $1 265 319.02 $1 315 931.78 $1 368 569.05 $1 423 311.81 $1 480 244.28 $1 539 454.06 $1 601 032.22 $1 665 073.51 $1 731 676.45 $1 334 905.84 cap rate as when you purchased

Purchase price $1 000 000.00

Total cash required $354 000.00

Total loan (assuming 70%) $700 000.00 Deposit (30%) Stamp duty

Year 1 net rental income

$75 000.00

Yearly review 4%

$300 000.00 $40 000.00

Term of ownership

Valuation cost

$2500.00

Loan interest rate 5%

Solicitor cost

$6500.00

Other purchasing costs $5000.00

15 years

Debt reduction (1=true. 0=false) 1 % of profit used for debt reduction 100

Table 25: Investment performance over 10-­year period

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YOUR NEXT MOVES • The key to an effective pay-­down strategy working well is to have continuous rent coming in. Focus on properties with long-­term tenants who appear to be staying for a very long time. For example, a vet or dentist, or a warehouse leased by an established business happy in their location. Properties that are under-­rented also indicate there’s less chance the tenant would want to move elsewhere for a better deal. • Aim for properties with strong relettability, so if you ever did lose your tenant, you could replace them quickly. • Work hard to make sure you have the best financing deal. 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/ • Pick properties with high yields. It goes without saying that the higher the yield, the faster you can reduce your debt. Just be careful not to chase a deal solely on the basis of its high yield, as this might lead to a riskier purchase.

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PLAY 3

HOW TO INCREASE CAPITAL GROWTH WITH VALUE-­ADDS This property play is about creating equity! This is done through value-­add strategies and selecting the right type of assets that will deliver you above-­average capital-­growth returns. As we mentioned earlier in this book, one of the biggest myths about commercial property is that it doesn’t enjoy strong capital growth or have as many value-­add opportunities as residential. Which is simply not true. So we thought we would dedicate a chapter to this topic as creating equity from these two methods is how you will make a high percentage of your total profits. Over the years we have been fortunate enough to have been involved in countless numbers of investments that have had significant upside, generating instant returns. We have also been very successful over the years in targeting asset types that have generated above-­average capital-­ growth returns for our investors. I personally feel that picking capital-­ growth markets in commercial property is easier than picking residential, as the commercial numbers tell you more of a story than the residential market, which is controlled more by sentiment. When it comes to implementing a value-­add strategy on a commercial investment, we’ve developed our own preferences over the years, and I am excited to share them with you. In this section we will also go into certain asset types and the opportunities that might come with each of them. Because not all commercial properties (or asset classes) are created equal. 197

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The property and its capital growth But first things first. Before you start bidding on properties, you must determine what type of commercial property you want. It’s almost as important as choosing between shares and houses, as each subsector of the commercial property market can perform vastly differently depending on the economy. We’ve introduced you to the key asset types and our recommendations for where to invest based on factors such as location, visibility, parking and layout. But we want you to get more bang for your buck, so let’s drill deeper into which properties can deliver the best results. As you know, there are many different property types and, depending on the economy and other factors, they will perform differently at different times. Following are examples of commercial properties we like (and some less so). The case studies illustrate clearly why these particular properties are high performers.

Industrial For almost a decade we have been investing heavily into industrial-­type properties. This is currently one of the most competitive subsectors of the commercial market due to a few key reasons:

•

Low vacancy rates. At the end 2022, CBRE released a market report stating that industrial vacancy rates were the lowest in the developed world, being only 0.8 per cent. Low vacancy rates cause strong rental growth, plus they reduce the risk of long vacancies.

•

E-­commerce continues to grow. With more and more people ordering products online, there is a greater need for manufacturing, logistics and storage capabilities. This all falls under the roof of an industrial property. This has boosted investors’ confidence in the asset class.

•

Rising building costs. This is good for existing industrial warehouses as if it costs more to replace them, it will be harder to supply more properties at the right price. If supply is less than demand, capital growth is expected. 198

How to increase capital growth with value-­adds

We are having great success in finding our clients quality on-­ and off-­ market industrial properties in price points from as cheap as $500 000 to more than $15 million. But no matter what the price, when they are well-­located industrial properties that have good access to local amenities, tenants can be easy to find. The best types of tenants include trade-­related businesses, mechanics, next-­day delivery companies, logistics companies, online businesses, manufacturers, cool-­ room storage and engineering companies. Also —­ COVID-­ 19 wasn’t a big disruptor for many of the types of businesses that operate out of industrial warehouses. This has contributed to this sector’s above-­average capital growth as more investors than ever felt comfortable with this asset class. If you purchased an industrial property in 2019–20, there is a good chance you benefited from more than 50 per cent growth in the three years that followed. If you put the same money in a CBD office space, you would be lucky to have had half that growth; demonstrating how important it is to invest in the right asset class at the right time.

CASE STUDY High-­yielding freehold industrial property We secured this investment for one of our clients in the rapidly growing industrial market of late 2022. Purchase price: $2 815 243; net yield: 7.30 per cent We purchased it direct from a fund manager, completely off-­market.

Fast facts • Purchase price: $2 815 243 • Net income: $205 560 —­ tenant pays all outgoings • Land holding significant: 4218 square metres • Building area: 1714 square metres

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• Net yield: 7.30 per cent • Frontage: 60.2 metres on a busy road • Asking price: $3 000 000 (6.85 per cent net) • Negotiated price: $2 815 560 (7.30 per cent net)

Why we liked this asset • In a major Queensland regional market close to the airport • A great net income of 7.30 per cent, meaning it would be an in-­ demand-­t ype asset even if interest rates were higher • Low vacancy rates in the industrial market, causing rental growth in the area. This gave us confidence we will see a steady flow of capital growth for the asset. Table 26 breaks down this purchase.

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Table 26: commercial purchase price $2 815 243 Deposit: 35%

$985 335.05

Stamp duty

$153 176.49

Building report*

$1 000.00

Solicitor costs

$8500.00

Valuation*

$4000.00

*

Total cash required

$1 152 011.54

Purchase price + purchasing costs Net annual cash flow return

$2 981 919.49 $205 560

Net yield on property

7.30%

Net yield on property accounting for the purchasing costs

6.89%

* approximate numbers

Now let’s look at the cash-­on-­cash return. Deposit needed: 35% + costs

$1 152 011.54

Cost of loan: 5.25% p.a. on 65% debt Cash flow after mortgage costs

$91 495.40 $114 064.60

Return on equity (pure cash-­flow return)

9.90%

Return on equity with a 5% capital-­growth rate

22.12%

Return on equity with a 7% capital-­growth rate

27.01%

Return on equity with a 10% capital-­growth rate

34.34%

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Retail Retail properties are often the easiest types of properties to understand if you have a residential-­investor background, because most people can relate them to their own retail consumer experiences. As a result, this can make retail investment a popular category, which in turn can cause yields to be lower than they typically should be for their specific quality compared to other asset classes such as office and industrial properties. However, in recent years we have seen retail investments become a little less desirable than a similar-­quality industrial deal, meaning the yields have got better. COVID-­19 caused many investors to unfairly judge that all retail will struggle. This is where we believe there is an opportunity to benefit from this negative sentiment. Good-quality retail investments can often be the pinnacle of the commercial world. For example, shopping centres with good-­quality essential services such as supermarkets, medical tenants and food-­related businesses. So as people realise that good-­quality retail assets are here to stay, there should be an opportunity to get above-­average capital growth as the yields return to their historical comparable norms. Something to watch out for: the location is absolutely crucial to the performance of many retail properties, which tend to charge higher rent per square metre than other commercial property types. For these investments, good foot traffic for their specific customers is essential, and they need to have the right balance between neighbouring tenants too. For example, you wouldn’t want too many hairdressers competing for business in one location.

CASE STUDY Shopping centre purchased for $11.8 million attracts 8.22 per cent net return We acquired this high-­yielding, fully tenanted shopping centre on behalf of our client in 2019.

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Fast facts • Net income: $971 500 • Significant land holding of 9925 square metres • Building area: 3500 square metres • Net yield: 8.22 per cent • Number of tenants: 12 • Asking price: $13 000 000 (7.47 per cent net) • Negotiated price: $11 800 000 (8.22 per cent net)

Why we liked this asset • An excellent tenancy mix of 12 tenants (80 per cent medical/health and supermarket) • Performed well even under COVID-­19, as the high proportion of medical and supermarket trade keeps the centre strong • At an 8.2 per cent net income, a very good buy in the market. We predicted this would be a good capital-­growth asset due to the high yield, allowing room for yield compression, rental growth potential and a stable tenancy mix.

Predictions well placed Our predictions of growth turned out to be well placed. In 2023 the valuation on this property was $15 400 000, which represented 30.5 per cent growth —­ a very good number considering the asset was clearing more than half a million dollars every year even after all the mortgage costs.

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To be clear, we’re not big fans of many types of retail investments. As mentioned, there is a general weakness in the retail shopfront markets. However, there are well-­tenanted exceptions well worth pursuing —­ for example, multi-­ tenant investments like this one, allied medical-­ t ype tenants in retail precincts, or any retail property that has a solid trading history and you’re confident there is a need for their services into the long term. Look for ‘destination’ retail assets —­ such as hairdressers, dentists, and cafés —­ where you need to visit the physical store to use their services so it can’t be moved online.

Another example of a retail investment we don’t like is the overpriced one. Here’s a sale from early 2023 that makes no sense to us.

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CASE STUDY Guzman y Gomez–leased restaurant investment sold on 3.81 per cent This investment sold for $6.3 million in an off-­market at an incredibly low yield of 3.81 per cent. This Guzman y Gomez is located in Orange NSW and was sold to a Sydney-­based private investor.

Fast facts • Net income: $240 000 • Lease: 20 years with 3 per cent fixed • Building area: 900 square metres • Land area: 1700 square metres • Net yield: 3.81 per cent • Number of tenants: 1

Why we don’t like this asset Mainly, this is massively overpriced —­ $6 300 000 for a single-­ tenant property in a regional city leaves no room for growth. The asset only generates about $25 000 passive income with a 65 per cent mortgage at a 5.25 per cent interest rate. As an investor I would be hoping to see a passive income of more than $200 000 for a $6 300 000  investment. Because of the terrible return this investor has bought into, the chance for capital growth will be much lower. One of the biggest mistakes we see investors make is that they fall in love with a long lease or a brand of tenant. However, the lease is only as good as the business running it and there is no guarantee a business can last 20 years in a location. The yield for a regional location such as Orange NSW may be low, however, this book aims to educate investors on how to avoid overpaying for investments like this one. Table 27 (overleaf) provides a breakdown of the purchase.

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Table 27: commercial purchase price $6 300 000.00 Deposit: 35%

$2 205 000.00

Stamp duty

$376 488.40

Building report*

$1 000.00

Solicitor costs

$8000.00

Valuation*

$6000.00

*

Total cash required

$2 596 488.40

Purchase price + purchasing costs

$6 691 488.40

Net annual cash flow return

$240 000.00

Net yield on property

3.81%

Net yield on property accounting for the purchasing costs

3.59%

* approximate numbers

Now let’s look at the cash-­on-­cash return.

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Deposit needed: 35% + costs

$2 596 488.40

Cost of loan: 5.25% p.a. on 65% debt

$214 987.50

Cash flow after mortgage costs

$205 012.50

Return on equity (pure cash-­flow return)

0.96%

Return on equity with a 5% capital-­growth rate

13.10%

Return on equity with a 7% capital-­growth rate

17.95%

Return on equity with a 10% capital-­growth rate

25.23%

Office space

At the time of writing this book, the office sector of commercial investments is not the most popular one. COVID-­19 has put into question the need for businesses to occupy as much space as they once did. Vacancy rates in Australian capital cities roughly doubled due to the pandemic. So the question you might ask is, why would I invest in this asset class? All good investors might understand that when others are fearful there might be an opportunity to get a very good deal. If you can buy well there is a chance to get an above-­average yield, and this could contribute to above-­ average capital growth as the office market slowly recovers. It’s also worth remembering that office markets have grown on average 5.63 per cent since 1995. I believe that as Australia’s immigration levels return to their historical norms, there will be a slow reduction in the vacancy rates around the country. This will strengthen the office markets in some areas. Many different industries need an office from which to operate, which ensures a wide pool of potential tenants. Often office tenants are high-­ quality tenants too, as professional firms are more likely to maintain the building and fit-­out to a higher standard than other commercial tenants. Car spaces are extremely valuable in office properties. A higher car space:floor space ratio can make your property more attractive to tenants and as an investment. So, although you need to be careful with 207

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this asset class, there is always an opportunity to get a good return on investment if you pick the right asset, get a great yield, and purchase in an improving market.

CASE STUDY Office space with allied health tenant Purchase price $1 725 000, net yield 6.78 per cent We secured this investment for a client in late 2022. The property is in a premium location and comes with a medical tenant on a 5+5-­year lease.

Fast facts • NLA: 154 square metres • Current total net income: $117 000 • Location: Brisbane City • Lease: 5+5 years • Outgoings: 100 per cent payable by the tenant • Asking price: $1 850 000 • Negotiated price: $1 725 000 This is an example of an office property we rate highly. It’s in a small complex, which makes it stand out from the big CBD towers. Due to this you have less supply competition, which should help with rent growth over time. Table 28 (overleaf) breaks down this purchase. The tenant is also a good one, being in the medical field.

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Table 28: Commercial purchase price $1 725 000 Deposit: 35%

517 500

Stamp duty

86 209.26

Building report*

$600.00

Solicitor costs

$7000.00

Valuation*

$3000.00

*

Total cash required

$614 309.26

Purchase price + purchasing costs Net annual cash flow return

$1 821 809.26 $117 000.00

Net yield on property

6.78%

Net yield on property accounting for the purchasing costs

6.42%

* approximate numbers

Now let’s look at the cash-­on-­cash return. Deposit needed: 35% + costs

$614 309.26

Cost of loan: 5.25% p.a. on 65% debt

$63 393.75

Cash flow after mortgage costs

$53 606.25

Return on equity (pure cash-­flow return)

8.73%

Return on equity with a 5% capital-­growth rate

22.77%

Return on equity with a 7% capital-­growth rate

28.38%

Return on equity with a 10% capital-­growth rate

36.81%

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The types of office spaces we would be wary of are assets that have these weaknesses:

• • • •

old buildings in disrepair high-­rise buildings that have a lot of vacancy markets where you need to offer large incentives to attract tenants offices with no competitive advantage such as limited car parking, no views, poor layout, poor location etc.

The types of office spaces we like:

• • • • •

freehold investments newer buildings if they’re part of a strata high car space ratios good facilities offices with a view!

Specialty Outside the three main types of commercial asset classes is the specialty sector. This is for single-­use properties such as car washes, childcare centres, service stations and so on. There is added risk in this sector: if the tenant of your property site fails financially, it could be more difficult to find a new one. However, as the businesses themselves are often worth money, the owners simply won’t let them fail if they are wanting to retire or move on. The business itself is instead sold on to a new operator and part of the business’s value is associated with a strong lease. So specialty commercial properties are known to have strong leases. Due to this strength in lease, many investors target these types of assets, creating strong demand in most markets. This is good for capital growth. You can generally expect strong rental growth from these assets. For example you might have 4 per cent annual increases on a 10-­year lease. If you get 4 per cent per annum compounding, that equals a total rental and capital growth rate of 48 per cent over that 10-­year period. If there is yield compression, you will get more growth on top of this figure. 211

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These types of assets generally hold their value well through property downturns. This consistency makes it a good investment if you want predictable capital growth that roughly mirrors the increases in the lease each year.

CASE STUDY Brand-­new childcare on 15-­year lease This deal, secured for our clients in early 2022, was purchased off-­market and only Rethink Investing got to see it. We were pretty excited to lock this one in as it was a rare opportunity to purchase a one-­of-­a-­kind, brand-­ new childcare property close to the Perth CBD. As you can see the yield is lower than some of our other investments; however, the investor valued the 15-­year lease and there were also great depreciation benefits, which would add about 0.5 per cent to the net yield. Table 29 breaks down this purchase. It’s located in an established community retail strip  5  kilometres from Perth’s CBD, with a 15-­year lease in place and option to 2046.

Fast facts • Location: Perth • Building area: 528 square metres internal over 2 floors + additional outdoor areas • Land area: 814 square metres freehold site • Lease: 15+10-­year lease • Position: 76-­place centre in prime catchment area • Annual income: $295 000 p.a. + outs + GST • Security: $148 500 bank guarantee

Why we liked this property • Brand-­new building = very high depreciation (which added about 0.5 per cent to the post tax yield, not factored in the numbers that follow) • High-­quality building for this price point

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Table 29 (overleaf) breaks down this purchase.

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Table 29: Commercial purchase price $5 575 000.00 Deposit: 35%

$1 951 250.00

Stamp duty

$288 743.00

Building report*

$900.00

Solicitor costs

$7500.00

Valuation*

$4000.00

*

Total cash required

$2 252 393.00

Purchase price + purchasing costs

$5 876 143.00

Net annual cash flow return

$303 850.00

Net yield on property

5.45%

Net yield on property accounting for the purchasing costs

5.17%

* approximate numbers

Now let’s look at the cash-­on-­cash return. Deposit needed = 35% + costs

$2 252 393.00

Cost of loan (5.25% p.a. on 65% debt) Cash flow after mortgage costs

$190 246.88 $113 603.13

Return on equity (pure cash flow return)

5.04%

Return on equity with a 5% capital growth rate

17.42%

Return on equity with a 7% capital growth rate

22.37%

Return on equity with a 10% capital growth rate

29.80%

Showroom

Showroom investments are another asset class where we expect to see relatively strong capital-­growth rates. There are several reasons for this. 214

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Firstly, they are a relatively scarce type of property. Good showrooms are located on high-­exposure roads and take up a lot of space. As a result, there is limited amount of stock compared to other asset types like warehouses or offices, which can be found in many more locations away from main arterial roads. Showrooms are often tightly held as well; they come with potentially very long leases to well-­k nown national tenants (e.g. BCF, Petbarn, Total Tools, Harvey Norman, Fantastic Furniture). Often they come with attractive rental increases built into leases, which helps contribute to rental and capital growth. These types of investments can also be viewed as a hybrid between a warehouse and a retail investment. Sharing the strengths from both these asset classes makes them generally a little easier to rent.

CASE STUDY Entry-­level showroom investment Purchase price $1 070 000, net yield 6.02 per cent This commercial property was recently secured by the Rethink Investing acquisitions team on behalf of a client. The property comes with a global tenant on a three-­year lease. This investment clears over $25 000 per annum in passive income. This is after 100 per cent of the outgoings and a 70 per cent mortgage cost at the current interest rates!

Fast facts • Net income: $64 400 per annum • Tenant: a global tenant • Building area: 560 square metres • Location: WA • Lease: triple net —­ meaning tenant pays land tax, rental management and 100 per cent of the outgoings

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• Asking price: $1 150 000 (5.6 per cent net) • Negotiated price: $11 400 000 (6.02 per cent net) This is our client’s second property with Rethink Investing. They are a busy professional who is looking to replace their income in time. Their first property was a high-­yielding industrial property in Queensland. The pair of properties now give them more than $50 000 in passive income. Table 30 breaks down this purchase.

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Table 30: commercial purchase price $1 070 000 Deposit: 35%

$321 000

Stamp duty

$46 805.70

Building report*

$700.00

Solicitor costs

$6500.00

Valuation*

$3000.00

*

Total cash required

$378 005.70

Purchase price + purchasing costs

$1 127 005.70

Net annual cash flow return

$64 400

Net yield on property

6.02%

Net yield on property accounting for the purchasing costs

5.71%

* approximate numbers

Now let’s look at the cash-­on-­cash return. Deposit needed = 35% + costs

$378 005.70

Cost of loan (5.25% p.a. on 65% debt)

$39 322.50

Cash flow after mortgage costs

$25 077.50

Return on equity (pure cash flow return)

6.63%

Return on equity with a 5% capital growth rate

20.79%

Return on equity with a 7% capital growth rate

26.45%

Return on equity with a 10% capital growth rate

34.94%

Now, here is an example of a property we believe is overpriced.

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CASE STUDY International tyre company investment sold at an incredibly low yield of 3.99 per cent! Note: This is NOT one of Rethink Investing’s deals.

Our thoughts as investors We cannot see value in yields at this level unless there is immediate upside. In this case there is none, as it’s a long-­term ‘set and forget’ play with fixed increases in the lease. Mathematically you are unable to generate a worthwhile return versus inflation on your equity, no matter what lending ratio you use for debt. Note: As with all property investing we believe using debt should be part of your strategy to maximise your returns (check out any fund manager’s balance sheet for evidence of this). So why would an investor accept a yield this low, you may ask? We believe they would be an investor just looking to park cash up, rather than looking for decent return on equity. If I was purchasing a property worth $4 250 000, I would be hoping to see a passive income after debt costs of over $120 000 per annum. Which would be a 6.5 per cent net yield asset and 35 per cent cash down (65 per cent debt at the current interest rates). Using the same preferred debt level on this example property, see the numbers in table 31. As you can see, it wouldn’t take much for the property to go underwater from a cash-­flow perspective.

Fast facts • Purchase price: $4 250 000 • Net income: $169 733 • Lease: 5-­year corporate net lease to 2027 • Building area: 858 square metres • Net yield: 3.99 per cent

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How to increase capital growth with value-­adds

• Number of tenants: 1 • Location: South-East Queensland Table 31: commercial purchase price $4 250 000 Deposit: 35%

$1 487 500

Stamp duty Building report

$241 280.20 $1200.00

*

Solicitor costs*

$6000.00

Valuation

$4000.00

*

Total cash required

$1 739 980.20

Purchase price + purchasing costs

$4 502 480.20

Net annual cash flow return

$169 733

Net yield on property

3.99%

Net yield on property accounting for the purchasing costs

3.77%

* approximate numbers

Now let’s look at the cash-­on-­cash return. Deposit needed = 35% + costs

$1 739 980.20

Cost of loan (5.25% p.a. on 65% debt) Cash flow after mortgage costs

$158 843.75 $10 889.25

Return on equity (pure cash flow return)

0.63%

Return on equity with a 5% capital growth rate

12.84%

Return on equity with a 7% capital growth rate

17.72%

Return on equity with a 10% capital growth rate

25.05%

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The property and value-­add opportunities Once you have found the type of investment you like, it’s time to drill down into that asset class to see what upside you can extract. And part of making a deal great is choosing the correct value-­add strategy. These are the most common strategies we implement for our clients as well as ourselves: 1. increase rental values 2. increase length of leases 3. improve tenancy mix 4. renovate properties 5. increase net lettable area 6. build full-­scale developments 7. add value with solar panels. We will now go through each of these seven value-­add strategies using a real-­life example of a property we have been involved in.

Increase rental values One of the easiest methods of adding capital value to your commercial property is by increasing the rent, as values of commercial properties are largely driven by rental returns or the potential for capital growth. To determine if there is an opportunity to add capital value through rental increases, you need to understand what the going square-­metre rate is for similar properties in the area. If the tenant is paying $180 per square metre and every other similar property in the area is renting for at least $210 per square metre, there is a potential to raise the rent by $30 per square metre. This would represent a 16.67 per cent increase in the rental value. If you purchased it at the old rental income, then the value of your asset could also increase by 16.67 per cent.

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Now let’s be honest: you can’t just crash your way in there and hit the tenants for an extra $30 per square metre from day one. It will take time and negotiating skill to raise the rents to the fair market value. The first step is to negotiate the rental rate when you can legally do so. For example, if the lease has three years left to run, there isn’t much you can do. However, if you are within 12 months of lease expiration, there may be an opportunity to negotiate with the tenant early on, especially if they love the property and want to stay. We find that sometimes tenants don’t understand the current state of play in the market, so showing them a spreadsheet with all the other square-­ metre rates in the area can be a good way of enlightening them and helping you to justify a rental increase. This is a great strategy to use when the tenant is paying below-­market rates. It also takes some of the emotion out of the negotiations. You can easily research comparable properties for lease online (using sites such as CoreLogic) to see how the property you’re interested in stacks up. It’s worth keeping in mind that most property leases are based on cost per square metre plus outgoings, with GST usually payable on top of rent. So make sure you look at the total costs of the outgoings in your rates. If it all gets too confusing, a good local rental manager will be able to take over the lease negotiations for you.

CASE STUDY A recent example —­ a Brisbane industrial asset Initial net rent: $79 000 per annum (valuation: $1 316 000) New negotiated net rent: $105 000 per annum (valuation $1750 000) At the market capitalisation rate of 6 per cent for this area, the $26 000 rental increases represented a valuation uplift of $434 000. This negotiation happened in early 2023.

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Another way to slowly build capital in a commercial property is simply to allow the rent to increase over time. If you are negotiating the lease yourself, this could be an opportunity to add value at a faster rate. As we’ve discussed, most leases have an annual scheduled increase built 222

How to increase capital growth with value-­adds

into them. We outlined in Part II how, as the rent grows, so does your commercial property’s value. There are a few options for annual rent reviews. You can set them to coincide with the CPI (consumer price index), which is the most common approach. A fixed percentage increase is the other main option, with 3 per cent the most common increase; 4 per cent is considered a big increase and anything above that is recognised as very high. It’s worth remembering that different markets have different rules, but most use the CPI or 3 per cent. What this means for your return on investment is that with each annual price increase you’ll see more cash coming in each month. Also, when you revalue the property, the higher the rent, the more equity you may be able to release.

Increase length of leases The second-­most common strategy we have used over the years to improve the value is to negotiate a longer lease. The reason this adds value is the longer the lease, the greater the security. Investors value security so they will often pay more for longer leases. This was the first value-­add we personally made. As mentioned earlier, we were able to increase the lease on the supermarket in our first commercial property from 12  months to five years. This increased the valuation as soon as the lease was confirmed. Some people will get excited about a lease and pay too much. Just like that Guzman y Gomez–leased investment discussed in Play 3. High level, you can expect about a 3 per cent increase in value for every extra year on your lease. Table 32 (overleaf) is a guide I have personally followed as an investor.

Improve tenancy mix This is more of a long-­term value-­add strategy best used for retail shopping centres or other multi-­tenant properties. 223

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Table 32: lease length guide Value ($)

Yield (%)

Length of lease (years)

1 000 000.00

8.00

0

1 030 000.00

7.77

1

1 060 900.00

7.54

2

1 092 727.00

7.32

3

1 125 508.81

7.11

4

1 159 274.07

6.90

5

1 194 052.30

6.70

6

1 229 873.87

6.50

7

1 266 770.08

6.32

8

1 304 773.18

6.13

9

1 343 916.38

5.95

10

1 384 233.87

5.78

11

1 425 760.89

5.61

12

1 468 533.71

5.45

13

1 512 589.72

5.29

14

1 557 967.42

5.13

15

What this strategy requires is purchasing a property with lower-­grade tenants then, over time, replacing them with higher-­quality tenants. Lower-­quality tenants could include:

• • •

small single-­operator restaurants tattoo and massage parlours other tenants that might not have wider market appeal.

The more unpredictable the tenant type, the more you need to price in for risk. Generally, the higher the risk, the higher the yield.

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So, what if you could replace these types of tenants with higher-­quality ones? These could include:

• • • • •

big-­branded tenants medical types well-­k nown franchises tenants with premium fit-­outs tenants in high-­growth industries.

These types of tenants are lower risk, which means you can value the rent at a premium in relation to the price. This is another form of yield compression, where people will pay a premium for better-­quality tenants. To replace something like a newsagency with a dentist requires effort, some luck and possible capital expenditures. But if you can pull it off, it can pay up big time. For example, one of our clients purchased a shopping centre in Canberra. They had a struggling tenant who was running a supplement store. That tenant ended up leaving. Eventually they found a replacement tenant, which was a physiotherapy (allied health medical). This tenant had a number of other stores, which added to their appeal. The result: the valuer confirmed that the cap rate changed for those specific shops’ valuation from 6.5 per cent to 5.75 per cent due to the improvement in tenant quality. This represented a 13 per cent uplift in value, even though they were paying them same amount of rent.

Renovate properties Another strategy to help improve tenancy mix, increase rental values and the overall desirability of your commercial property is to renovate the asset. The same reasons to renovate a residential also apply to commercial property.

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See below a recent example of James, a friend and client of Scott’s, who carried out this renovation in late 2022. This is the shopping centre at the time of purchase.

Concept Renders.

After photo: this was taken in 2023 just as they were completing the renovation.

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How to increase capital growth with value-­adds

This renovation has increased the equity in the property as the rents now have the ability to be pushed higher. There might even be the chance to attract some more medical-­type tenants over time, which will also be good for equity creation.

Increase net lettable area Another way of increasing your rental income is creating more space to lease out to tenants. This can be done by creating a larger building footprint, or being more efficient with the space you have. For example, the plans overleaf are from one of the properties we own. It’s a shopping centre and there is a large internal common area that is not leased to any tenants. This space was larger than it needed to be, so we thought there must be a more efficient use for this wasted area. As a result, we are currently extending the IGA floor area. This will involve some internal modifications, plus we will need move the Asian takeaway to the vacant shop next to it. The result will be an extra 200 square metres of leasable area. The leasing rates in the area are $300 per square metre; this means there will be an extra $60 000 per annum of new rental income. At a 6 per cent cap rate, this will create $1 000 000 in

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new value. We are also exploring a secondary option in which a wellknown gym is interested in occupying the space should the IGA vacate. This would bring a longer lease, higher rent per square meter, and a larger floor area, all of which would add considerable value.

Build full-­scale developments When it comes to development, most people think of residential property. Most investors love the idea of one day building duplexes, unit blocks or even just their own home. Few people ever think about what commercial property development could include. However, many fortunes have been made through commercial real estate development, but this is not a strategy without risk. Only in recent years have we started looking into this and starting our own developments. The returns can be as good as, if not better than, the best residential and, in most cases, you want to keep the end product rather than just sell it off. Developing commercial property results in creating more net lettable area, which can be leased to create income. That future income will dictate how much capital value you have created. Table 33 is an example of a development we are currently undertaking on one of our shopping centres. Note: this involved purchasing some land adjacent to the shopping centre to create the extra space needed. 228

How to increase capital growth with value-­adds

Table 33: development cost breakdown Development costs Unit

Rate $500 000

Land (including adjustments) Note: assumes slight reduction to list price 4.5%

$22 500

Holding costs

6%

$27 500

Building costs

($)

Stamp duty

-­Civils/pavement/40 car parks

1

350 000

350 000

-­ Electrical

1

20 000

20 000

-­ Landscape

1

20 000

20 000

950

1650

1 567 500

-­ Signage

1

15 000

15 000

-­Tenant fit-­out & incentive costs

1

75 000

75 000

5%

$102 375

-­Building works

-­ Contingency

$2 699 875

Costs total Consultants

$75 246

Da/ba fees

$30 000

Infrastructure charges

$120 500

Development management fee

$75 246

Legals & statutory fees

$10 000

SUBTOTAL

$3 010 866

Finance costs

Unit Duration

-­Build: Amount: $1 397 419

5.50%

0.8

$61 486 $61 486

Total finance TOTAL DEVELOPMENT COSTS

$3 072 353 (continued) 229

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Table 33: Development cost breakdown (cont’d) Development costs INCOME

CAP

$300/sq m net x 950 sqm

7.00%

$4 071 429 $4 071 429

Gross realisation Less costs to sell

$324 675

-­ GST -­Legals (leases)

1

$10 000

$10 000 $334 675

-­Total adjustments NET INCOME

$3 736 753

NET PROFIT

$664 401

RETURN ON TOTAL DEVELOPMENT COSTS

230

21.6%

How to increase capital growth with value-­adds

Add value with solar panels As the cost of electricity skyrockets, solar panels have become increasingly important for commercial investors to consider. Why? It’s because commercial tenants tend to use a lot of power during daylight hours —­ perfect for solar panels. As a result, we have partnered with industry experts to launch Rethink Renewables (rethinkrenewables.com.au). This business provides a unique zero-capital-cost solar system to businesses that lease roof spaces from commercial owners across Australia. This increases the yield on their properties and creates equity through additional third-party lease income. Tenants also benefit from savings by offsetting their grid dependence and consuming renewable energy from the solar system. Rethink Renewables pays landlords an annual solar-access fee for the rights to lease the unutilised roof space, typically a 10+5+5–year lease, which can be valued similarly to a normal tenant income. This creates equity and cash flow for the landlord, plus saves the tenant significant power costs. Win-win-win. We set this up because we couldn’t find companies that would lease out to this business as a third party. Pros:

• •

There’s no capital outlay.

•

The performance of the solar system and its annual upkeep are not your responsibility.

•

Selling electricity to the tenant is not as simple as it seems; the solar-­system owner requires an electricity retailer exemption to be granted by the Australian Energy Market Operator (AEMO) before the electricity can legally be sold. Rethink Renewables takes on this compliance responsibility.

You don’t have to deal with the tenants to receive payment for electricity, valuation increase to your property or new rental income. (This is a legal agreement called a power purchasing agreement, which needs to be set up.)

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Cons:

•

There is a five-­to six-­year pay-­off on the solar panels. If you pay for the solar panels yourself, you can chase the tenants to pay you back each quarter and in five to six years the payments you will receive from them will be higher than the rent you receive from Rethink Renewables.

•

As Rethink Renewables will hold the lease to the roof space, this may present complications if you are planning future capital improvements or developments such as a forecast roof replacement within the contract period, redevelopment of that section of building or adding an additional storey.

How much equity does a solar lease create? It depends on the cap rate of the market. Let’s say it’s 6 per cent and you are leasing your roof for $5000 per annum for 10 years at a 3 per cent per annum increase. Table 34 shows how these numbers reflect the equity gained each year: Table 34: solar rent equity Year

Solar rent (3% p.a. increase; $)

Equity created at 6% cap rate ($)

1

5000

83 333

2

5150

85 833

3

5305

88 408

4

5464

91 061

5

5628

93 792

6

5796

96 606

7

5970

99 504

8

6149

102 489

9

6334

105 564

10

6524

108 731

11

6720

111 993

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How to increase capital growth with value-­adds

Year

Solar rent (3% p.a. increase; $)

Equity created at 6% cap rate ($)

12

6921

115 353

13

7129

118 813

14

7343

122 378

15

7563

126 049

YOUR NEXT MOVES Find out where the leasing markets are strongest by reading property reports from major valuation and real estate agencies. In summary, focus on a specific target market that you are comfortable with but, as great deals can come in many forms, do not disregard other asset classes. Work with agents, leasing managers and/or a buyer’s agent to locate potential properties in the chosen field. Ensure that the property can be easily relet and consider the seven strategies to add value through commercial property. Most importantly, purchase a property with a good yield in a capital-growth market for the best return. Once you find your ideal commercial property, remember our seven most common strategies to add value through commercial property: 1. increase rental values 2. increase length of leases 3. improve tenancy mix 4. renovate properties 5. increase net lettable area 6. build full-scale developments 7. add value with solar panels.

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PLAY 4

HOW TO CHECK THE NUMBERS SO YOU DON’T OVERPAY Prior to transitioning from residential to commercial property investment, it is essential to be well-informed to recognise the potential risks and to not offer too much (or too little) for a property where it can kill the deal for you. Unfortunately, there is a lot of inaccurate information out there that can mislead inexperienced commercial investors. As with any type of investing, there are risks, but these can be managed by understanding them and taking the necessary steps to increase the likelihood of a return on investment. Therefore, for this play, we will focus on how to ensure that you do not overpay for the investment by focusing on the numbers. This is the most reliable way to make informed decisions during the acquisition process. Let’s talk about that sense of excitement you feel when you come across what looks like a really good deal. Your heart beats a little faster and you skim over the details: you might see a great yield, a dependable tenant, or a lengthy lease. When you have limited experience investing in a new asset class, it’s hard to know what you’re in for, especially when you see a commercial deal that looks very attractive on the surface. In that situation you may be suddenly in competition with many others who are ready to beat you to the deal. Many individuals find themselves in a precarious situation when they are pressured to make an offer on an asset without having the opportunity to conduct the necessary research. We have often 235

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been in a situation where we must submit an offer before a set deadline, without the time to properly assess the situation. The good news is there is a solution, you must ensure you put in an offer subject to both ‘due-diligence’ and finance if you are financing the property.

Offer subject to due diligence A due diligence clause in a sales contract provides the buyer with an exclusive period to conduct research and evaluate the asset. If any issues arise during this period, the buyer may renegotiate the price or terminate the contract without penalty. To reiterate, a due diligence clause is an allencompassing clause in a sales contract that allows you to effectively walk away from the deal for any reason whatsoever. It’s worth mentioning that you can’t negotiate a due-diligence period with the vendor 100 per cent of the time. However, as a buyer potentially spending your life savings, you should insist. If you can’t, it might be safer just to let the deal go to someone else. For example, out of the thousands of successful transactions we have conducted for ourselves and our clients, we have always included a due diligence clause.

What about auctions? It is not possible to negotiate a due-diligence or finance clause when a property is going to auction. Therefore, it is strongly advised to avoid commercial auctions, as they are typically more beneficial to the seller. The property may either be sold at a high price or pass in, so it is unlikely that you will ever get a great deal with this method of sale. It’s also a risky situation as you might find the numbers presented by the agent could have errors. This could affect how much you pay for the property. You simply need the time to check every single aspect of the property when it comes to commercial property.

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How to check the numbers so you don’t overpay

CASE STUDY Due-­diligence check In this example, one of our clients nearly paid too much for a property based on incorrect numbers supplied by the agent. We’ll show you how it played out and how we saved our client a lot of money. In 2019 we helped the client purchase a multi-­income commercial property. It was advertised as producing a $134 005 gross income with outgoings of $17 490 per annum. This indicated a net income of $116 515. Remember, net income is what you work off to calculate value as an investor. If the net income is higher, the property is worth more. If the net income is lower, the property is obviously worth less. The agents were asking $1.6 million, which represented a net yield of 7.5 per cent. After some solid negotiating, our buyer’s agent managed to secure the property for $1 425 000, which represented a net yield of 8.18 per cent. A contract with a 21-­day due-­diligence clause was drawn up for our client. This meant the contract was conditional on us completing our due diligence. So far, so good.

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But as we carried out our due diligence, we noticed that there were approximately $5000 worth of outgoings that the agents had missed in their information memorandum. Now, that price difference might not sound enormous, but when you back-­calculate it against the yield, you can see it had a major impact on price: Net rent (expected): $116 515

Net yield (expected): 8.18 per cent

Net rent (actual): $111 515

Net yield (actual): 7.83 per cent

By submitting an offer subject to due diligence, we were able to triple-­ check the outgoings of the property and confirm that our buyer was worse off from a net-­income perspective. We did this by verifying the actuals on the property through viewing tenant ledgers, invoices and reviewing the leases to see what was legally allowed to be passed on to the tenant. Our next step was to renegotiate the price down prior to going unconditional on the contract. From our point of view, the fairest result was to lower the price to secure the original 8.18 per cent net yield. So we went back to the agents and asked for a $50 000 discount prior to going unconditional on the contract. This didn’t get us to the exact 8.18 per cent but it got us within reach of it, at 8.11 per cent. Net yield (after $50 000 discount): 8.11 per cent After a lot of hard back-­and-­forth negotiating with the agent and owner, the owner accepted the discount request and the property settled a month later. As you can see, even a $5000 variation in outgoings had a major impact on the price. So always remember to check the outgoings! Furthermore, the agents often present approximate numbers as outgoings, so if you don’t check them you may end up with a property that is not generating the assumed income, which can mean overpaying for the property when it’s too late to renegotiate the lease.

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How to check the numbers so you don’t overpay

Agents represent the seller, so they will generally underestimate the numbers to help the vendor get a better price. Also, remember that while agents do their best to present the exact correct information —­ it’s in their best interest to do so —­ sometimes they are supplied incorrect information from the vendors themselves. It’s up to you to cross-­check everything.

Buy a property with excellent relettability qualities Buying properties that can be relet without difficulty is a cornerstone of good investing. It’s so important because if you lose a tenant, you can market the property and find one sooner rather than later. Remember the old story about commercial properties having longer vacancies? Well it’s true, but if you buy the right property in the right area you should not have much trouble finding a tenant. This will cut down the costs of lost income, but also keep your current tenants in the location longer. One key to getting this play right is knowing the leasing market very well. Unfortunately, there are no real shortcuts for investors, and you will need to do the work on the ground by speaking with the relevant leasing professionals, who can help paint you a true picture of what the rental market is like. These days we’re lucky because we know the market extremely well. We live and breathe the commercial property market and we’re constantly helping clients to purchase properties. At the time of writing, we have been helping our clients purchase three to five commercial properties per week across the country. It’s likely you won’t have this depth of experience, but that’s okay. What you need to do is find similar properties you can compare to the one you’re trying to buy.

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One trick we use is to jump onto the CoreLogic property website. If, for example, we’re looking at a 500-­square-­metre warehouse, we’ll view similar-­sized vacant properties and see how long they’ve been on the market. You’ll be able to source the data on the average vacancy period of similar warehouses and qualify it to, say, a three to four months’ vacancy, which is a workable period you can allow for. Following is a general definition of the vacancy periods we use:

• • • • •

1–2 months —­ very tight market with minimal leasing risk 3–4 months —­ more balanced market with minimal leasing risk 5–6 months —­ slightly weaker market with moderate leasing risk 7–12 months —­ weaker market with higher leasing risk 13–24 months —­ extremely weak market with an unacceptable leasing risk.

In general, if you find it’s taking more than six months on average to find tenants, this should probably be a market you avoid. The market is telling its own story, and you’re likely barking up the wrong tree.

YOUR NEXT MOVES • Always triple check the numbers via an appropriate due-diligence period. • Try avoiding commercial auctions at all costs. The risks are too great for investors. • Use online property-­search tools such as CoreLogic to view vacancy periods. • Speak with as many rental managers as you can to determine how they feel about the market on the ground. Please note: some people will have a vested interest in talking you into or out of a deal, especially if you are buying a property from a competitor.

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• Be ready to put in the time. If you are trying to understand the leasing market, you will need time to build up your knowledge on the ground. A great way to fast-­track this is to visit areas in person. • Don’t be afraid to pay for a buyer’s agent. They know the market from an investor’s point of view better than most. You can tap into their contact bases as well as market knowledge.

241

PLAY 5

HOW SYNDICATION CAN WORK FOR YOU Syndication’s a buzzword in commercial property circles right now. And for good reason. Basically, syndication allows you to acquire a portion of a high-­value commercial asset. It guarantees you a split of the rental income and enables you to ‘shoot higher’ than your budget would otherwise allow. Sounds good, right? Well, there are many pros and cons to consider before going down this path. So let us walk you through how syndicates really stack up verses a direct commercial investment.

So what is a syndicate? A syndicate is an organised group of individuals, corporations or entities. It can also be professionally run as a managed fund, where managers charge you fees for their involvement. The group works together to pursue and promote its collective business interests. Here’s another way of looking at it that most people will be familiar with. In a lottery or horse-­ownership syndicate, a group of people pitch in to buy a ticket or own a share of a horse in the hope they’ll win big. If they do, the winnings are divided between the individuals who form the syndicate. A commercial property syndicate works along similar lines. But rather than relying on the long odds of these examples, a commercial property syndication guarantees a split of the rental income and capital growth profits of the asset or assets the syndicate controls. The syndicate manager or company is responsible for negotiating the purchase of the property;

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arranging all leases, financing arrangements and other agreements; maintaining all corporate and financial records; and dealing with estate agents, tenants and contractors.

Different types of syndicates Property syndicates, REITs (real estate investment trusts) and property funds have the same function of pooling capital for commercial investment properties and then splitting the returns based on the percentage amount that each individual contributes. However, there are some key differences between each of these entities, which you need to be aware of. Firstly, what is not a syndicate? Direct property investing refers to purchasing a property without others contributing funds other than a bank where you organise the loan. Direct property investment requires the investor to have the funds to acquire the property or with the assistance of funds from a loan. The individual investor would have 100 per cent control and enjoy 100 per cent of the profits. You will be able to borrow 60–­80 per cent depending on the loan structure, location, asset price and asset type. Next, what is a syndicate?

Private commercial syndicates or unit trust investments Commercial property investment syndicates are usually an investment in a single asset. How it works: rather than acquiring the entire property yourself, you invest your funds with a trustee who will manage the investment for you in your best interests. This is something I have personally been a part of a couple of times. In my cases, one of my clients had the skill set to manage the property and distribute the correct percentage of funds monthly to the beneficiaries of the trust.

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How syndication can work for you

The trustee of a unit trust investment is obliged to conduct their operations in an effective manner. Each unit holder will be entitled to a proportion of the rents and capital growth, depending on the number of units they have acquired. This helps investors enter the real estate investment market if they are unable to purchase entire properties. To structure this legally, there needs to be 20 or fewer members, or it would need to be incorporated or formed under an Australian Financial Service License (AFSL). Often the minimum investment amount is $50 000, though the minimums for each real estate investment can vary and can be as low as $10 000, and as high as $100 000 or more.

Listed real estate investment trust (REIT) This is also known as a public REIT where a company owns, operates or finances income-­generating real estate. REITs pool the capital of numerous investors. The biggest difference between a REIT and a real estate syndication lies in the specific asset people are investing in. With a real estate syndication, investors have equity in a specific property, whereas REIT investors own a share of the company that owns a portfolio of properties across multiple markets. Many REITs are publicly traded, so they’re easy to access and invest in —­ just like stocks, which can be traded with a very small amount of money —­ making it appealing to many investors, particularly those just getting started with real estate investing. Investors can usually invest for as little as $10 000. A REIT will need to provide a product disclosure statement and a single responsible entity is appointed to run the syndicate and comply with investment rules set by ASIC (under an Australian Financial Services Licence).

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A REIT business also tends to sell its properties every five to seven years so it can transition your capital from one asset to the other. The main goals of this are to realise profits and charge you more fees, as this is how these businesses make money. For example, they may charge you 1 to 3 per cent of the purchase price on acquisition, 0.5 to 1.2 per cent annually as a management fee, 1 to 2 per cent as a selling fee, plus take 25 per cent of the total capital growth over the entire holding fee. I’ll go into these fees later, but this is one of the main reasons why direct property investment will give you a better investment return.

Unlisted REITs or wholesale property syndicates Most syndicate products outside those listed on the ASX will be known as wholesale investment products. Who is allowed to invest in a wholesale property syndicate is much more restrictive. You must be known as a ‘sophisticated investor’, defined in corporations law —­ this requires each investor to obtain a signed confirmation from their accountant or taxation agent, confirming that the investor either owns assets of greater than $2.5 million or has earned more than $250 000 in each of the previous two financial years. Where an investor invests $500 000 or more in a syndicated offering, they are not required to provide a ‘sophisticated investor’ certificate. Unlisted REITs are not subject to the same regulatory scrutiny as public REITs (they are actually exempt from SEC registration), so there are plenty of opportunities for managers to make decisions that aren’t necessarily in the best interest of shareholders. The other big difference is a lack of liquidity. It’s also much harder to sell your initial investment compared to selling shares. Like public REITs, there are high commissions. In fact, there are reports of private REITs that pay as much as 12 per cent in marketing fees and commission. This means that if you invest $10 000 into a private REIT, as little as $8800 of your money could end up being invested. 246

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The benefits There are some notable benefits to forming syndicates in the commercial world. Similar to direct property ownership, syndicates benefit from investing in one of the world’s best asset classes, the Australian commercial property market. The property market in Australia is strong, resilient and growing, off the back of:

• • •

strong migration and decent birth rates

• •

low unemployment rates

great supply:demand ratios rising construction costs (which directly benefits existing property values for commercial) increasing amounts of interest flowing from residential markets towards the commercial higher-­yielding markets.

All contribute to growth and stability. A property syndicate will enable you to invest in the property market quickly and other benefits are listed next.

Purchase ‘out of reach’ investments A group of independent investors in a syndicate can pool their money to create a deposit on a high-­value commercial investment they could not afford on their own. The size and scale of these assets, high-­quality tenant covenants and solid, long-­term rental returns on offer simply wouldn’t be accessible to most individual property investors on their own. For example, you would have the reach to buy retail centres, industrial facilities or office buildings. Through a syndicate, you can bid for these assets and have a much greater chance of sealing the deal.

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Free leverage Many, if not most, syndicates have what’s called a ‘non-­recourse’ bank loan within the syndicate structure. This means that if the borrower defaults, the bank can seize only the assets put up as collateral for the loan. The lender can’t seek further compensation from the borrower, even if the assets used as collateral don’t cover the full amount of the loan. For example, the syndicates we have been involved in normally have an LVR of around 50 to 55 per cent. This means that in a $10 million syndicate, $5 million of that total amount of funds will come from a bank loan, with the other $5 million as cash from the syndicate members. This means your money is leveraged without your having to visit the bank yourself. Then the $5 million in cash can be split up into ‘units’. So, if you invested $500 000 into the syndicate with a 50 per cent LVR, you would essentially control $1 million worth of property because the bank doesn’t own units in the syndicate. The $500 000 would mean you own $500 000 out of the $5 million —­ or 10 per cent of the units in the syndicate. And that means you’re entitled to 10 per cent of the cash flow and capital growth profits. This can be particularly useful when you don’t have the ability to get a loan yourself. For this reason we use the term ‘free leverage’ —­ because it’s a loan you probably couldn’t have otherwise secured.

Save time Most syndicates are set up by professionals who manage the purchasing process and the running of the investment fund. You generally take a back seat when investing in a syndicate. That means less time spent having to manage your investment yourself. However, only a well-­ managed property syndicate unburdens you of your time and energy. If you are the one running the syndicate, it can be a full-­time job, so watch out!

Less money down In many cases, you can invest in a syndicate with lower amounts of capital. As we’ve described, to purchase a property on your own you need at least 248

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$100 000 for the deposit on an entry-­level commercial property. However, managed syndicates backed by an Australian Financial Services Licence (AFSL) may allow you to invest with much less. This could be as low as $10 000, but every syndicate has its own rules on minimum deposit levels.

Diversify your investment A property syndicate, created with pooled funds, will help you to access a variety of different types of property. For example, you could allocate some of your capital to an industrial fund, an office fund and a retail fund that all hold those types of assets within their portfolios. Diversifying your portfolio helps you spread your risk.

Stable returns By diversifying across multiple funds, you can benefit from a predicable return if all is going well with the economy and the properties. Most companies will sell you their funds with a predicted monthly distribution rate. They normally are about 2 per cent higher than the interest rates at the time. Just be careful, though, as these returns are never guaranteed.

What’s the catch? Like most benefits in life, syndicates have drawbacks too. We’ll explain these in some detail so you can better evaluate if a ‘direct’ or a ‘syndicate’ purchase best suits your situation.

Less control Perhaps the greatest drawback of syndication relates to working with a group. The longer you need to hold the investment with others, the greater the chances that your goals will diverge from those of other syndicate members. For example, at the start of the property acquisition you might all agree to hold the investment for seven years before selling. However, during the seven-­year period some members may wish to exit the syndicate sooner than planned. This could cause problems for relationships within 249

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the syndicate but, given the long-­term nature of investing in this asset class, any relationship issues must be managed. We had personal involvement in several syndicates that had to be sold prematurely due to a majority shareholder’s decision to relocate abroad and withdraw their funds from the investments. As a result, we missed out on the subsequent market boom. In another instance, we bought out the other shareholders to gain full ownership of the venture. It is often difficult to collaborate with people whose objectives may vary from year to year.

Less leverage Generally, investors in property syndicates prefer not to provide personal guarantees. Banks will typically provide non-­recourse loans if the LVR is 55 per cent or less. So a 55 per cent debt is normally the maximum you’ll be able to achieve. This is less than the LVR —­ up to 80 per cent —­ if you purchase commercial property on your own. When it comes to creating wealth though property, amplifying returns via leveraging is critical.

More fees Investing in a syndicate managed by a fund manager may involve fees such as a 1–3 per cent acquisition purchase fee, a 0.5–1.2 per cent annual management fee, and a 1–2 per cent fee when the asset is sold. These fees can reduce the return on investment. Conversely, when investing directly, the only costs incurred are interest and taxes.

Potential management issues If you engage a fund manager to manage the investment, you will need to stay informed of all management-­related matters. Seek regular updates from your manager so that any potential issues are addressed in a timely manner. The returns for investors and the company’s performance can often be at odds with one another. For this reason, I have always preferred direct ownership as I believe no one is more invested in your money than you. However, syndicates can be a great option when you don’t have the full 250

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capital to purchase a quality commercial property on your own. With full control, you can usually achieve higher returns than the best funds in the industry due to lower fees and better leveraging benefits for direct ownership compared to REIT returns.

FACTORS TO CONSIDER Here is a list of factors you should consider before investing in a commercial property syndicate in Australia: • Property type —­ Buying into the right asset class is critical. You can choose from the usual classes of industrial, retail, office, specialty or even developments. If it is a development opportunity, there’s typically no return for the initial period during the development stage. A development opportunity is exposed to increased risks in an attempt to enhance returns. • Duration —­ The duration of a high-­yield, secure investment is important. The longer your money is tied up, the more risk and higher return you should expect. • Management —­ What are the experience and qualifications of the property syndicate management? Are they a fund with $100 million of property or $20 billion? They all have their own ways of charging you, as well. While you can engage a professional manager to manage the affairs of the property syndicate, a successful investment does require your time and effort. • Interest rates —­ W ill any changes in interest rates affect the syndicate’s investments? • Tenants —­ What is the quality of the tenant? The quality and stability of the tenant will affect overall returns. • Cash-flow requirements and yield —­ Consider what returns you are expecting to receive on a periodic basis. Ensure that this periodic return suits your cash-flow needs now and into the future. (continued) 251

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(continued) • Costs — Investing in commercial real estate does have costs. As mentioned in the section on REITs, the fees charged in REITs can be significant. They all vary, as well, which might influence your decision to go into a certain fund or not. Check the total of management costs, marketing fees and exit fees. • Government policy —­ Many government policies can affect the returns and gains of an investment in property. Most of these changes are beyond our control, but you should be aware of the trends in policy setting. • Taxation benefits —­ Most high-­yield secure investments producing an income or gain will incur taxation costs. It is wise to consult an accountant to understand these costs and the best strategy to minimise your tax expense. • Exit strategy —­ You might need to exit a commercial property syndicate for a variety of reasons. Consider the most likely or obvious reasons and ensure that the agreement covers these contingencies. • Reinvestment —­ To grow the value of your investment in the property syndicate, you might wish to reinvest some, or all, of your returns in the syndicate. Consider how the agreement will accommodate reinvestment.

Setting up a syndicate If you would rather not hand over all the responsibility to a business or property syndicator, there is another option. You can set up your own syndicate with family or friends. This would mean creating a private commercial syndicate or unit trust investment, which I mentioned above. There would be no AFSL, fees or company controlling the properties’ every move. However, they are still complicated to get right. So how does it work and how do you set one up? Here’s what you need to do:

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•

Work with a highly experienced accountant and solicitor to set up the correct structure (for example, a unit trust).

•

Use your unit trust to make an offer on the property. Make sure you allow yourself enough time to raise the capital and secure the bank loan.

•

Work with a skilled mortgage broker who can source the best loan for your syndicate.

•

Agree to distribute the funds back to the investors each month or quarter.

•

Draw up an agreement on how long you will hold the asset.

CASE STUDY Two properties in one syndicate The best way to illustrate this property play in action is through sharing our own personal experience. A number of years ago, we teamed up with a client to participate in a syndicate purchase of two assets. We liked the idea of just using cash and not having to go through a lending process to purchase a direct investment. It was also a way of diversifying our portfolio, as we had recently purchased several commercial properties. A syndicate seemed like a sensible next step. Besides ourselves, the syndicate comprised six others, and the deal involved purchasing two multi-­tenant commercial properties.

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Property 1

• This multi-­tenanted shopping centre with extra land for future STCA development was set on a 5823-­square-­metre block of land in SouthEast Queensland. • Three of the well-­established tenants are household names —­ IGA, The Bottle-­O and Chemist Warehouse. • The WALE was 5.2 years. • Original sale price was $4 400 000. We negotiated $395 000 off for the syndicate. • The current rent was 15 per cent below current market rates, giving the investor added opportunity to boost the net yield.

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• The net yield was 7.7 per cent. • The site offered opportunities for future development, with the possibility of adding a car wash STCA.

Property 2

• This multi-­tenanted shopping centre was on a prominent corner block of 3025 square metres, providing a net lettable area of 1387 square metres. • The mixed-­use commercial asset was fully leased to 10 separate tenants. • The property consisted of three separate buildings. • Net return was 8.7 per cent. • The WALE was strong.

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Structure of the fund • The two properties were worth a total of $10 500 000. • They had a total net income of $873 000. • Their total net yield was 8.31 per cent. • A 65 per cent loan was used to secure the property. That meant the other 35 per cent plus costs were cash provided by the syndicate (eight investors). • The result for us, and for the other investors, was that we had put in our own cash to create cash returns of around 11 per cent, plus capital growth. We didn’t have to speak with a bank, yet we got to enjoy these leveraged returns in high-­quality assets.

The result We were able to join six like-­minded individuals who had a common goal —­ to maximise their passive income. These two high-­yielding investments did exactly that. The risk was spread between many different tenants, which gave us more security over the income.

To syndicate or not? It’s worth noting that the leveraged return for a direct investment can be just as good as, if not better than, a syndicate due to the higher loan ratios. Table 31 illustrates this by showing the difference between investing $200 000 through a syndicate and through a direct purchase. Assuming growth and yield are identical, you will make a greater return on equity for one reason alone: direct investments allow for higher leverage. Table 35 has assumed this is a private syndicate with family and friends with no fees.

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Table 35: comparing a syndicate to direct investment Syndicate

Direct investment

Net yield

7%

7%

LVR

50%

70%

Deposit invested

$200 000.00

$200 000.00

Controlled property amount

$400 000.00

$666 666.67

Assumed capital growth (4% p.a.)

$16 000.00

$26 666.67

Total return cash flow

$22 000.00

$32 666.67

Total return on equity

19%

30%

Buying direct versus REITs This is how a 6 per cent yield on a REIT compares to a 6 per cent yield on a DI:

•

Assumptions: 5 per cent growth for both the commercial DI and the REIT

•

Result: 232 per cent better result for direct commercial ownership.

So if you have the capital required to purchase a commercial property yourself, the returns will be superior to most REITs. And having full control, plus the benefits of superior leveraging ratios, will make a wealth of difference. For example, if you had 1 per cent ownership in a REIT worth $100 million, you could expect a 10 per cent return on equity. However, if you had 100 per cent ownership in commercial property worth $3 million, then you could expect a 23 per cent return on equity. This is broken down further in table 36 (overleaf).

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Table 36: REITs vs DI Real Estate Direct Notes Investment Commercial Trust (REIT) Investment (DI) Net yield

6%

6%

LVR

50%

70%

Deposit

$1 000 000

$1 000 000

Controlled property amount

$1 000 000

$2 857 142.86

Assume 5% purchasing costs for DI, REIT cash returns already factored in for LVR.

Assumed capital growth (5%)

$37 500

$142 857.14

REITs generally have a 25% performance fee for capital growth. We have assumed that the amount has been taken off the REIT capital growth.

Total return on cash flow

$60 000

$83 571

For DI, we have assumed 70% debt at 4.5% interest only.

Total return on equity (cash flow only)

6.00%

8.36%

Income = 139% better return comparable for DI vs REIT.

23%

Income + Growth = 232% better return comparable for DI vs REIT

Total return 10% on equity (cash flow + capital growth)

For REIT, a 6% yielding distribution is roughly the industry average for the highest returning funds.

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Unit trust versus direct investment or ownership I often get questioned about investment using a unit trust as opposed to direct investment or ownership of commercial property. The benefits of an unlisted or listed unit trust is to be able to invest with relatively lower initial capital contributions. I suppose the challenges are: 1. The investor is limited in his choice and control, and relies on the fund manager for all decision making. 2. Fund management means compliance costs. 3. Potential restrictions of exit plan: if not listed, someone else will need to be willing to purchase the units before they can be disposed of. The benefits of direct investment or ownership of commercial property is the investor’s choice and control of the asset class —­ during purchase, maintenance and exit plan. With the right level of leverage and right choice of acquisition, there are enormous benefits in direct ownerships. The banks like this direct ownership, making it easier for further gearing (in time with the increase in value of the existing investment), and assisting in further purchases and investments. Arguably, there are significant taxation benefits for this proposal and asset protection can be undertaken correctly as well. So, direct ownership has some strong merits and generally much higher returns, albeit with initial work in due diligence, finance arrangement and right structure establishment. However, the risk can be higher because you are dealing with the asset yourself without the protections that may come with a well-­managed syndicate. It’s worth having a chat with a qualified commercial buyer’s agent, who can help you remove the risk and improve your chances of a higher return.

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YOUR NEXT MOVES • Make sure the property suits your individual needs. For example, if you are comfortable with investing in medical or industrial properties, this should be your target for a syndicate purchase. Essentially, you need to treat a syndicate purchase with the same level of oversight and interest as if you’re purchasing the property direct yourself. • You still need to do your due diligence, as you would with any deal, and not just assume that because others are investing you don’t need to worry about it. • Understand the overall plan of the syndicate and make sure it aligns with your own investment goals. For example, many syndicates have five-­to seven-­year hold periods. If this is too quick for you, then maybe it’s not the syndicate you should buy into. • Know the difference between all the different types of syndicates. • Understand the fees involved. There’s normally an acquisition and disposal fee for the property, and an annual managed fee for many AFSL-­operated syndicates. • Before joining a syndicate, be sure to compare the returns proposed to those if you purchased a commercial property on your own. In our experience, direct investing can often trump syndicate returns.

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PART III SUMMARY What we love about our property plays is that we haven’t simply pulled them from a book or read about them somewhere. They work because we’ve done them all ourselves. We stepped off the fence and jumped into a new backyard because we recognised a good deal when we saw one. Our hope is that you are now better equipped to grasp this too. Here are our key takeaways for each of our Top 5 Property Plays: 1. How to build a $200 000 passive income. To reach this objective, consider investing in high-yield commercial real estate as a $200 000 passive income is simply too hard to reach with residential property. Although entry to this market requires saving a considerable deposit, those who can have achieved results few others have. 2. How a property can pay itself off in 12 years. Buy properties with higher net yields, and lock in a strong debt reduction strategy. 3. How to increase capital through value-­adds. Learn how to identify a value-­add opportunity and how to execute it. Understanding the market and the lease will deliver great results, but it’s also about specific property and tenant types. 4. How to check the numbers so you don’t overpay. Do your due-­diligence checks to ensure everything lines up and buy properties that can be easily relet. 5. How syndication can work for you. Buying out-­of-­reach properties can accelerate your profit, but you need to ensure that the syndicate suits your needs.

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CONCLUSION Congratulations, you’ve made it! How do you feel now that you’ve finished the book? Excited? Overwhelmed? Tired? You’ve invested the time and energy to get to the end, and we appreciate it’s been a lot to get your head around. As with any new learning, you may feel many different emotions by the time you reach these last few pages. We’ve introduced you to the ways we think work best, as learned over many years. We’ve shared some of our highs and lows on the journey towards winning our financial freedom through commercial property investing. Wherever you are on your property journey, we hope you’ll be able to draw on this book to learn something new about jumping over the fence into the land of commercial.

Would you like to further your knowledge of commercial property? Want to continue to build your knowledge in the field of commercial property? We have also created the first-­ever detailed online education course for commercial investors. We have called it Rethink Commercial Education, where you’ll have access to recorded content from us and the professionals we work with such as our property manager, solicitor, finance 263

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guy, insurance expert and more. This education course downloadable guides, checklists, templates and other resources to fast-­track your learning and thus your journey to commercial property success. The course also includes many live masterclasses and connection with a peer-­ to-­peer community, including access to industry-­leading experts across all commercial professions, to ask the questions you need to answered. This will not only transform your skills, but will also connect you to like-­ minded individuals helping to hold you accountable for achieving your financial goals sooner. The course will also go into detail on the commercial property market fundamentals including how to identify and find great commercial deals, and will walk you through the due-­diligence, legal, finance and purchasing processes. In addition, it will also guide you in how to manage your commercial property by adding as much value to it as possible over the long term. This course is an extension of this book. It will take your knowledge to a whole new level, and support you as it inspires you to future commercial investment success. For more details, please visit: RethinkCommercialEducation.com.au We’d like to also leave you with a few thoughts to keep in mind.

Why invest now? For decades, residential property investment has been the number one option for mums and dads seeking a comfortable and secure retirement. If you have owned one or more investment homes, you’re already familiar with residential processes and how to juggle the various moving parts when buying and selling your properties. Our whole philosophy is that the residential market is not the be-­all and end-­all of investing in real estate. Especially now that the numbers simply do not stack up from a cash-­flow-­return point of view.

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For most property investors, commercial property is still not ‘relatable’ —­ in fact, it’s downright feared due to the common myths we have mentioned in the book. Yet Australia’s largest property owners and companies mostly hold only commercial real estate. Commercial property can be one of those unsexy-­type products. Most of us wouldn’t swoon at the notion of owning an industrial-­size shed on a concrete floor, as we might over a heritage home with a salt­water swimming pool. Or stand around the barbecue chatting about the local office market or how industrial tenants are evolving. Commercial property is generally far less familiar and understood, so there’s a huge knowledge gap. This is exacerbated by a general lack of dialogue, less media coverage and less conversation about commercial property in everyday life, which limits opportunities for broader education. It should be said, though, that we’re beginning to see indications that commercial investing is becoming more popular. The fact that on any given day commercial tends to be more profitable than residential is never lost on us, because it’s confirmed by almost every transaction we make for our clients. Sure, commercial may still be unfamiliar, but we have found it to be an excellent way to start or to expand your portfolio. Commercial property in Australia will give you the highest cash-­flow benefit out of any asset class. Never in our history has cash flow been more important. We have the massive baby-­boomer population retiring now and the next generation isn’t far behind, either. The number one issue preventing most from retiring comfortably is having a large enough passive income. The classic asset-­rich, cash-­flow-­poor scenario is all too common. There is a simple solution to all of this. That is, don’t tie too much of your capital into low-­yielding residential property. Also, the comparable difference between true net yields has never been stronger for commercial investments compared to residential.

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I have been lucky enough to be part of the revolution of thousands of new investors participating in the commercial markets. I have a goal of helping more than 10 000 new investors in the next 10 years invest in this space.

What’s happening in the market right now? As this new decade unfolds, we are seeing a trend towards yield compression. This means investors are paying more for a commercial property relative to the rental income. The tightening of yields makes it more difficult to find commercial gold, yet it also presents an opportunity for capital growth. As the year progresses, it is important to be ahead of the competition when it comes to acquiring properties. The recent interest rate increases have resulted in commercial properties being sold at higher yields, creating further opportunities. There are four main reasons for the market’s current long-term yield compression:

•

Lower interest rates. At the time of writing the first edition of this book, interest rates were at an all-time low. This made financing more affordable, which made investing in commercial real estate more attractive due to the potential for high returns. When writing this second edition, rates had risen, yet yields remained relatively steady, demonstrating the resilience of the commercial market. The key point here is that rates have been trending downwards over that last couple of decades.

•

Shortage of stock. This has become a persistent obstacle for many commercial sales agents around the country. Without much stock to sell, it’s harder to earn a good living. The main cause for this shortage of stock is the lower interest rates. When rates are low, fewer investors are selling. Their commercial assets are growing in value but are also providing them with good incomes. Many tenants are also looking to purchase commercial

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property to occupy, so tenanted investments become scarcer and in greater demand.

•

More residential investors are seeking cash-flow assets. Investors in residential properties are increasingly looking for assets that generate cash flow. With over 550 000 residential sales compared to 20 000 commercial property sales annually, a significant shift in demand towards the commercial property market could be seen if only a fraction of these residential investors make the transition.

•

The search for yield has never been stronger. In 2020 and beyond, one of the biggest challenges for all types of investors is achieving high yields in their various portfolios. Share payout dividends (passive income for shares) are less certain and residential yields are already at record low levels. This means more investors are seeking cash-­flow assets in the commercial space to generate higher returns. The stability of price is one of the redeeming factors attracting investors to all types of Australian real estate and this extra demand will put upwards pressure on values (capital growth!).

Who’s performing best in 2023? It is worth noting that not all commercial properties are equal. Therefore, where should investors look to for potential investments in 2023 and beyond? The commercial property market is anticipated to be a mixed bag, with some asset classes performing better than others. The industrial sector is expected to be one of the most successful, with strong demand for industrial space driven by the growth of e-commerce and the need for logistics and warehousing. According to a report from CBRE, industrial real estate is projected to remain the top-performing asset class in the coming years, with a projected growth rate of 6.2 per cent in 2023. This is due to the continued expansion of e-commerce, which is expected to drive demand for industrial space. Industrial properties are profiting from the retail shift because many online companies require warehouses to store their goods for online sales, creating great opportunities for commercial investors. Since 2020, the industrial sector has outperformed all other asset classes in terms of total returns. 267

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The medical sector is also expected to be a strong performer in 2023 and beyond, with the sector benefiting from the increasing demand for healthcare services and the growing demand for medical facilities. According to a report from JLL, the medical sector is expected to experience a growth rate of 5.2 per cent in 2023. This is due to investors seeking this asset class because of its lower volatility and they are seeing an increased demand for healthcare services, as well as the development of new medical technologies. The retail sector is also expected to be resilient in 2023 and beyond, with the sector benefiting from the increasing demand for goods and services. According to a report from CBRE, retail real estate is expected to experience a growth rate of 4.2 per cent in 2023. This is due to the continued demand for quality retail, as well as the increasing popularity of online shopping. This asset has greater yields than both industrial and medical properties, thus presenting a potential investment opportunity. The office sector is expected to be the weakest performer in 2023 and beyond, with the sector facing weaker demand and growth outlook due to the shift to remote working and the increasing use of technology. This is evidenced by the weak performance of office assets since COVID-19 changed work behaviours, resulting in increased vacancy rates which could have a lasting effect on rental growth. Overall, the Australian property market in 2023 and beyond is anticipated to be a mixed bag, with some asset classes performing better than others. The industrial, medical and retail sectors are expected to be the strongest performers, while the office sector is expected to be the weakest performer. Investors should be aware of the different performance of each asset class and adjust their portfolios accordingly.

Are you up for the challenge? No doubt about it, commercial property remains a road less travelled. While many of our clients say commercial property is the ‘end game’ for their investment goals, rather than the starting point, many other investors don’t even get that far. Going against the flow can be daunting. 268

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They’d rather throw commercial property into the too-­hard basket and hunker down safely in their own backyard. You know now that the numbers tell a very different story, as we have illustrated throughout this book. We have shared many stories and case studies showing how the numbers tend to stack up better for commercial property than for residential property. Our goal has been to demystify commercial investing, because when you understand how it works, and better appreciate the risks and rewards, you’ll be more likely to consider commercial property earlier in your investment journey —­ perhaps even for your very first investment. You’ll need to stay positive on your journey. There will be hurdles, and trends will come and go, so it’s up to you to have the right mindset to tackle problems and adjust to changes as they crop up.

Keep moving forward Two final pieces of advice: keep learning to demystify this asset class, and never forget the long-term goal you’re aiming for. We began our journey by educating ourselves on commercial real estate. The more we learned, the less risk we perceived and the more opportunities we discovered. Education was the key to our success. This book is the one we wish we had when we made our first commercial investment many years ago. You are already ahead of us in this regard. To further your knowledge, be sure to check out our latest resource, Rethink Commercial Education. It’s essentially a degree in commercial property that we have put a year of our lives in creating. Many individuals aspire to achieve a passive income of $200 000 or to gain more freedom to work when and where they desire. Commercial property is an asset class that can provide these opportunities more than most, due to its structure. Despite having thousands of clients who understand this, they can still be tempted to return to the lower-yielding residential asset class, which can be detrimental to their goals. Fortunately, this is a rare occurrence, with only about one in three hundred clients making this 269

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mistake. Therefore, it is important to stay focused on your goals in order to reach them in the shortest amount of time.

The annual review We advise our clients to sit down once a year and refocus their plans and strategies. It’s important to review your goals and revisit what you want to get out of investing. This is easier if you’re a couple. Being a team of two can be a big advantage, because when your goals are aligned you can create more momentum and sustain it over a longer period. Don’t be afraid of sitting down once a year —­ or even every month or week —­ to discuss your financial goals. Remember that working towards a retirement-­income goal is what sets professional players apart from part-­ time investors. Remember too that it’s okay to ask for help if you don’t have all the answers or knowledge. Whether you seek advice from experts in specific areas, or you just need a good broker or commercial buyer’s agent on your books, there’s plenty to gain from recruiting professional help. We’ve seen too many people fall into the trap of wanting to do it all themselves. Knowledge is power, so don’t hesitate to seek out opportunities to learn from others who have more experience than you. It’s so important to surround yourself with the right team —­ people whose judgement you can trust because they’ve done it all before.

The last word Mina For me, the best part of this journey is adapting and evolving every day into a brighter and better person through personal experience which can

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be used as fuel to embrace changes in my investing journey. Exploring new avenues with confidence and excitement for new experiences in this everchanging industry. Whenever the goalposts shift, I draw out something new that I’ve learned, because I believe in always moving forward with new learnings. Which I never forget what is important, keeping in mind the ingrained learnings of life can be taken in an instant and to remember to breathe when others may have never been able to, spending more time with family and wanting not having to work and learn. When I look back over our investing journey so far, I feel I’m exactly where I should be. The best part is enjoying good cash flow as well as good capital growth on the properties we have bought over the years —­ it feels as though we’ve got the best of both worlds. We played our cards right and did the right groundwork whenever we went into a property deal, making sure we didn’t forget our main goal and the result we needed to achieve. I believe one of our biggest mistakes was putting our money in a principal place of residence at the start of our investing career. That’s because no investment driven by emotion will ever give you back money or passive income. As we’ve said, you don’t want to fall into the emotion trap, because buying on emotion is not a good way to invest and can complicate things immensely. Remember once again: what is the goal, what is most important to you? However, we did it and we learned from the experience. And we used it as leverage to buy our next principal place of residence. We sold the original because the cash flow was poor, which was hurting our lending capacity. So it wasn’t all bad. Buying this at the start wasn’t ideal, but that didn’t mean we were not going to do it at some point. At the end of the day, goals evolve too but as our family now grows, we also accommodate the happiness we want to create for them in our home and enjoying the everprecious life and time we have with them. Today, I must say we’re much more calculating. We look at our outgoings and mortgage repayments, and manage our property portfolio in a very detailed manner where every cent is calculated to create the best result. We have a standard of only investing in a yield of 6 per cent and above, we evaluate our financial situation on a yearly to two yearly basis, we

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calculate each outgoing and analyse every lease on every property with careful analysis on a daily basis. However, this yield can be compressed for various reasons such as getting a property with a large amount of land or buying into a very tight market. As interest rates drop, 6 per cent is looking like our new minimum. We focus on commercial properties with long leases and evaluate our portfolio holistically so we can make the best decisions moving forward.

Scott While we always like to look forward, it’s also helpful to go back and learn from our mistakes. My biggest regret was that I didn’t get into commercial property earlier. You might think that retiring from a day job at 28 is young, but the truth is, we didn’t seal the deal on a commercial property until we had more than a dozen residential properties. Some were not the best performers in terms of cash flow and growth. Had I jumped over the fence half a decade earlier, we would have saved ourselves a lot of hassles from dealing with the large numbers of residential tenants we are still managing today. Commercial property was just so much more streamlined and efficient for us, which is why I wish I had known even earlier what I know now. But find me a successful investor who’s never made a mistake, and I’ll be shocked! You’ll be hard-­pressed to find anyone alive who hasn’t put a foot wrong. The problem with mistakes isn’t in making them, but in giving up as soon as you do. It’s perfectly normal to stuff up deals along the way. What distinguishes good investors is that they learn through their daily practice and continuously fine-tune their processes over the years. Personally, I’ve learned more from my mistakes than from my successes. They’ve made me a better investor. I believe all investors should be more open about what’s worked for them and what hasn’t. One of my biggest fails was a few years ago when we bought a site in Adelaide. I thought it was a prime site for development, which is not something I’m experienced in and is not part of our regular strategy. 272

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But given my appetite for risk, I thought, why not? I was looking for quick gains, and here was my perfect opportunity. Our purchase occurred during a market trough yet, ironically, we overpaid, resulting in a disappointing yield. Lack of market activity coupled with inadequate research on my part added to the issue. I fell into the emotional trap of pursuing a development project—an elementary blunder! As expected, this backfired, although not in a dramatic fashion, but enough to mark it as a misstep in our journey. Instead of resorting to a loss by selling, I opted to mitigate my losses by maintaining a long-term hold on the deal. One of the wonderful aspects of real estate is that time tends to resolve a majority of problems. The big lesson is that investment is a long game. You need to think of commercial property investments as requiring many years or even decades sitting in your portfolio, because that’s when the benefits will truly be experienced. I’m delighted to be where we are today, and we are just getting started. I love the thrill of the hunt for seeking out lucrative commercial real estate investments, and the more you do it, the more adept you become. I have learned from my mistakes and have been determined to not settle for the ordinary, and this has enabled Mina and I to achieve the kind of passive income we once only fantasised about while I was working on the railways in my 20s. However, my current focus is to impart knowledge and empower others to achieve financial freedom. This is my true calling as I transition to the next phases of life. This is why I collaborated with Mina to create this book, and why I developed the Rethink Commercial Education program. My ambition over the next decade is to help at least 10 000 Australians to invest in this profitable asset class, just like we have. For those of you who are ready to join us, there’s no time like the present to look over the fence and rethink your investing journey. We couldn’t be happier to share our knowledge so you can benefit from our experience. When you’re ready, we’ll be happy to welcome you into our backyard! If you’re looking for help investing in the lucrative world of commercial property, please visit rethinkinvesting.com.au. 273

ACKNOWLEDGEMENTS It takes a lot of people to write a book, and we were certainly not alone in this journey. First and foremost, we would like to thank our family, specifically our parents Nada and Chris (Mina’s parents) and Lyn and Laurie (Scott’s parents) and our extended families. Thank you for being there and supporting us through this journey. And our wonderful daughter, Willow, thank you for being the brightest star in our universe —­ everything we do is for you. To the teams at Rethink Investing, Rethink Financing, Rethink Property Lawyers, Rethink Property Insurance, Rethink Renewables and Rethink Commercial Education, we couldn’t ask for a better work family. Your dedication to our cause —­ to help everyone achieve their wealth goals —­ is what helps us get up in the morning. Thank you for your help and patience while we were writing, and for always supporting us when things get difficult. To the team at Wiley  —­  Lucy, Chris, Ingrid, Francesca, Bron and Renee —­ thank you for believing in our idea, and helping us every step of the way to edit, publish and market the book.

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To our clients, thank you for believing in us, for seeing the value in commercial property investing, and for trusting us with your investment strategy. Finally, thank you to you, the reader, for considering us as your guide to the next phase in your investment journey. These steps and plays have worked well for us, and we’re certain they will work just as well for you.

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COMMON COMMERCIAL REAL ESTATE TERMINOLOGY If you are looking to buy, lease or sell commercial or industrial property then you’re going to have to liaise with many industry professionals such as agents, accountants, lenders, solicitors and property managers. Below are the definitions of some of the common commercial real estate terms that you’re likely to come across. The more you learn, the easier it will be for you to cut through the overwhelming commercial jargon! Amenities: The features and benefits of a property that create value. Tangible amenities could include onsite parking, while intangible amenities might be the proximity to local transport or retail outlets. Anchor tenant: The is the main tenant in a leased commercial property, who generally attracts other tenants and/or people to the property.

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Annual percentage rate (APR): The annual rate charged for borrowing, or made as a result of investing, expressed as a single percentage value. This represents the actual yearly cost of funds, or income from investing, over the term of a loan. Appraisal: An informal estimate of the price of a property, usually provided by a real estate agent. An appraisal is not the same as a formal valuation. Arrears: Overdue payments on a debt or liability, when one or more payments have been missed on an account that requires regular recurring payments, such as a mortgage, rental agreement, utility bill or any type of loan. Asking rent: The amount of rent a landlord is advertising for a space, quoted as the dollars per square foot, per year. Asset management: Activities or services designed to maintain and increase the market value of any asset so the owner can benefit from returns. In real estate, asset management focuses on maximising property value and ongoing returns from the property, usually in the form of rental income. Building Code of Australia (BCA): Written regulations created and maintained by the Australian Building Codes Board, setting the minimum standards of health, safety, amenity and sustainability for the construction industry. The BCA details technical requirements for the design and construction of buildings in Australia. Capital: In general, this refers to financial resources available for use. Capital can be used to generate wealth when it is invested or used to produce goods and services. It can also be combined with labour to produce a return. Capital in the form of property can be rented out to generate income. Cash on cash: A cash-­on-­cash return is a rate of return often used in real estate transactions that calculates the cash income earned on the cash invested in a property. Put simply, cash-­on-­cash return measures the annual return the investor made on the property in relation to the amount of mortgage paid during the same year. It is considered relatively easy to understand and one of the most important real estate ROI calculations. 278

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Consumer price index (CPI): The average change over time in how much households pay for a fixed basket of goods and services. In Australia, the Australian Bureau of Statistics publishes CPI figures. The CPI can indicate changes in economic inflation and variations in the cost of living. Contiguous space: Two commercial spaces that are adjacent to each other, either on the same floor of a building, or that sit directly above or below one another. Contingencies: These are items that need to be met, changed or remedied in order for a deal to close. Conveyancing: The process of transferring property between a buyer and a seller. In real estate, conveyancing involves drawing up and carrying out a written contract that sets out the agreed purchase price and the date of transfer, as well as the obligations and responsibilities of both parties. Counter offer: A new offer made by a seller or buyer on a property in response to an unacceptable offer by either party. Covenant: A condition in a real property deed or title that limits or prevents someone from using a property for certain purposes. Depreciation: The reduction in value of a tangible asset over time. With real estate, depreciation can also mean a drop in the value of property assets due to poor market conditions. Due diligence: Investigating a potential investment or purchase to confirm all material facts. When someone is preparing to purchase a property, the buyer needs to examine, among other things, the contract of sale, and the planning controls in place that will affect how the land and/ or buildings are used. Effective rent: The actual amount of rent paid on average per year. Fit-­out: Preparing a leased space for occupation by a tenant. This may include the installation of things such as floor coverings, partitions and signage. Fit-­outs are usually a tenant’s expense, but this can sometimes be negotiated.

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Fixtures: Fixed parts of a commercial property included in a sale, such as light fittings and carpet, as opposed to loose items like furniture, which are often excluded. Gross area: The total floor area of a building, usually measured from its outside walls. Gross leasable area (GLA): The floor area that can be used by tenants. Generally measured from the centre of the joint partitions to outside wall surfaces. Gross lease: Tenant pays base rent and increases in operating expenses over an expense stop or base year. Heads of agreement (HOA): The agreement with a prospective tenant before the lease is signed. ICR/debt cover: The interest coverage ratio measures a company’s ability to handle its outstanding debt. This is something the banks look at when assessing loans on a commercial property. It is one of several debt ratios that can be used to evaluate a company or lender’s financial condition. Incentives: Essentially a tool used by building owners to entice businesses to lease space within their properties. Incentives are generally referred to and applied in various forms Land tax: An annual tax on the value of a piece of land. In Australia, land tax is administered by the state and territory governments. Lease: A document that outlines the terms and conditions for a tenant to occupy a commercial property for a set period. Leasehold: That there is a lease in place with the freeholder, also known as the landlord, to use a property for a number of years. Lessee: The tenant of a leased commercial property. Lessor: The owner of a leased commercial property. LVR: Loan-­to-­value ratio. Market reviews: Market rent reviews are often used if a tenant wishes to exercise their option to renew the lease, or at certain increments during a long-­term lease. They allow the landlord to reassess the applicable rent for the premises so that it keeps pace with the market. 280

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Minimum divisible: The smallest area allowed in the division of a property. Mortgage insurance: An insurance policy that the lender or borrower can purchase to protect themselves against mortgage default. In Australia, lenders mortgage insurance (LMI) is usually required for mortgages greater than 80 per cent of the property value. In most cases, the borrower pays the insurance premium for LMI. National Australian Built Environment Rating System (NABERS): A national rating system that measures the environmental performance of buildings in Australia. NABERS analyses 12 months of performance data relating to a building or tenancy’s energy or water bills, or conducts a waste audit, and provides a star rating. This rating is scaled relative to the performance of other similar buildings in the same location. Negative gearing: Borrowing money to buy an asset and receiving income, other than funds used to cover the loan interest and maintenance costs, from the investment. In Australia, the shortfall between income earned and interest due can be deducted from an individual’s tax liability. Negative gearing becomes profitable when the property is sold, assuming that property values are rising and a capital gain can be made. Investors considering negative gearing must have the finances to fund their ongoing interest and maintenance costs until the property is sold. Net leasable area (NLA): In a building or project, floor space that may be rented to tenants. The area upon which rental payments are based. This generally excludes common areas and space devoted to the heating, cooling and other equipment of a building. Ratchet: A ‘ratchet clause’ is a clause in a lease agreement that prevents rent from going down after a rent review has been conducted. Real estate investment trust (REIT): An investment vehicle for real estate, whereby investors can buy a stake in property assets, including buildings and mortgages, without tying up their capital in the long term. REITs can be traded, like stocks, on major exchanges. They give investors exposure to large-­scale real estate assets, including warehouses, hospitals, shopping malls and apartment buildings. ROI: Return on investment. 281

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Sale and leaseback: When a company sells their building to an investor and then signs a long-­term lease for the space, providing income for the investor. Stamp duty: A tax on legal documents that relate to the transfer of assets or property. Property sales and acquisitions throughout Australia are subject to stamp duty, although rates vary in each state and territory. Strata title: A form of ownership created for multilevel apartment blocks, and horizontal subdivisions with shared areas such as car parks and swimming pools. Strata-­title properties consist of individual lots and common property. Sublease: A lease or rental agreement between a tenant who already holds a lease to a commercial space or property and another party, called the sublessee or subtenant, who wants to use part or all of that space. Tenant security: A tenant will often have to provide the landlord with a security deposit as a form of protection or guarantee for the performance of the tenant’s obligations under the lease. Tenants in common: The co-­owners of an undivided interest in the same property. Each has an equal right to the possession and use of the property. Each owner can bequeath their interest to beneficiaries through their will. In contrast, in a joint tenancy, if one party dies their share passes automatically to the remaining owner or owners. Term deposit: A deposit held at a financial institution for a fixed term that may range anywhere from a month to a few years. The conditions of a term deposit are that the money can only be withdrawn after the term has ended or by the borrower giving an agreed number of days’ notice. Typically, a longer term will offer a higher interest rate, and if the cash is withdrawn early, a penalty may be charged. Torrens Title property: A property where the owner holds the title to the building and the land it is on. A Torrens Title document will list all details and interests affecting a property and its land, including easements, caveats, mortgages, covenants and past changes in ownership. Trust account: A bank account set up by one person on behalf of another. For example, an agent may set up an account for an owner to collect a commercial property buyer’s deposit. 282

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Valuation: A formal process of establishing the value of a property from an objective and independent point of view. In most Australian states and territories, a formal valuation can only be provided by a qualified valuer who has the necessary qualifications and training. WALE: The weighted average lease expiry is used to indicate the average expiry period of all the leases within a property. This figure enables you to more clearly assess the current and future income stream that the property will provide. Generally the longer the WALE, the more attractive the investment is as it has greater certainty of long-­term income potential. Yield: The rent that a commercial property currently generates for the owner, expressed as a percentage of the market value of the property.

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