8
M
any residential property
investors harbour a yearn-
ing to get into commercial
property investment, but
don’t know how to make the leap.
The attractions are obvious to anyone
who has suffered at the hands of wayward
tenants – for example, the long leases in
commercial are extremely appealing.
Unsurprisingly, the special commercial
property theme for the Tauranga Property
Investors Association’s monthly meeting in
July was very well attended.
Simon Clark from Colliers International in
Tauranga kicked off the event by saying he
had been in the industry for 23 years – yet
was learning something new every day.
“The commercial property market is hot at
the moment,” Simon told the meeting. “We
have record low interest rates. People are
keen on commercial. We’ve never had such
good conditions for positively gearing com-
mercial property in my 20-odd years.
“But there is still caution there – people
are remembering the past eight years.”
He says the sector has been pulled down
somewhat by the Tauranga central busi-
ness district (CBD). People were attracted
to the shopping malls, but the CBD would
reinvent itself, he predicted.
“Industrial is going gangbusters, mainly
because Port of Tauranga is doing well.
Fringe areas and the office sector are doing
well, while bulk retail in areas such as
Mount Maunganui are setting records.”
Simon then explained the main benefits
of commercial investment, compared with
residential:
•
Net return
•
Very little input required
•
Incremental growth
•
Larger gains with change of use
•
Low maintenance
•
Long-term security
•
Some guaranteed growth.
“The net return is the yield after all rea-
sonable costs (excluding maintenance). The
tenant would usually pay the rates, insur-
ance and maintenance – some even pay a
management fee.
“Very little input is required. You invoice
the operating expenses, conduct regular
inspections and can even pay someone else
to manage it for you.
“All rents rise over time and the underly-
ing land appreciates in value. There are lim-
ited land supply areas such as downtown
the Mount and the Mount industrial area
– there is no more land in those markets.
You don’t have to
concentrate so much on the tenant.
“You can get larger gains through change
of use, say industrial to retail or commercial
to residential.
“And there is low maintenance. The ten-
ant pays most of the internal maintenance
costs, including minor leaks and clearing
the gutters. The body corporate is obligated
to maintain the exterior of the building.
“Long-term security is provided by the
lease term – typically 6-15 years, often at
a yield of 6-7%. Higher profile sites are
always in demand, such as road frontage
industrial units.
“There is sometimes some guaranteed
growth. Rents can be subject to regular CPI
[Consumer Price Index] reviews or you can
conduct market reviews, which are more
complex. You can also use a combination of
the two.”
He then explained how commercial prop-
erty is valued, saying first-time investors
often struggle to understand the formula.
“The equation is: Rental divided by Return
equals Value.
Stuart Jackson, a senior relationship man-
ager at the ANZ in Tauranga, looks at the
commercial property scene from a lender’s
perspective.
“There are opportunities in every market,”
he explained. “What we look for is similar to
what the investor should be looking for.”
The analysis starts with the asset metrics:
the location, yield, age, quality. Does it have
an alternative use? Is it easy to re-let, sell or
convert?
“There are ways of mitigating weak asset
metrics. We can shift the focus to the tenant’s
strength. Perhaps there is a long lease, or we
are able to view the tenant’s financial state-
ments. We may find enough strength to fund
that deal.”
It also depends on the bank’s LVR position,
says Stuart. “Banks generally have a maxi-
mum of 65% these days for funding, but there
are always exceptions to the rule, particularly
if the asset is more specialist.”
The bank will seek recourse (personal guar-
antees) when the LVR is above 50%. If it is
a company, the bank will want a shareholder
guarantee. “If it is less than 50%, the bank
may do a non-recourse deal.”
The bank will also calculate the forecast
interest cover – how many times does the
net rent cover the interest on the loan? Stuart
explained WALT, the weighted average lease
term calculation used by the banks. This
shows the average time left on the lease(s). If
there is a single tenant, the WALT is the lease
term. If several tenants, the WALT is the aver-
age amount of time across all those tenancies.
“A short WALT is not necessarily a deal
killer. We can recognise the good certainty of
a re-let by the existing tenants.”
When it comes to fixed interest or floating,
the bank will leave that decision up to the
customer. While a fixed rate stabilises the
return equation, he says, investors should also
consider the 5-10 year outlook for rate rises.
The bank will also look at the NBS – the
earthquake rating of the target building. If
the NBS is less than 33%, Stuart suggests it
will be difficult to fund unless the buyer has a
good strategy to remedy the situation.
Typically, industrial space is in the 33-67%
range, while office space is above 67%.
“There are ways and means of funding the
33-67% area, but this is on a case-by-case
basis.”
The bank can also fund syndications,
perhaps five or six people or right through to
those offered under the Financial Management
Act. Without recourse in the deal, the maxi-
mum funding is 50%.
What the banks look for
Photo courtesy Salina Galvan Photography
