We love commercial property at Pure. It’s a fantastic asset class that has some very important characteristics for investors:

  • It’s often considered a hedge against inflation. This is because a lot of the annual rent reviews are linked to inflation (CPI). Therefore, as inflation goes up, so does your rent. Even if your property isn’t linked to CPI reviews, there are enough that are in the market that the overall market rent changes, and this helps partially protect the value of your investment in a rising interest rate environment.
  • Commercial property is often negatively correlated to other classes such as equities. We often see equities fall due to an economic shock, which in-turn sees interest rates fall. In a falling interest rate environment, commercial property values normally increase. The converse is true, when we start seeing interest rates rise, commercial property values can take a hit, especially if interest rates rise ahead of, or more rapidly than, inflation.
  • Overall, the phases of the property cycle are often different to the sharemarket cycle. Therefore, commercial property provides good diversification.
  • There are some drawbacks too: The transaction costs (purchase and selling) are expensive, which normally makes commercial property a long-term investment. While cashflow is often high, capital gain is normally lower than residential property; and as commercial property isn’t traded on an exchange and each asset is different and specific, it’s considered less liquid (i.e. harder to buy and sell).

As with most investments, you make your money when you buy, not when you sell. This is because you have a lot more control when you’re buying. When you’re selling, it’s the market that has control over what your asset is worth, so it’s important to understand how to value the asset and make the correct offer in the first place.

 

Here’s an example from over 20 years ago: I’ll join the crowd at the moment and pick on the big banks.

 

The banks found themselves wanting to exit rural markets. They had a bunch of big sandstone buildings in the high-street of town that were expensive to maintain and staff, and didn’t do that much business, especially with the growing online banking services. So what was their best strategy? They could have just sold their building and maybe got $1 million dollars for vacant possession. Let’s say market rent was about $100,000 per annum in the town for that size retail floorspace. Therefore, the rent they would have been paying was around 10% ($100,000 ÷ $1,000,000)

Here’s what they did: they offered to sell the building with a lease-back in place for 3 years, plus two 3-year options. i.e. 3 + 3 + 3. The starting rent was $250,000 per annum. I hear you ask, why would they pay so much when the market rent was only $100,000 per annum? Let’s look at it. An unsuspecting buyer looks at the investment, and says, ‘these guys have been here forever and it’s a very specific building for them, with a big safe, and giant marble counter. They aren’t going anywhere. Who else could even use this building? These guys will be my tenant for 9 years.’

So the investor looks at the 10% market yield and agrees to buy the building for $2,500,000. Oh, now we see what the bank is doing, but they’re still paying too much rent. Let’s consider the 3 year lease at $250,000. It totals $750,000 for the full term (slightly more with annual rent reviews but we’ll ignore that to keep it very simple). More importantly, the rent is $150,000 above market, so they are overpaying by $450,000 during the 3 years. When you consider that they received $2.5m up front on sale, which was $1.5m above market value, and they are only losing $450k off the additional $1.5m in over-rent, it looks like a great strategy for the bank. i.e. this simple strategy allowed them to make an additional $1m profit over the three years (or double the value they received from their asset). Sneaky right. 

It gets worse for our unsuspecting purchaser: after three years, the bank didn’t exercise their option (remember it’s the tenant’s option, not the landlord’s). They probably never intended to, but it sure made the purchase look more attractive. So, the bank move out (exit strategy complete), and the landlord is left with an empty sandstone bank with an enormous steel safe. He puts it on the market, and no-one wants to rent it because it’s too specific in layout. While other sites would get $100,000 p.a. in rent, he has to discount his rent to $80,000 and spend a lot on re-fit to get a tenant.

His lending bank (actually the same bank that was his tenant) now turns around and says we think the value of your building is only $800,000. Although we agreed to lend you 60% of the $2.5m you paid ($1.5m mortgage), we now only want to be at risk for 60% of $800,000. i.e. we need you to reduce your mortgage to $480,000. Can you please deposit $1m into our account by Tuesday.

Unfortunately, our buyer doesn’t have $1,000,000 lying around after just completing a re-fit and he’s just lost $1.7m in value from his investment. But don’t worry, the bank did OK. They always seem to…

It’s a hard lesson but important for all of us, and I’m very happy to learn it indirectly.

Valuation

This article wont make you a valuer, but I hope it helps you think about the basics in a different way and I also hope it makes your valuer’s report more meaningful to you. Perhaps, you’ll even ring him up and challenge some of his comments or data. And remember, commercial property is very much buyer beware compared to residential property, so the more you know, the less risk you have.

There are many available valuation concepts for commercial property and some are specific to the type of commercial asset, such as childcare that’s valued on a per/child basis, or large-format retail that might include turn-over rent, or hotels that need to factor in occupancy, but in the following blogs, I’ll just concentrate on the three basics: Capitalisation Rate, Discounted Cash Flow, and Direct Comparison.

Today, we’ll discuss the Capitalisation Method, but first let’s look at the golden rule of investment:

 

The Risk Premium

Let’s start with the Risk Free Rate of Return. If we assume that the Australian government won’t fail like Venezuela or Zimbabwe, then we can safely assume there is no risk in Government bonds. The easiest proxy for this is the RBA cash rate, currently sitting at 1.5% and reviewed on the first Tuesday of every month. If you’re interested you can see it on the RBA website front page at www.rba.gov.au , which also shows inflation (CPI); another useful figure for us in commercial property. If you’re interested, you may also like their economic snapshots: http://rba.gov.au/snapshots/economy-indicators-snapshot/

Assuming that there is no risk in the 1.5% government cash-rate, then any return above this entails some level of risk. The higher the return the higher the risk. By default, if you’re getting 15%, you are taking more risk that someone getting 5%. Or to reverse the equation, if a corporation has to offer 15% to the market to get people to buy their debt, then this reflects their risk. If there was no risk, they would offer 2% and people would take it over the government rate of 1.5%. NB: they will only offer the lowest rate required by the market to get the debt away. The difference between the Risk Free Rate of Return and the expected, desired or required rate of return is the Risk Premium.

The overall Risk Premium for Commercial property does vary with the economic cycle and the outlook, but there is always a risk premium. i.e. people are only willing to take the risk to gain the return if it is above the Risk Free Rate of Return. Let’s say this averages out at a 5% premium. i.e. when cash rates are at 4% we would expect to see commercial property yields around 9%. At present, with the cash-rate at 1.5%, we see commercial yields compressed to around 6.5%. The risk premium is still roughly the same, but yields are much tighter (lower) because the Risk Free Rate of Return is lower.

 

Capitalisation Rate

One of the simplest ways to value a commercial property is to capitalise the income. When we hear people talk about yield, they are really referring to the Capitalisation Rate. The income of a commercial property is generally set in the lease and doesn’t change except for annual reviews (normally fixed or CPI) or market reviews. Ignoring reviews for a second, the value of the property is simply the rent divided by the Capitalisation Rate (market yield).

 

Net Income per annum

———————————–            =         Value

Capitalisation Rate

 

Remember the Capitalisation Rate (yield) is the component that moves with market forces such as interest rate changes, economic growth, vacancy rates, inflation, lease covenants, tenant quality etc, not the rent during a lease (which is normally fixed).

Here’s an example: A property rents for $100,000 per annum, and the market yield for that type of property, with that quality of tenant and that length of lease is say: 6.5%. We calculate the value as follows:

 

$100,000

———————————–            =         $1,538,462

0.065

 

If the interest rate falls, then the market yield (Cap.Rate) may tighten too. Even though the rent doesn’t change, this will affect the value of your property. Let’s see what happens if interest rates fall to 6.0%:

 

$100,000

———————————–            =         $1,666,666

0.060

 

We just picked up $130,000 in value (at least on paper anyway). Of course, you could go to the bank with your new valuation in hand and ask for more money to buy another property, or you could sell and realise the gain, but otherwise it’s just a snapshot in time of the current value.

Unfortunately, a move in the other direction is possible too. If the interest rates rise, then the market yield (Cap.Rate) would rise too. Even though the rent doesn’t change, this will affect the value of your property. Let’s see what happens if interest rates rise 1% to 7.5%:

 

$100,000

———————————–            =         $1,333,333

0.075

 

The value of our property just went down around $200,000 from our starting point of 6.5% and nothing changed, other than the market yield. The rent was the same, the tenant didn’t move, outgoings didn’t change, but our value sure did.

You might even find that your bank starts getting concerned with this increase in Loan to Value Ratio (LVR). i.e. the debt that they gave you hasn’t changed, but your value has gone down, meaning your LVR has gone up. For example, if you had a 50% LVR at $1.538m ($769,231 in debt) and the value of your asset dropped to $1.333m, your LVR has gone from 50% to 57.7% ($769,231 ÷ $1,333,333). This might be OK if your loan facility has a 60% LVR available, but might be problematic if your loan only goes up to 55%. The banks can call this a technical default and charge additional interest.

Beware of leveraging up to the maximum when interest rates are low.

It’s easy for us to produce a simple sensitivity matrix in Microsoft excel so you can see how the value of the above property changes with interest rates. For example:

It’s important to see the inverse relationship that commercial property values have to interest rates. The higher the rate, the lower the value that people are willing to pay. NB: their risk premium hasn’t changed, but the market value has.

Remember earlier when I said that commercial property can be a hedge against inflation. Here’s where this fits in. Let’s say that your annual rent reviews are tied to CPI and the RBA is raising rates to try and slow inflation. If inflation was running at 4%, which caused the current  interest rates to rise to 2.5% (and the Capitalisation Rate to rise to 7.5%), then this loss of value is partly offset by the increase in rent. In this example, rent goes to $104,000, and with the rent capitalised at 7.5% we have the following value:

 

 

$104,000

———————————–            =         $1,386,666

0.075

 

This is $53,000 better than our previous 7.5% example. While it doesn’t prevent the market value change in full, it helps protect against Interest Rate Risk, which is one of the main risks in commercial property.

As a side note, the cash-rate cycle is generally considered to be 4-5 years from trough to peak to trough again. Some investors are very sensitive to interest rate risk and choose to lock in their mortgage rates to try and mitigate the impact, but this is to do with their own cashflow, not the market value, which is based on the Risk Free Rate of Return plus the Current Risk Premium to determine the Capitalisation Rate for valuation purposes.

Next month, we’ll talk about Discounted Cash Flow, which is another very important methodology for valuation. Normally, we wouldn’t rely on a single method, but rather look at all three. Often, we’ll rely more heavily on one or the other, but most times we’ll just average out the three. Hopefully they’ll all be roughly consistent to give us comfort and make sure we’re paying the correct price.

 

Happy investing,

 

Andrew Glen
Pure Property – Commercial Management Re-Defined

 

 

Over the past few months we’ve been exploring Commercial Lease Essentials on our Facebook page – covering they key points on renewals, administration, provisions, and other aspects of a commercial lease document. Now that the series is finished, we’ve collected these points here for you to refer back to as needed.

What is a Commercial Lease?

A commercial lease is a legal contract between a landlord and a tenant for real estate. The lease is a formal and binding commitment that covers a set of obligations for both parties. The lease contains all the information and answers you could ask as either an owner or tenant, so it’s important to read and understand this document as it will be your handbook for the life of your lease term!

What is a Heads of Agreement?

A heads of agreement is the non-binding precursor document to a commercial lease. It outlines the key terms of a lease deal that reflects the commercial intent of the parties involved in the agreement.

Dealing with an expiring lease

Understanding the process around lease expiry is essential to the smooth and efficient managing of a commercial lease. We approach our tenants and landlords as early as possible before an upcoming lease expiry to understand the needs of both parties and to enable us to secure a renewal, or new tenancy, as required.

Sections of a Commercial Lease

A typical commercial lease is made up of a number of key elements and clauses: reference schedule (summary of all major terms and conditions), definitions of terms, parties involved, the legal premises being leased, lease term, building rules and regulations, tenant and landlord obligations, rent and information regarding rent reviews, fixed per cent increases, and outgoings, insurances, and lease security.

It is important to review each of these sections of the lease and do your due diligence before signing.

Renewing a Commercial Lease

Options are a renewal term that follows the expiration of the initial lease term. Options to renew are often included in commercial leases and tend to be favourable for the tenant. A notice period is given around three to six months prior to the expiration of the lease and the option can be taken to extend at that time, typically with the same terms as the initial period.

Commercial Lease Administration

This essential commercial lease tip is one for the property managers: it is crucial for a property manager to completely understand the lease so that we can assist both landlord and tenant during the lease term with their enquiries, questions, and any issues which may arise.

Understanding the lease and being aware of key dates means we can manage efficiently, ensure your tenants tenants are fulfilling their obligations, and that your commercial assets are protected.

Permitted Use of the Property

Commercial leases will outline the permitted use of the property in question. This explains what the premises can and cannot be used for, and typically the development application will have a general outline of these scenarios.

Property Condition Reports

Much like a residential lease, a commercial lease will include a condition report as part of the lease document package. This document is used to detail the condition of the property prior to the tenant taking occupancy and is used as a reference point for the state of the property for the duration of the lease.

Commercial Lease Holdover Provisions:

This is a provision within the lease that gives the tenant an option to hold over past the lease expiry date without entering into a new lease agreement. This is often conducted under the discretion of the landlord and may or may not be applicable for every lease circumstance.

 

Have a question about Commercial Leases not covered here? Feel free to reach out to us by phone on 1300 111 776 or by email info@purepm.com.au to see how we can help.

 

Resources: REINSW – Essentials of a Commercial Lease Webinar Article

Industry News

Is it time for your business to make the move to its own commercial space? We’re loving this article from Commercial Real Estate covering the key points to consider before making the jump, you can read it here.

Brisbane’s industrial market is pushing towards undersupply territory with construction and consumer-supply sectors driving the demand for well positioned assets. This is likely to strengthen rents across the area for this financial year. You can read this Brisbane market update here.

Available Listings

Salamander Bay – Light Industrial Shed
$15,272 per annum including outgoings (plus GST). Approximately 150 sqm, high clearance roller door with easy access, internal amenities.

Nelson Bay – Retail space ready to move in
$20,000 per annum including outgoings plus GST. Approximately 31 sqm of retail space in the heart of Nelson Bay CBD.

Wickham – High Exposure Office Space
$120,000 per annum plus GST and outgoings. Tired of parking problems in CBD? Why not move to Wickham. Easy parking for customers and staff, only minutes from CBD.

For more information on these listings contact: Jane Lestone
M: 0427 776 776 | T: 1300 111 776 | E: jane@purepm.com.au

Are you following us on Facebook and LinkedIn? If not, you should be! We’re kicking off a new Info Series this week across our social media this week. The first series focuses on the Essentials of Commercial Leases – we’ll be reviewing key points on renewals, administration, provisions, and other aspects of a commercial lease document.

 

Industry News

The 2018 Budget was announced early in June and has some inclusions that could impact the commercial property market across the country. You can read about the budget here.

Looking for some information on Commercial Property Loans? Real Commercial has a fantastic run down on the basics on their website. If you’re considering purchasing commercial property and investigating your loan options, have a read here and then get in touch with our team to talk through how we can help!

Recently Leased

240 Waterworks Road, Ashgrove
ONLY 1 SPACE REMAINING! Quality 148m² Retail Space available providing maximum exposure. Attractive lease incentives offered. Contact Anna Deam: 0429776776

Available Listings

Soldiers Point – High Exposure Office Space
$15,400 per annum plus outgoings (plus GST). Approximately 110sqm, undercover car space. Right alongside a professional office.

Salamander Bay – Light Industrial Shed
$15,272 per annum including outgoings (plus GST). Approximately 150 sqm, high clearance roller door with easy access, internal amenities.

Soldiers Point – Re-configured Office Space
$9,240 per annum plus outgoings (plus GST). Approximately 66sqm. Air Conditioned. High exposure floor to ceiling windows.

For more information on these listings contact: Jane Lestone
M: 0427 776 776 | T: 1300 111 776 | E: jane@purepm.com.au

Welcome to the Pure Property Management April Update.

Early in the month Jane and Andrew attended the Tomaree Business Chamber Breakfast, a fantastic networking event helping to connect like minded professionals within the area. As new attendees, we had to do a Corporate Speed Date as part of our introduction. It was a pleasure to attend and participate!

       

Industry News
Brisbane is seeing an upward trend with industrial/commercial investment after Q1 with investors showing strong interest in the area. You can read about this trend here.

Available Listings

 

Alta Mira, 18 & 19, 12-14 Soldiers Point Rd, Soldiers Point
$20,700 PA + GST + Outgoings – ~176 sqm retail/office space, located on street level providing high exposure with floor to ceiling glass frontage.

132 Hannell Street, Wickham
$90,000 PA + GST + Outgoings – Approximately 556 sqm of showroom/office/warehouse under the one roof. Only minutes from Newcastle CBD. with the benefit of a mezzanine.

1/27 George Road, Salamander Bay
$17,823.16 PA + GST + Outgoings – Zones IN2 – Light industrial, full brick construction, 104 sqm plus mezzanine level. Sectioned into warehouse and shop but could easily be altered.

For more information on these listings contact: Jane Lestone
M: 0427 776 776 | T: 1300 111 776 | E: jane@purepm.com.au

Welcome to the Pure Property Management March Update.

Industry News
There are a number of fantastic retail projects opening across the country that are excellent examples of landlords focusing on the way to enhance the retail experience for consumers, driving further business into these spaces. You can read about it here.

There’s an increase in initiatives to improve workplace collaboration and culture through innovative design in commercial spaces. A recent article, focusing on a Brisbane company, explored how an updated design to their communal space has had a positive impact upon their employees and the work culture within the firm. Could implementing innovative ideas in your commercial spaces make your employees and customers happier? Learn more here.

Management News
2 Lincoln Street, Lane Cove
The PURE team are proud to be appointed as Managing Agents for the mixed use development in Lane Cove. It comprises refurbished offices and warehouses and is overlooking Lane Cove National Park and connected to Sydney’s arterial ring road.

FEATURED LISTING FOR LEASE: Alta Mira, 18 & 19, 12-14 Soldiers Point Road, Soldiers Point, NSW 2317

Think outside the square, modern office space with loads of parking! Air conditioned, high exposure location.

For Lease $22,800 including GST plus outgoings. Contact Jane Lestone for more information: 0427 776 776.

Welcome to the Pure Property Management February Newsletter.

Industry News
In broad industry news, recent research is showing that the relationship between commercial landlords and tenants is shifting towards a provider/customer model with landlords focusing on flexible office spaces with shared facilities that enhance the tenancy experience. You can read more about this here.

In local NSW news, a new vision for Nelson Bay’s future has been announced this month by Port Stephen’s Mayor Ryan Palmer: Nelson Bay Next is an initiative that has been developed to help showcase exciting projects led either by Council or the community within the town centre. You can read more about this fantastic initiative here.

Management News

Early in the month Jane from our NSW team attended the official opening of the Spark CoWork space. The opening was conducted by the Mayor of Port Stephens and covered by Port Stephens Examiner. Congratulations to our tenants on their official opening, we can’t wait to see how this space develops and the positive effect it will have for small business in the local area. You can read more about the opening here.

240 Waterworks Road, Ashgrove QLD
The home of the newly refurbished 2 level Goodlife Gym and Hypoxi Studio. Highpoint Plaza is certainly shaping up to be a local health and wellbeing hub. Over the Christmas period new leases were negotiated which saw current tenants Metro Radiology expand their space and new tenant Vitalita commence their fit out in preparation of opening a detox and wellness space that is a perfect fit with the medical practice, holistic skin therapy, physiotherapist and beauty clinic that are already onsite.

77 Hudson Road, Albion QLD
Is Headquarters to Vita Group, Telstra’s only master licensee. This building is currently undergoing a full renovation and is now 75% complete. During this renovation the building had a new café installed on the ground level and just prior to Christmas this was completed and is now open and fully operational. Currently work is being completed on the top level which will provide the tenants with a stunning and modern outdoor break out area.

50 Hunter Street, Newcastle NSW
Sidcor are the main tenancy at this property and they have recently benefited from a full refurbishment of level 4, check out the photos below. The senior leadership team at Sidcor moved in late January.

The owners of the building also obtained a DA late last year to remove the old police gym staircase to increase the Net Lettable area on levels 4 and 5, which also subsequently increased net rent.

For those of you interested in commercial property analysis, the capitalisation rate uses the net rent and market yield to determine the value:

Net rent ($) ÷ Capitalisation rate (%) =  Value ($)

for example $100,000 net rent at a cap.rate of 7% would be:

$100,000 ÷ 0.07 = $1,428,571

 

NEW LISTING

NEW LISTING FOR LEASE: 132 Hannell Street, Wickham NSW

High Exposure Warehouse on corner block, roller door access, and air conditioned offices. For Lease $90,000 P.A. Exc. GST + Outgoings. Contact Jane Lestone for more information: 0427 776 776.

Industry News
The QLD market is the focus of our industry news this month, with the publication of reports highlighting urban development and growth in the commercial sector across QLD.

The QLD market outpaced Sydney and Melbourne in 2017, with the majority of the growth being attributed to high demand for commercial office space – which is continuing into 2018. Diversification could be the key for investors in this market in 2018 – you can read more about this here.

There’s also substantial urban development happening on the Gold Coast in the lead up to the 2018 Commonwealth Games, with this growth having impacts for both the livability and commercial interests of the area. You can read more about this growth here.

 

Management News
In management news this month we have recently been appointed as the managing agents for the Newcastle Leagues Club at 17 National Park Street, Newcastle West.

For more information about the club, check out their website.

Tip Series: Buying vs Leasing Commercial Space
We launched our latest Tip Series over on our Facebook and LinkedIn pages in January. This series focuses on the age-old debate of buying vs leasing a commercial space.

Our first tip is an important and simple question – can you afford to buy?

Purchasing a commercial space will eat into your working capital, which may hinder your business goals, so it is crucial to do your due diligence and ensure you’ve got your sights set on your long term goals and success of your business.

Our upcoming tips will explore the pros and cons of each option, and as always, if you have any questions don’t hesitate to get in touch with our team for specialised commercial advice.

Make sure you like our Facebook page and follow us on LinkedIn to catch the rest of the series and other updates!

Available Listings


For Lease: 1/27 George Road, Salamander Bay, NSW 2317

Full brick construction, 104 sqm plus mezzanine level. Currently sectioned into warehouse and shop but could easily be altered to suit as required. $17,823.16 + GST per annum, plus outgoings.

For more information contact Jane Lestone: 0427 776 776

Welcome to the Pure Property Management November Newsletter.

The last weekend of November our team was proud to support one of our Directors, Gavan Reynolds, in his Newcastle Toyota 86 races as part of the V8 Supercar Series. You can read more about Gavan and his racing ambitions in this article from the Newcastle Herald.

In community news this month we are happy to announce that our NSW team was one of the main organisers for Soldiers Point Public School’s 70th Birthday Celebration which was held on 4th November 2017.

To coincide with the event we ran a major raffle which we began selling tickets for in August. PURE donated an iPad which was one of the major prizes. The raffle raised over $10,000 for the school and this money will be put towards updating their information technology equipment.

Overall, the Birthday Celebration raised $25,000 and the event was mentioned in State Parliament this week to acknowledge such a significant community milestone. You can watch the Parliament video here.

The PURE team are proud to support such a great local community.

Management News
Our QLD team is excited to have been appointed as the asset manager for 77 Hudson Road, Albion QLD. The tenant for this building is VITA group. Vita Group is a multifaceted lifestyle solutions provider, and as Telstra’s only Master Licensed Dealer, VITA Group operate a third of the Telstra branded stores across Australia. We are delighted to have been selected to manage such a prominent and valuable asset.

 

Welcome to the Pure Property Management Blog. Our team hopes that through this publication we can keep you up to date with the current commercial market and information that is relevant to both investors and tenants.

The team at PurePM were proud to support Breast Friends Fundraising and their annual golf day on the 6th October. Thanks to the generous support of everyone on the day, they were able to raise $12,400 to help fight women’s cancers.

 

Management News

Fund manager Aviator Capital has made its first foray into the Brisbane market by snapping up the Highpoint Plaza complex in Ashgrove for $33.5 million. The purchase of the 240 Waterworks Road property was the company’s largest acquisition to date and adds to its holdings in Newcastle.

The centre comprises a mix of commercial and medical tenancies and is dominated by the latter category. It sits on a 5,648sqm site and is anchored by Good Life Health Clubs, Metro Radiology and Ashgrove Family Practice. It also houses Ashgrove Serviced Offices, a Bank of Queensland branch and Brazilian Beauty.

The property, that includes a 230-vehicle car park, was sold with a weighted average lease expiry of 5.6 years.

The team at Pure is proud to be managing this building on behalf of Aviator Capital.