What should you do if you bought a commercial property with an existing tenant?
Hey everyone, Kim Quach from Duo Tax,
here for another video designed to help you become a better property investor.
Commercial property investments can be highly complex because they have their own set of rules
and things to consider when you compare it with residential properties.
So the due diligence process can be fairly different and require you to
consider a number of other things that you might not in residential properties.
One of the most frequently overlooked things we see are to do with clients
considering commercial investment properties with existing tenants.
Now, existing leases can be good or bad, it just depends on your circumstances.
So in today’s video, I am going to run you through the things you need to look out for
when investing in a commercial property that has existing tenants.
But, before we start, we want to be clear that this video is for informational purposes.
In no way should you interpret this as financial advice. We always recommend working with a
qualified financial advisor or tax agent to give you the best advice for your situation.
Alright, let’s get started.
As a property investor myself, I have never quite understood why so many investors still perceive
buying commercial property as a higher risk because there are actually plenty of benefits.
Arguably, one of the biggest benefits is that it promises higher potential returns in cash flow.
Commercial rental yields range anywhere between 5% and 12%.
And higher yields mean more potential for positive cash flow.
There’s also potentially more rental stability because leases
can generally be longer than residential leases.
A lot of commercial property lease agreements also contain a fixed rental increase clause,
and generally, the increases are higher than inflation, ranging between 3% and 4%.
But, of course, you do need to weigh all these things up against
factors like stricter mortgage terms, GST implications and complex lease agreements.
As I mentioned earlier, you also need to think about how
having an existing tenant will impact your investment.
Don’t get me wrong, purchasing property that is already leased can be pretty
beneficial for investors who aren’t looking to change its current purpose.
In other words, if you’re not looking to make any significant changes or refurbishments that may
change what the building is currently used for, then this could be an ideal situation for you.
The biggest benefit and the most obvious reason why investors like
already tenanted spaces is that they have the opportunity to generate rental income
from the get-go without the hassle of looking for tenants and the risk of having a vacant property.
But like all good things, there are potential downsides.
For example, buying a property with an existing lease agreement is not ideal
if the rental rate is not competitive in the current market or if the fixed rental
increase clause will be detrimental to the future growth of your investment.
And unfortunately, if the existing lease forms part of the contract of sale,
it can be very difficult to negotiate its terms.
So, it’s important to do all the necessary due diligence on the property,
the tenants and the likelihood that your investment will perform in your favour.
It’s also super important to seek legal assistance
when it comes to interpreting the terms of the contract,
the flexibility to negotiate terms and how you may be able to end the lease if you wanted to.
You’ll also need to be aware of what happens with
the existing fit-out in the commercial property space.
Once the lease comes to an end, it’s possible you may need to return any assets
that the tenant installed during fit-out.
But this is obviously entirely dependent on what the lease agreement says.
For example, if a commercial tenant vacates the property and doesn’t remove the fit-out
that they installed during the duration of their lease, and the lease doesn’t stipulate that the
assets must be returned, you may be able to claim the remaining commercial property depreciation
for the items or even the scrap value if you’re looking to throw it out.
If you’re watching this video and have already decided to purchase a commercial property
with an existing tenant, you may want to consider getting a Quantity Surveyor to help you
understand what you could potentially claim in depreciation for further tax benefits.
Claiming depreciation on commercial properties can be quite different because
there are substantial tax benefits for both the commercial property owners and tenants,
so you need to understand what you’re allowed to claim and what’s limited to the tenants claim.
Getting your hands on a depreciation schedule
could be a major advantage for you to boost your cash flow.
So, if you’re in this situation and need some advice, get in touch with us today.
Otherwise, if you know someone who is looking to invest in commercial property,
make sure to share this video with them.
I’m Kim Quach from Duo Tax, see you next time!