- Hello, it's Connie from Prosperity Finance. How are you?
My goal is to give you timely insights and tips
to help you master the game of finance,
and ultimately help you achieve your goal.
Last week, I shared with you some pro and cons
of buying commercial property,
'cause a lot of people are considering
investing in commercial property.
Now this week, I will continue this topic,
and I will cover some of the areas you need to consider
if you are looking to purchase commercial property,
so that it will help you to make a good purchase,
and it'll help you to get your finance sorted smoothly.
So what are the area that you need to consider
if you're looking to buy commercial property?
The number one rule is location.
Same as buying a residential property,
location is the most important factor.
If you buy in a good area,
that help you to minimize the asset risk.
The number two tips is the building type.
Not every building is equal.
Some building are purposely built,
such as daycare or petrol station,
swimming school, or motel, hotels.
If you have one of these commercial property,
think about who would be your potential buyer
when you're ready to sell,
or who will be your tenants.
Are there a lot of options, or are they very narrow?
The more narrow, the less the demand,
and the more risk, obviously.
And even with the generic building types,
you also need to think about it:
Who will be your potential tenants or buyer?
Let's compare retail or offices,
versus industrial property, like factory or warehouse.
What are the most popular type of building,
especially after COVID?
It's really obvious, right?
Lot of offices, like I said in the last video,
are empty now,
so if you invest in these types of offices,
you probably get very short lease,
or the tenants probably do not need much space anymore,
versus industrial or warehouse type of property,
they are in good demand.
So building types is very important.
Let's move on to tip number three.
Number three is the IEP report.
It's kind of a jargon.
IEP stand for initial evaluation procedure,
so in another word,
it's basically like earthquake rating report.
It's a percentage compare against the new building standard.
This came about after Christchurch earthquake.
You probably remember, some building
actually damaged during the earthquake,
and lot of people died as a result,
so the commercial building standards
is getting really important when it come to purchase,
and also very important for the lender to lend you the money
to purchase that type of property.
Now, I live in New Lynn in Auckland.
I remember a few years back, Lynn Mall,
which is close to my home,
it used to have Westpac and ANZ banks in the building,
but because the rating doesn't reach the standard
that the bank policy,
so they basically stopped renting the place.
So ANZ completely exit the building.
So as a landlord, potential landlord,
it is important for you to understand what is the IEP
for the building you're potentially buying.
Also, for the bank, the IEP ideally reached 67% or more.
If slightly less than 67%,
it doesn't mean it definitely can't be accepted,
but you do need to have a plan, and know the cost
how to bring it up to 67%.
The minimum probably 33%
in order to get a building insurance.
So let's move on to the next one,
which is the tenants.
Now, with the tenants,
what you need to be aware of, firstly,
is what industry they are in.
Are they in a declining industry, for example, retail,
'cause a lot of goods are sold online,
so if they have a retail store,
or a few years back, you probably remember
there's some video stores.
Now it doesn't exist, right?
So if your tenants are in a declining industry,
the bank may have a concern,
because eventually, they may not be able to pay the rent.
And also look at the business itself.
Even though the bank won't require a financial statement,
because it's confidential,
and the tenants won't give you that,
but you need to look up their website
and just see how long they've been trading for,
what kind of business they are in.
So just get idea
how strong the business performance look like,
'cause a bank will do that type of due diligence as well
when they make assessment on your loan application.
And also look at what is the concentration risk
of the tenants?
What I mean by that is,
do you just have one single tenants,
or you have multiple tenants in the building?
If you just have one tenants, what if they leave?
It's going to take ages to replace the tenants,
versus if you have multiple tenants in the building,
if one leave or if their business is not performing well,
then at least you have other tenants,
so it's not same level of risk as single tenants.
So that's the concentration risk part
in terms of your tenants.
Now let's move on to the next point,
which is very, very important, is the lease, lease term.
So if you look at the Deed of Lease,
you will see the lease has a plus sign,
sometimes a lot of plus sign,
so the number after the plus sign, it basically means
the tenants have the right to renew.
For example, if the lease term says three plus three,
that means after initial lease term of three years,
the tenants have the right to renew for another three years.
So basically, that's your tenants rights,
but there's no guarantee that they will renew,
so the bank only look at the number before the plus sign.
Now, normally, this lease term
need to be at least three years or more.
If it's shorter than that,
the bank not comfortable lend you the money,
because the tenants can leave the building,
exit the building, in a short period of time.
So normally, the bank will give you the loan term
basically aligned with the lease term,
so give them the right or opportunity
to review your situation,
and see if they renew the lease
or if you have find a new tenant
to replace the lease income,
otherwise you may face the risk
of repay the remaining loan,
even though you still have 10 years to go.
So with the commercial lending,
the repayment term can be up to 15 years,
but the loan term it only align to the lease finish dates.
So it's really important that you are aware
of the lease term, not after the plus sign.
Let's talk about the next point, which is the yield.
Now, one of the reason people invest in commercial property
is the higher yield.
With commercial property,
you probably expect yield between 5 to 6%,
so if you see a commercial property
and you know the asking price, you know the lease income,
you can basically work out the yield
and see if it's a fit in that kind of a band.
Or you can use it in a different way.
For example, if you know the rent,
then you can work backwards to work out
what is the maximum purchase price you want to offer,
so that you can stay in that yield range.
Let's do example.
There's one single tenants, and they can pay you 50K a year.
That's a gross rent.
Now, bank allow 95% shading,
because there's very little cost
of owning a commercial investment property,
so basically, 50K timed by 95%,
so that's a net income of 47,500,
and then you can divide by 5%,
so that give you 950K,
so basically, that will be the maximum purchase
that you want to offer.
If they ask more than that,
you probably need to think about twice.
Okay, so yield is important,
and help you to work out the maximum purchase price.
By the way, we have a simple calculator
that you can download it.
If you wait to the end of the video,
we'll give you that link.
So if you input the asking price
or maximum purchase price you want to offer,
and also the rent,
then it will give you idea
what is the maximum borrowing capacity
you can borrow from the bank.
So stay to the end.
Okay, next point is the loan-to-value ratio, LVR.
So in my previous video, I talk about
commercial property LVR can be up to 65%,
but it's case-by-case.
If you buy a purpose-built property, like a daycare,
you wouldn't expect 65% LVR, probably 50.
Or if you have a single tenants,
it will be less than 65% as well.
So LVR is something that you need to be aware,
and the bank will use LVR to make a decision
on your maximum borrowing capacity.
The next point is the servicing ability.
Just like a residential property purchase,
the bank need to look at how much income you have
in order to service the loan.
Now, with a commercial investment property,
they use the commercial income
to evaluate your servicing ability.
Now, banks use a kind of calculation called interest cover
to work out the servicing ability.
So how it works is that, basically,
you use gross rent timed by 95% to get the net rent,
and then you divide by interest cost.
How the interest cost is calculated,
so basically, you use the loan amount timed by 4.5%.
Use that as a kind of test rates,
and work out the annual interest.
And then you use the net rental income
divide by interest cost per year,
and see how many times.
So if it's two times or more,
then you can service this amount of loan.
If less than 2%, then the bank may reduce your lending.
So servicing ability and the LVR
are the two most important factor
when the bank calculated your borrowing capacity.
So that pretty much the area that you would consider
when it come to buying commercial property.
I also want to emphasize that it is very important
that if you are start looking to purchase,
make a offer on particular commercial property,
please engage with your solicitor and accountant
as early as possible.
Your solicitor will help you work out
what condition you need,
what kind of due diligence you need to do.
With the accountant,
they will help you figure out the best ownership options.
And also, I just want to let you know
that once you purchase the commercial property,
it's not the end of it.
The bank will have ongoing requirements.
For example if your LVR is over 50%,
then they would require every couple of years
you need to do a register valuation
so that the bank know the value of the property.
If it's less than 50%, there's a higher chance
that bank can waive that requirements.
Also, they want to know the tenancy schedule,
and make sure your tenants are still in place,
so it gives them an early warning if your tenants leave,
so tenants' schedule is very important.
It is part of a ongoing requirement from the bank.
I also want to remind people,
if you plan to use the commercial property
for your own business,
and if you are buying the commercial property
for your own business,
the loan-to-value-ratio, LVR, can be over 65%,
because basically,
if your business performance is really strong,
the bank are happy to lend you more.
Basically, the 65% is a secured lending
against the commercial property.
They can allow interest only on this part of the loan,
and then they lend you up to 35%,
and you have to repay the loan within up to five years.
This part of a loan would be unsecure loan,
so the interest rate will be higher,
but at least you don't need to come up
with any cash deposit.
So it is possible to borrow 100% of the purchase price
if you're using for your own business,
and this is how it works,
but your business must be trading
at least two years or plus,
because you are your own tenants.
The bank lends you a very high percentage of lending.
If your business only trading for a year,
it's just huge risk for them to lend you that money,
so at least trading for two years,
and you can demonstrate
your business is doing really, really well.
Okay, so I hope this video gave you some kind of a insight
when it comes to purchasing a commercial property.
We also talked about what is the borrowing capacity
if you know the purchase price and the rental income.
And please don't forget,
please don't forget to download this calculator
that will help you quickly work out your borrowing capacity.
This is just indicative,
so if you do have a commercial property
you're looking to buy,
it's best to get in touch with us,
so we can help you get a personalized solution.
Thank you so much for watching.
I will see you next time.
Take care. Bye-bye.