Things to know BEFORE investing in commercial property

Residential and commercial property are two different ball games. Mish Daniel says commercial property investors need to complete their due diligence and analyse the tenant, lease and adaptability of a building before purchasing.

Mish is the founder of Revolve Commercial and a commercial property investor with over ten years of experience.

On the Get Invested podcast with KnowHow’s Bushy Martin, she shared the key questions investors need to be asking when considering the move into commercial property.

Commercial property key #1: The strength of the tenant

While residential property investors focus heavily on area/region, commercial property investors need to firstly be chasing the numbers and quality of the tenant.

“When you’re buying a residential property, you essentially go to an area and you’re saying, hey, this area’s gentrifying, and so you’re going to be looking at the building, street, environment, and surrounds. But when you’re buying a commercial property, you take that out of your mind completely, because we’re chasing the numbers. It doesn’t matter where the street is, it doesn’t matter what the area is. If the numbers stack up, we look at that first,” Mish said.

“Once we look at the numbers, we say, hey this is a really nice property, the numbers stack up, now let’s have a look at the tenant. Is the tenant suitable in that area? How long have they been there? What business do they run? Has it got longevity? Has the business got legs? So I’ll give you an example. We looked at a photocopying business, which initially at face value we thought, hmmm no photocopying businesses are going out because everybody does copying at home. Well, not really, because this one was in a fairly regional town. And not only do they do photocopying, they do additional services that the regional town only has one office to go to, so that’s a great little business to be investing in. And they had a five plus five year lease they were willing to sign because they didn’t want to move. This means that, in the lender’s eyes, you’re looking at a ten year lease, so there is longevity in it.”

Commercial property key #2: The lease

Investors need to understand the structure and legalities of a commercial property lease.

“One of the major things that is very different to residential versus commercial is the lease. Because your residential lease is six to 12 months, there are a lot of escape clauses in that. It’s to the benefit of the tenant. Whereas in a commercial lease, it’s a legal binding document and it’s to the advantage of the owner of the property. It locks the tenant in and the tenant is is liable. Even if they default, they’re liable to pay that rental. So it gives the owner a lot of power with that lease,” Mish said.

“So that’s one of the things in your due diligence to look at. We analyse the tenant, the financial situation, and we have a look at all the escape clauses in the lease. I’ll give you an example. We had a look at one lease for an engineering shop. It was a five year lease and it looked great, but there was a little line that said should the tenant choose to vacate, they, give the owner six months vacation period. And I went to the solicitor and said, hang on, wait a minute, to me that sounds like an escape clause that if the tenant wants to leave, they can give us six months notice. And he said, you’re right. So that lease is not worth the paper that it’s written on.” 

Commercial property key #3: The adaptability of the building

Bushy and Mish emphasised that investors need to ensure a property is flexible and adaptable enough to be applied to a range of different purposes. This will minimise the risk of a property sitting vacant for an extensive period of time should a tenant leave.

“We’ve got hundreds and hundreds of points of due diligence that we apply to various different types of assets. So you’re looking at the bricks and mortar, so the roofs and walls and structure. You’re looking at where the building is located, whether it is ideal for that type of business should the tenant decide to vacate. And you’re looking at what other type of businesses could go into that building? Whereas in residential, it’s just another person that eats and drinks and sleeps and watches TV. But in commercial you want to have a look at how can you repurpose that bricks and mortar to facilitate various different types of businesses,” Mish said.

“I’ll use the case study of a retail industrial unit, which means it’s got a retail shop in the front and it’s got three roller doors in the back. What this tells you straight away is that the building can be split into three to four tenants down the line. So we look at what the exit strategies are. If that photocopy business were to shrink down, they’d always want the retail in the front, but they might say, hey we don’t need those warehouses anymore. Well happy days, let’s call them up and rent those out. So you’ve got various different types of assets that are going to give you advantages should tenants default, should they move out, should they move on, whatever it is. So whenever we look at a property we look at those exit strategies.”

Listen to the full interview here.

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