Have you ever been tempted to broaden your investment horizons by getting into the commercial property?
Well anyone who has done it will tell you it is vastly different from investing in residential property. Michael Yardney gives us the lowdown on that and tells us about some of his personal experiences.
Kevin: With the residential markets slowing down or showing signs of slowing down, many people wonder if this could be a time to switch to commercial property. There are some differences. Let’s find out exactly what they are. Michael Yardney joins me.
Michael: Hi, Kevin.
Kevin: You’ve had experience with this, not only on behalf of the people you work with but personally, the differences between commercial and residential investment, Michael.
Michael: In my mind, they’re very, very different investments, and while I can understand why some people are tempted to get into commercial property, I’d be suggesting to leave it until later on in your investment career. It’s really more an investment for the big boys.
What are commercial properties? There’s a range. There are shops (which we call retail), factories and warehouses (which we call industrial), and offices (which we tend to call commercial). The big difference is that they’re yield-based investments.
Kevin: Does it take a different type of investor to become involved in those, Michael?
Michael: It depends in which stage of your investment career you are and what your investment philosophy is. To me, residential real estate is a high growth but low yield investment, and as I started to say, commercial is really a lower growth investment (because the increase of the values of commercial properties tends to be pegged to the CPI) but they have a higher yield.
Some people say, “If the return is the same overall, why not go for the one with the high yield that gives me cash flow?” The big thing, Kevin, is many beginning investors need to grow their asset base. And while yields are taxed, capital growth isn’t, so it’s much easier to build a big asset base using residential property, and then later in life, transitioning into the commercial field.
Kevin: If that’s the case, Michael, then why do some people consider getting involved in commercial property?
Michael: I guess they’ve noticed that institutional property investors as well as those investors of the BRW Rich 200 list own commercial properties, and they wonder why. They see them getting high yields; it seems a bit attractive. They don’t understand the downsides, Kevin.
Kevin: Michael, I wonder if you would be kind enough to spend a minute or two and take us through what you see as the fundamental differences between commercial and residential investment.
Michael: Sure, I’m happy to. I got involved in commercial real estate in the late 1970s when I bought my first factories, and. I did a lot of commercial and industrial development in the late 1980s. Great properties; some of them I still own.
Interestingly, since then – and that’s 25 or 30 years – those properties have only doubled in value. They’ve had good rental return, they’ve not been vacant long, they’ve had great tenants, but because they only go up much more slowly, they’ve only doubled in value.
Having said that, a lot of the residential real estate I own has doubled in value in eight or ten years, sometimes even five or six years if I’ve done some developments. That means my wealth has grown because the rents have grown proportionally, as well.
So, it’s something I’d be recommending people consider when they’re at a different stage of their life, or maybe in their superfund where they’re looking for more cash flow. I know I haven’t answered your question about the big differences, but I thought that was an important place to start.
Kevin: It is indeed. You said that commercial properties tend to yield higher returns.
Michael: Yes, they do. Now, it depends upon the lease. The more secure the lease… If you have a lease to Officeworks for 15 years, you actually are prepared to accept a lower return than if you have a fish and chip shop leased to mom and dad.
First of all, if you want to get involved in commercial real estate, to get the benefits of the security of the long leases, you normally need much deeper pockets – firstly, because probably unless you’re spending $2 million or $3 million, in my mind you’re not buying an A-class commercial property; you’re buying secondary properties – and you shouldn’t do that.
The other thing, Kevin, is banks will often only lend you maybe 60%, sometimes 70% of the value of the property. You need more deposit because they have lower loan-to-value ratios, and also many banks charge you a slightly higher interest rate.
One of the big differences is that you need much deeper pockets and you need to be looking to get cash flow out of them.
Kevin: Yes, we can see there are some fundamental differences there. I guess like anything, Michael, we should always take advice on this before you take those kinds of steps.
Michael: This even more so. Even the leases are complicated, Kevin, so you don’t get the normal property manager to do those. You need a solicitor’s advice for this. The due diligence is significantly different, and commercial real estate is very much more cyclical. It depends a lot more upon how the economy is going and what happens with interest rates, so a lot more homework and due diligence.
Kevin: Michael Yardney from Metropole Property Strategists. Michael, thank you for your time and your insight. I appreciate it.
Michael: My pleasure, Kevin.