Own your factory by tweaking the numbers

By Bob Dey

Property editor


How to make a million without spending too much.

That's the proposition outlined by Barfoot & Thompson Commercial manager Chris Dunn for a Pakuranga industrial property.

Barfoot's industrial broker Roger Revell is taking the 12-year-old warehouse to market for N.M Wallace & Sons, which lost its tenant, Manukau Knitting Mills, when that company pulled back to its Howick base because of parallel importing.

Dunn enjoys reasoning his way through an equation that will show a good outcome, and for this one he says the flexible package offered by vendor Neil Wallace would benefit both an owner-occupier and a tenant wanting to ease into ownership.

Basic ingredients of the deal are that the 16,000 sq ft of warehouse and office be bought at $885,000, giving a land and building cost of $55 a sq ft. Fully leased at the fair market level of $5.50 a sq ft for the warehouse and $8.50 for the office, the property would return $97,000 a year.

On that basis the initial yield would be 10.96 per cent.

Some surplus land allows for further development, and a second egress right-of-way bisecting the neighbour's yard could be realigned, bringing some payment to a new owner.

Dunn says the deal would be structured so the buyer puts in $130,000, just under 15 per cent of the purchase price, supported by $450,000 of bank first mortgage for 51.5 per cent of the price, and by a $305,500 vendor loan.

For a buyer occupying the premises, servicing the bank debt at 7.5 per cent would cost $33,750 a year, giving a rental "profit" of $63,250 on the year's rent of $97,000.

Rounding up the rental profit to $65,000, the buyer structures repayment of the vendor finance so that sum is repaid in each of the first two years, leaving $175,500 of vendor finance outstanding in the third year.

The buyer's trust, as owner, would insist on two-year rent reviews. Raising the rent to $6.50 a sq ft of warehouse and $10.50 a sq ft of office would raise the rent to $116,000 a year. At the same time, Dunn assumes the bank interest eases to 7 per cent, dropping that annual interest bill to $31,500. The outcome of those two moves would be a rise in rental profit to $84,500.

Using that rental return to pay off vendor finance would leave $91,000 more on the second mortgage.

At this stage, Dunn introduces revaluation. Because the rent has risen and falling interest rates would see property yields firm, he has capitalised the higher rent of $116,000 at 10 per cent, down from the initial 10.96 per cent, thus raising the property's value from $885,000 to $1.16 million.

The remaining $91,000 of vendor finance would be disposed of by increasing the bank loan by that amount. Because the property's value has been raised, gearing on the higher mortgage sum would actually be lower, at 46.5 per cent.

The increased mortgage still has to be serviced, but Dunn says at 7 per cent the servicing of a $541,000 loan would only take $37,870, which can be serviced out of the $116,000 rental stream. The balance of the year's rent, $78,130, can be dedicated to repaying principal.

"The essence is, that by paying a market rental, the buyer ends up owning the asset," says Dunn.

In his model through to year nine, Dunn shows the annual rental surplus being used to repay principal on the bank loan, taking it to just under $5000 at that point. He uses a 7 per cent interest rate from year three and on the second rent review, at year four, raises the warehouse rent to $7.50 a sq ft and the office rent to $12 for a $133,500 return.

On the Dunn model, the building has paid for itself after nine years and would be worth $1.405 million - $133,500 rent capitalised at 9.5 per cent. That gives a profit of $519,763 on the original $885,000 purchase price.

As the investor is putting in $130,000 at the outset, the increase in equity over nine years would amount to $1.275 million.

Of course there are a few other issues which an investor needs to keep in mind. This model does not take into account depreciation, the need to provide for maintenance and the rate at which an aging building might reasonably be capitalised.

Dunn says "you can make it complicated" by introducing factors such as depreciation and tax. "I've tried to keep it simple."

He says the building is a clean, well built warehouse with basic airconditioning and few mechanical parts, so would require little maintenance in the first 10 years.

The point for a potential building owner is that they can be eased into ownership through a tenancy deal, and figures such as the increases in rent can be justified if the operation is robust.

"In most cases it's so crippling. you spend all your dough on servicing mortgages and never get to the equity. In this case, it's in your interests - as owner, say through a family trust - to be unmerciful on the operating company."

On the issue of which direction interest rates will move in - and recent suggestions from bankers that they are on the rise - Dunn argues that it is not in the interests of Reserve Bank governor Don Brash to allow that rise, because it would bring foreign investors flooding back in, raising the exchange rate and making life harder for exporters.

But he says the calculations are a model. "You can run up, down and sideways over some of these figures."