By COLIN TAYLOR
About four years ago Grant Easter, an experienced property investor with a portfolio of 15 residential tenancies, started switching to commercial property.
He now owns 11 factories leased to small businesses.
It's a maturity thing, he explains.
"To me, investing in commercial property was the next step up from renting houses.
"Some people go straight to commercial property but you can get caught out quite easily."
Easter says there are real advantages to owning residential properties. Anyone can enter the residential market cheaply with a 5 per cent deposit, or sometimes even with no deposit.
Also, the interest rates are lower than for commercial properties, for which most banks ask for a much bigger deposit of 30 to 50 per cent, which keeps a lot of people out.
The advantages of commercial property are that the returns are higher - up to 10 per cent before tax - and this is a real return, as the tenant pays costs such as rates and insurance. Maintenance costs are also usually lower.
In contrast, residential property might return 6 per cent, but after rates, insurance, garden maintenance and lawn mowing costs are taken out, the return before tax might be 4 per cent or less.
When it comes to investing in commercial property, knowledge is power, says Easter.
"Everyone lives in a house or apartment and, even if they don't own a house, they know what appeals about a house.
"They know if it's got road appeal or if it's got French doors leading out to a garden.
"But we don't all live in factories, or warehouses, or shops or offices or even work in factories, warehouses, shops or offices.
"So we don't have that instinctive knowledge of what will make a commercial property a successful investment, as we do with houses or apartments."
"Putting French doors in a factory doesn't boost its appeal or increase the rent."
Easter says his knowledge is mainly confined to small factories because he works in a small factory/warehouse.
"Being an importer/wholesaler myself, I can talk the language of people who are in similar small businesses, so I tend to buy these properties."
The important thing to consider is what will be important to the tenant?
"If you're pitching to the automotive trade the commercial property needs lots of parking.
"On the other hand if you're renting to an importer or exporter, they want the warehouse to have a high stud for storage.
"But what do car guys want high studs for? They are only working on one level."
He believes small business premises are a good investment because around 80 per cent of all workers in New Zealand are employed in small businesses.
He believes someone starting out in commercial property investment should find a mentor, such as a knowledgeable real estate agent.
His mentor is Nigel Hall of Barfoot & Thompson on the North Shore, who specialises in commercial property.
Hall says the risks associated with commercial property are much higher, but so are so the returns.
He agrees that investors should take good advice before jumping in.
"Location and future use are extremely important when it comes to commercial property," he says.
"And the owner really has to manage commercial property to reduce the risk and maximise returns.
"If you haven't got the knowledge, employ someone who has," he says.
Easter agrees. He says a prospective commercial property investor could easily walk into a premises for sale and say, "Hey this is really nice". But they may not be able to rent it.
The risk factor really comes into play when there's a downturn in the business market.
With a dip in the residential market, a landlord can drop the rent $20 and almost certainly rent a house or apartment immediately.
But if there is a downturn in the economy and the business climate, it can be very difficult to rent out a commercial property.
"Businesses won't move because they have signed two-year leases and the landlords won't let them out of them.
"Also their current landlords are offering deals to keep them, because they know they won't re-rent the property in a hurry.
"They'll even offer to halve rents for six months to persuade the business to stay rather than have the premises lie vacant.
"When there's a downturn in the commercial rental market, dropping the rent $20 doesn't make any difference.
"When the market goes bad it goes really bad and buildings can sit vacant for months.
"A building I have now was vacant for nine months.
"You would be unlucky, even in a downturn with a residential property, if it sat vacant for nine weeks."
"That's why a sizeable equity is needed in a commercial property to keep mortgage repayments at a minimum.
"Significant capital is also needed to weather a storm. If the property is vacant you still have to pay the mortgage, rates, insurance and in some cases the body corporate."
But such losses can be mitigated. If an investor has only one large property and it is vacant for a long period of time they will suffer big losses.
But if the investor has several properties and has staggered the leases, purchased different sized buildings and rented to a variety of tenants, he or she will be protected.
"If one goes vacant and there's enough equity in it, the others can carry it through a downturn and you will pick up the money at the other end."
Commercial properties, like residential properties, reflect the areas they are located in.
Businesses on the North Shore will pay more rent than those in South Auckland and even in a particular locale, returns will vary.
"Albany commercial properties will return higher rent than the Wairau Valley for example."
Easter also recommends making friends with a valuer because valuers have specialist knowledge.
He says it is also important to insert a due diligence clause into any purchase agreement to allow time for the valuation of an intended purchase, as valuers will often point out faults such as cracks in the structure that may not be apparent to the untrained eye, or reveal that a motorway bypass is to come through the property in the near future.
"I've put in offers with a due diligence clause and used the time to obtain a valuation which resulted in me dropping my offer by 20 per cent."
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