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Making The Switch

Moving into commercial property is becoming an increasingly attractive option for many investors. Miriam Bell gets the lowdown from some who have already taken the plunge.

By: Miriam Bell

1 April 2018

Times are tough for residential investors right now. Not only is the spectacular market boom of recent years winding down, but the net of restrictive regulation circling investors is growing.

While the Reserve Bank may have eased its LVRs slightly, the much tighter financing regime is still in place. Uncertainty remains around how far new government policies aimed at curbing “speculators” will go, but compliance costs for landlords are mounting. At the same time, many investors feel they have to contend with a strong “anti-landlord” climate.

This environment is prompting some investors to look away from residential property to other options. And, for growing numbers, the commercial property sector presents a compelling alternative.

But investing in commercial property is very different to investing in residential property. While it has many attractions, it also has challenges. To find out more we spoke to several investors who have successfully made the move from residential to commercial.

Many years ago, Christchurch investor Aaron Shurmer was profiled in this magazine as a “young gun” of the residential property sector. Shurmer had built up a large portfolio of multitenant student flats and professional accommodation, with his business partner and their parents, while still in his early 20s.

But, eventually, the stresses and strains of what had become a full-time job got to them. They sold up their portfolio, split the profits and Shurmer shifted his focus to establishing a web design company. Still, the lure of property remained and so he started investing in commercial property.

He says tenants were the major reason behind his move to commercial. “I had multiple occasions where tenants did thousands of dollars’ worth of damage to a property and then complained about the bond being taken off them. I became sick of a system which is poorly designed with protections only in one direction.”

‘The risks are maybe greater but the cashflow is better, the margins are better, management is easier and the tenants are the biggest difference’ AARON SHURMER

Tenant management was also an issue for him. “Because of the type of residential property we focused on, we had about 99 tenants. I’d get calls at any time of the day or night and the expectation was that issues would be sorted immediately.”

That doesn’t happen with commercial tenants, in Shurmer’s experience. “Commercial tenants don’t want to damage your property because it’s their place of work, where they have clients coming, so they look after it.”

These days he owns eight commercial properties across a range of sectors; light and heavy industrial properties, small office properties, and a warehouse with offices.

“My experiences with commercial property have been great,” he says. “The risks are maybe greater but the cashflow is better, the margins are improved, management is easier and the tenants are the biggest difference. I’ve never had anyone do wilful damage to one of my buildings and, if they don’t pay, they have to go.”

Despite this, he acknowledges there are challenges with commercial – vacancies can be a problem and it is harder to get financing. In fact, it is financing that he picks as the biggest potential pitfall for a residential investor moving into commercial.

“There’s a pretty big learning curve. Most people know the deposits required are higher, around 35 to 40%. But interest rates are higher too. And when going to a bank, you need to provide them with information about the lease, the value of the building, the Net Promoter Score (NPS) rating, the tenants, and so on.

“You also need to be able to provide proof of income cover in case a tenant leaves. Banks want to build up a risk profile before deciding to lend. This makes financing more complex.”

While it may be more challenging than people think, transitioning to commercial is possible, Shurmer says. But, there are certain fundamentals that investors should observe. One is to always buy something tenanted with a reasonable lease on it and another is to always get a valuation of the property.

“Also, always buy something that is a good property. If you buy something that is on the cheaper end you will have to put in work on it. Buy in the right area, be sure it’s a good building with decent tenants and it will be hard to go wrong.”

Well-known as the vice-president of the NZ Property Investors’ Federation, Dan Keller has long been an advocate for residential property. Based in Tauranga, he has been investing in property there since 1994, he has served as president of the local property investors’ association, and he is the managing director of a property management company.

But the tide has turned for him and he is switching his focus to commercial property. In recent times, he has sold down about half of his residential portfolio and bought several commercial properties instead.

Keller says he was prompted to do so by a political environment which has been making it harder and harder to be a landlord. “I got fed up with all the regulations that were hammering landlords. Residential costs are going up and then there is all the ‘anti-landlord’ stuff.”

Commercial property may have its risks, but Keller says it is a good alternative, especially as there is limited government interference.

‘The relationship between commercial property owner and tenant is a business relationship so emotion isn’t involved and there is more surety’ DAN KELLER

“The commercial sector is more business-like. The relationship between property owner and tenant is a business relationship so emotion isn’t involved. There is more surety: if you don’t pay you’re out, no arguments.”

Another prompting factor, for a shift to commercial, is the LVRs currently in play for residential investors. Deposit requirements for commercial and residential property are now, essentially, the same, he points out. “Yet the returns are much better in commercial property. That makes it attractive.”

In his view, the major issue to be aware of is vacancies. “If a tenant stops paying the rent and has to be removed it’s much harder to fill the tenancy again. In residential you can just drop the rent a bit to get a tenant. But in commercial, you might have to drop the rent a lot to get another tenant, if times are difficult, or you might have to wait it out and carry the vacancy.”

That means investors moving into commercial should make sure that they educate themselves beforehand. Keller recommends reading everything possible, on relevant topics, and going to property investor association meetings and events.

“Make sure you talk to commercial investors and investors who have moved from residential to commercial. While the associations tend to have a majority of residential investors, there are now quite a few who have commercial investment experience, too.”

George Hawkins

Residential property was Hamilton-based investor George Hawkins* first love and, over the years, he built up a big portfolio. He still retains some of his residential properties, but commercial property is now his main focus.

The key reason for his change of heart was the hassle of managing residential tenants. He says that it became a major issue for him, along with the constant turnover.

“Residential tenants are passionate about where they live and, if anything is wrong, it is a big issue for them. If you have 20 to 30 residential properties it can become difficult and draining.”

In contrast, he has found that even if commercial tenants have problems, they don’t tend to be as extreme about them. “Because, if they are in the property for a six to nine year term, they are going to want to take good care of it – it’s their workplace. So they budget to do small things themselves, and they tend to coordinate them, reducing problems.”

Commercial has other attractions too, he says. “There are longer-term leases and tenants pay 100% of outgoings. The combination of better, less demanding tenants and improved costs was the biggest attraction for me. But on top of all that, the returns are great.”

This prompted Hawkins to move into commercial property. He now has 18 commercial properties, all in Hamilton. They encompass the sector spectrum. But his favourite are his Te Rapa industrial properties because they attract good tenants and are easy to manage.

Commercial properties are easier across the board, he says. “They are just less hassle than residential properties. For that reason, I manage all my commercial properties myself. As opposed to residential, where I have a property manager.”

Building up knowledge of the sector is critical, Hawkins adds. That’s because there are many factors which don’t come into the equation with residential property. Those factors include: borrowing requirements, earthquake requirements, risk factors and council zoning in different areas for a start.

“Vacancies can be a problem with commercial and investors need to be aware of the risks involved. But if a building is well located, tidy and well maintained with adequate car parks and showroom space if required, then vacancies shouldn’t be a problem.”

When it comes to commercial, Hawkins has one big tip and that is to cultivate an agent. “Build up a fantastic relationship with a good commercial agent who covers leasing. That agent can help to make you a lot of money.”

Description: A Commercial Agent's Perspective

There’s no doubt that growing numbers of residential investors are thinking about a move into commercial investment. Colliers Auckland director of investment sales, Gareth Fraser, says they are seeing a definite trend in that direction, with increasing enquiries of late.

The cooling-off of the residential market, and the capital gains prompted by the boom, is playing a significant part in that, he says. “Investors are now looking at residential yields of around 3% and saying ‘they are just not cutting it anymore’. So they are looking to commercial as an option because the yields are generally better.”

Additionally, the fact that residential property values, particularly in Auckland, have gone up so much means that, at the smaller end of commercial, the entry point for investors is more affordable.

Fraser says an investor can still get a property for under $500,000 which makes for good returns. “But even if a property is up between a million and $1.5 million the returns can still be good. Unlike a residential property for the same price in Auckland, for example.”

Commercial also offers a better level of tenants, longer tenure, and the market hasn’t yet been affected by a slowdown in capital appreciation which means it is still strong, he says.

“However, commercial does demand more sophisticated knowledge than residential. Leases are more complex, GST is involved, and location and tenant selection is critical. It pays to get advice if you are just starting out.”


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