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Commercial Valuations?

Discussion in 'Real Estate' started by Simon, 13th Oct, 2005.

  1. Simon

    Simon Well-Known Member

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    I am looking at a couple of places going to Auction. Retail shops and Cafe style businesses well located in busy suburban strips.

    Because they are for Auction I do not have a figure to base my DD on.

    How are these valued by investors? Using a % yield based on annual rental? If so what % is typical? I imagine they are different for each area and if so where do I find it for mine?

    Thanks team
     
  2. Simon

    Simon Well-Known Member

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    No takers?

    **Bump**
     
  3. Nigel Ward

    Nigel Ward Team InvestEd

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    Hi Simon

    I have not bought retail shops so this is theoretical only.

    I would have thought though that you would value on yield as you suggest and then adjust that price by factoring in things like:

    1) general desirability of the building - will substantial capex be required in the future or is it brand spanking new and packed with depreciable goodness :D
    2) location - is it on the high street or a back alley (presumably this is already factored to a large extent into yield)
    3) development plans in the area - will there be a giant woolies next door to kill your tenant or will a traffic calming create a fantastic pedestrian area right outside the cafe...etc etc
    4) what alternate uses are there for the property?
    5) is their potential for redevelopment upside?
    6) who is your tenant and how long and strong is the lease? In particular:
    a) who pays outgoings?
    b) how are rent reviews conducted and how often? Are they ratcheted i.e. it can't go down?
    c) how much time until lease renewal and what are the tenant's intentions?
    d) what options are there to renew and for how long? You might for example be stuck with a tenant for the next decade when you want to get in and gut the place etc...

    The yield should be compared with what other properties in the vicinity of a similar type are renting for. Ask the selling agent to provide you with some data.

    Hope that helps. Let us know how you go.
    Cheers
    N.
     
  4. MJK

    MJK Well-Known Member

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    My opinion with commercial is that the main game is "income" and the secondary game is "capital growth" Both need to be considered though because if either come through well you've got an investment that works.

    My personal cut off is 8-9% pa nett of outgoings but needs to have a good depreciation schedule done to bring income up to 10%. Mind you, you could do better for income in the Navra retail fund but a commercial can be a great tax haven in a portfolio and if you get cap growth even better.
    Capital growth depends a lot on the economy and interest rates with commercial and is harder to pedict than residential.

    In my portfolio things are shaping up as follows,

    40% residential (capital growth)
    25% commercial ( income, tax benifits, capital growth)
    25% PPOR (residential - security)
    10% Managed funds (5% Borrowed/ 5% unencumbered)

    I think its a good balance. I certainly wouldnt put any more commercial into my situation just yet, until I increase the other areas, as it carries the highest risk.

    My 2c plus a bit more. :eek:
    MJK :D
     
  5. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    My understanding is that there is generally little or no inherent capital growth in commercial real estate - prices/values are based on income. If the income goes up, the value goes up, hence you get capital growth. For this reason it is very important to ensure you get regular (annual) rent increases written into the lease.

    Naturally, this growth is vulnerable to a change in the economy - if things are tight, there might be less demand for that type of commercial property, hence rents drop, and values drop.
     
  6. Nigel Ward

    Nigel Ward Team InvestEd

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    Sim

    So there is in fact capital growth... ;)

    From what I've read retail strip shops on the "high street" have been selling on historically lower yields...i.e. in the past you might have bought them typically around an 7% net yield in an area but people are now buying them on 5% net yield...

    Maybe it's a matter of symantics but I reckon this IS inherent capital growth...whereas residential real estate that is driven by irrational prices paid by homeowners (and thank heavens for that!)...this is NOT inherent capital growth :D

    N.
     
  7. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Since we are playing semantics :p ... I will rephrase my statement to suggest that there is little direct capital growth in commercial real estate - it is indirectly a function of rental income for a given yield.

    What causes what I term direct capital growth is indeed changes in yield - which I guess is what you were implying. This is what indirectly drives the growth in residential real estate - lowering yields (which are a direct result of people willing to pay more for a property, regardless of the underlying rental income) ... indeed for owner occupiers there is generally no consideration given to rental income at all.

    The irrational prices that people are willing to pay directly results in capital growth.

    This does happen in commercial real estate from time to time - but my argument is that this is NOT the normal behaviour, and I suggest is merely is a side effect of a residential property boom.
     
  8. JoannaK

    JoannaK Member

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    Simon,

    you will need to use your desired yield or market yeild to substantiate the purchase price of the property.

    You will need to find a specialist in commercial property management to give you a very good indication of commercial/retail yields for the particular area you're looking at.

    the higher the yield, the lower the purchase price.
     
  9. MJK

    MJK Well-Known Member

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    My experience is that Commercial capital growth happens as a direct resut of low interest rates and a strong ecomomy. In a low rate environment many Businesses believe it is better to own their premises than to rent it. I have been told that as interest rates go up and it becomes cheaper to rent, many businesses put their properties on the market with lease back options.

    In this low interest rate environment most of the capital gain for commercial has probably already happened so focusing on income becomes more important than ever.

    When I was in the market for a commercial tenant, recently, I had many offers to sell and the agents told me that the businesses all wanted to own not rent. Good if your selling.
    MJK :D
     
  10. MJK

    MJK Well-Known Member

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    "Regular annual rent increases in the lease are a given". Often they are more aligned with expected inflation ie. 3%.4%,5% but must be negotiated or else you fall behind.

    An old italian guy who lives of commercial property rents told me.
    Work out how much you can afford to lose each year. Buy two commercial properties accordingly as close to the major CBD and hold for upto ten years. When the first one doubles sell it and pay off the other and retire. Simplistic? Risky? I'd rather buy 4 houses and one commercial and sell the houses to pay for the commercial, throw in some managed funds , keep the whole thing neutral etccc. But the point is you just cant buy commercial property as cheaply as you could 10 years ago and I expect the same will be said 10 years from now.

    MJK :D
     
    Last edited by a moderator: 14th Oct, 2005
  11. Qaz

    Qaz Active Member

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    Theres a good book out there on commerical property, I think its called "How Commercial Property Really Works" or something like that.

    If you haven't read it, it is probably a good starting point. But I think a central point is how much the property stands out to passers by and how you can go about adding value to the property by making it stand out more (in a good way of course).
     
  12. MJK

    MJK Well-Known Member

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    Qaz,

    I have to say, and don't take this personally, but I found that book utterly useless. :confused:

    MJK :D
     
  13. Qaz

    Qaz Active Member

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    It's ok, I haven't read it either. I'd just heard some good things about it.