Here we are again, ready to return to our Hot Tips for the Money Bits series, in which the experts at Acumen Finance divulge all of their knowledge on commercial property investment, and share all of their tips to ensure that you, as a new investor, make the best decision and, hopefully, maximise the profitability of your investment journey. We’ve already covered some fundamental steps in Part I of the series, and now we’re going to top it all off with more crucial information.
Back to it!
Understanding Commercial Property Finance
So, before you assume that you know, you should bear in mind that commercial property financing is a tad different to financing a residential property. In most cases, jumping into the commercial-investment bubble requires investors to have a higher income or net worth and a willingness to commit large sums of money to individual investments.
Let’s break down the nitty-gritty.
The Key Differences Between Commercial vs Single-Family Financing
You might be wondering how the two markets contrast with one another, so here’s a quick summary of the typical conditions found in commercial and single-family residential financing, followed by a detailed analysis of the status quo.
The interest rates on commercial properties are figured out in a different way to their residential counterparts. The rates are wholly dependent upon the current prime rate and the source from which the bank obtains the money which they loan to you - with either a fixed or floating interest rate.
The prime rate is the lowest available rate that capital can be borrowed commercially.
How Banks Borrow:
When you take out a loan from the bank, that money has been borrowed at the prime rate. It is then loaned to you with additional interest on-top, which allows the bank to profit overall.
If you’re not sure what the amortisation period is, here’s the skinny:
If you have a 10-year loan, which features a 20-year amortisation period, you will pay off less of the debt each month. If the amortisation period is shorter, you will pay more money per month.
A longer amortisation period has lower monthly payments with a higher interest rate.
A shorter amortisation period has considerably higher monthly payments, but a much lower interest rate.
Triple Net Leasing & Retail Financing
Here are the key facts for NNNs (Triple Net Lease), which we provided an introduction to in Hot Tips For The Money Bits Pt. I:
You’ll likely find that the down payment on for Triple Net leases and for retail financing, in general, will be between 25 to 35%.
The interest rate on NNNs is usually lower than alternative strategies, but as with all loans on real estate, it is often dependent on the size of the initial down payment and the length of the loan itself.
The terms of the lease will be used to calculate both the loan and the amortisation periods.
If a tenant renews their lease, the banks will likely refinance the commercial property. This could affect the interest rate, raising it above the average 5 to 6% that banks usually offer on their deals.
Multi-family properties aren’t short of financing opportunities. Here they are:
You could get a loan through Tier 2 or Tier 3 lenders with the assistance of an agency, like Acumen Finance, for properties that hit the seven-figure valuation mark. More often than not, these loans have amortisation periods of 30-years with a fixed interest rate for a set period of time - which is relatively low, usually.
You could also go down the traditional route of picking up a loan from a Tier-1 lender - the Big Four. However, the banks are less friendly when it comes to giving loans for commercial property and usually have 25-year amortisation periods with interest rates currently at 5 to 6%.
Financial Analysis of your Potential Commercial Property
The most important part of the commercial property investment journey is the market research and due diligence required to ensure you get a gold-mine not a pitfall. You need to understand how to analyse the finances of a property - or, how to read a commercial property pro forma, in essence.
You’ll need to know how to review the historical vacancy rates, gross revenue, and operating costs of the property before making any sort of financial commitment, to ensure that you don’t end up throwing money into a bottomless pit.
The gross revenue is, as you might assume, the amount of money flowing into the property under the assumption that it is completely occupied at all times. Gross revenue is income before expenses.
The vacancy rates on commercial property are usually a percentage of the gross revenue. The best way, or most commonly applied method, to calculate vacancy rates is to generate financial models of the property based off of 5% less than the current occupancy rate.
So, you probably already know what the property’s operating costs are - maintenance, utilities, management fees (where applicable), and taxes. If your tenant has signed a NNN lease, you won’t be paying for them, but if they have not, they’ll be coming straight out of your pocket.
To figure out an approximate cost, you should assume that you will spend 25 to 40% of your gross revenue on a multi-family property on these expenses. The outcome will be determined by the type of property investment - a value-add or cash-flow property, in other words. If it’s a value-added property, bear in mind that your outgoing expenses are going to be considerably higher because you’re renovating the property for future high-rental returns.
All pro forma documents involve a ‘debt service’ which just lists the terms of your debt payment, excluding operating costs.
Net Operating Income (NOI)
The Net Operating Income is worked out with relative ease; it’s the income that the investor or property owner will receive before taxes are deducted and after all of your operating costs are paid. It does not include your debt service.
The CAP rate is just your Net Operating Income listed as a percentage against the overall cost of the commercial property investment. You should think of it as the Return on Investment (ROI) that is generated before the debt service is taken out.
Cash on Cash
After you’ve taken out the debt service, Cash on Cash (COC) is reflective of your Return on Investment. The COC is calculated via the down payment on the commercial property, rather than the overall purchase price.
Internal Rate of Return
The Internal Rate of Return (IRR) is a way of gauging how your commercial property investment is performing by revealing the value of money that your commercial property has made, compared to another investment. It’s a great way for an investor to figure out whether his money is growing as planned ahead of making the investment, and also shows alternative options that could provide a higher IRR.
Commercial Buildings and Property Management
When it comes to investing in commercial property, you may find that you want to create an impressive portfolio with a myriad of different buildings. With that in mind, you’ll likely struggle to manage them solo and, to address this issue, there’s a whole sector of property managers who will gladly sit in your profitable pocket.
Commercial property managers come in all different shapes and sizes, as you’d expect, but they’re a tad different to their residential counterparts. These guys (or gals) have a flexible, adaptable knack so that they can adjust to the various different types of property in the commercial sphere. And, your dependency on a property manager is entirely dependent on your personal feelings and agreements with tenants - like, you don’t need one if you’ve leased your property on a NNN arrangement, for example, because the tenant is dealing with all of the menial tasks and day-to-day maintenance. Just bear in mind that, if you go completely hands-free and bring in a property manager to manage your assets, the higher the volume, the more they’ll cost you.
Do You Need Any Investment Assistance?
The Australian commercial property climate isn’t always the most friendly when it comes to beginner investors gaining access to startup capital, especially with the Big Four being more cautious than ever, post-scandal. With that in mind, we suggest that, if you haven’t already got wads of cash stuffed under the mattress, you look into investor assistance to fund your commercial property portfolio aspirations.
What investor assistance provides:
A team of experts are often made available to assist you with your ambitions, which allows for a degree of passivity on the part of the investor, rather than having to foray into unknown territory on a whim and all alone.
You’ll have experts on-hand who already know what they are doing, who will give you their input and apply their expertise to your investment.
They’ll ensure that you gain access to the very best deal available for your project, making sure that once contracts are signed, every party is happy.
The team at Acumen Finance would like to offer you some assistance. We have a whole host of specialists at the helm of a sophisticated pool of Tier-2 non-bank and Tier-3 private lenders who are ready and willing to assist you in your efforts to acquire the capital needed to launch your investment journey. So, if you’re ready to make your aspirations a reality, get in touch today, and we’ll be here to guide you to your pot of gold.