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June 11, 2015

Industrial strength

By KIERAN CLAIR

There’s a mistake most investors make, and it’s not about choosing cash flow versus capital gains, deciding between regional and metro holdings, or even whether houses provide a better option than units. The overriding error is forgetting that the world of property investment doesn’t end with residential.

It’s an understandable stumble.

Residential is too easy for most of us because we “get” housing. We live in, maintain, entertain, relax, build families, share memories and grow old in residential property. However, some buyers know there’s a whole world of investment potential in Australia’s suburbs where tenants pay outgoings and like to stay for years on end.

So, we cornered three experts to give us their arguments and strategies for getting into industrial investment.

THE VALUER

Matt Tanner, a commercial valuer and director at Herron Todd White in Perth, says principles used in residential investment can also apply to industrial.

For example, when you purchase you still need to ensure you can attract and retain a tenant, it’s just that their motivations are different in the industrial sector.

Matt Tanner

Matt Tanner

Tanner says the phrase “population based industrial subdivision” indicates investments that have a ready population of customers nearby, and these offer great first-time investor opportunities.

“With population-based industrial, we talk about your window framers, your small sheet metal workers and your mechanics – just very low-end style uses.

INDUSTRIAL STRENGTH PROS AND CONS

Pros

  • Outgoings paid by the tenant.
  • Longer tenancies.
  • Leases can include tenant re-carpet
  • and repaint on vacating.

Cons

  • Less capital growth potential than
  • residential.
  • Longer leasing up periods possible.
  • The sector’s strength depends on overall
  • economic confidence.

That’s the location you probably want to invest in.”

Industrial units are a purely investment driven vehicle. No one is going to fall in love with the colour scheme or pay a little something extra for Miele appliances.

Those dealing in this sector understand their holding’s value, and while there’ll always naturally be a price difference between buyers and sellers, that gap is tighter in industrial.

In its crudest form, market value is a matter of working out the annual market rent for the industrial unit, and deciding what that property should be returning the owner on a percentage basis, or “yield”. The assessed rent is then divided by the yield to give a value.

For example, if market rent is $24,000 per year, and a reasonable yield would be six per cent, divide $24,000 by 0.06 and you get a purchase price of $400,000.

Tanner says the yield is a key measure of risk. While in our example a six-per-cent return looks tasty compared to residential investment, there are greater risks with industrial property that need to be allowed for.

Tanner says industrial property is open to most investor profiles, as long as you’re able to weigh up and understand the risks compared to residential. For him, research is the key and consulting reliable professionals before you take the plunge is just smart business. His tip is to talk to a valuer about the market, and a solicitor about the lease.

“Understanding the value of the property is one aspect, but understanding the tenant that’s in there is a key part of your due diligence in buying one of these units.

“Questions for the previous property manager would likely be: ‘Has rent been paid on time? Are there any arrears at present? Have there been any problems?’ “You need to understand your tenant risk going in, given what you’re buying fundamentally is a cash flow, and you need to have some confidence that cash flow is going to continue into perpetuity.”

THE AGENT

Phil Grant is the director of commercial sales and leasing at NAI Harcourts. He says everyday investors avoid industrial because they don’t understand it but, ironically, most are already involved in the sector.Industrialstrength_playbutton

“They’re either an employer who’s leasing or owning a property, or they’re an employee who actually works within a commercial property, so that they’ve already got a first step into it, they just might not be aware of it.

“The biggest advantage is there’s a potential for a greater return on your money. The reason for that is as long as it’s negotiated in the lease, you can pass on 100 per cent of the outgoings to the tenant, so the rental income can 100 per cent go into your back pocket.”

Phil Grant

Phil Grant

Grant says you should grill the agent when you’re looking to purchase by discussing capital growth, vacancy rates and yields. You also need to know about any major infrastructure in your desired location.

“One factor a lot of people forget about with industrial is that a lot of the employees in industrial areas come from residential areas that are immediately adjoining. So, is there any major residential growth occurring in that area to support the industrial precinct you’re looking to buy within?”

When searching for opportunities, Grant says that most buyers like familiarity and stay within a few kilometres of where they live. Their first source of listings is the internet where two websites, realcommercial.com.au and commercialrealestate.com.au, hold the lion’s share of possibilities.

INVESTOR CASE STUDY

Names: Simon and Donna Ogle

Live: Eatons Hill, Qld

Number of industrial holdings: 7

Invest: Brendale, Qld

Get your motor running!

Simon and Donna Ogle are a match made in motorbike heaven. This early-40s couple share a love of the two-wheeled kind, according to Simon.

“I own a motorcycle repair business and Donna has a pretty large motor-x apparel and accessories business next door.”

It’s this common ground that brought them together in 1992.

“We met at TAFE. She went to do a maintenance course on spare parts and I was doing an update course on motorcycles myself. I had to give her a hand with a carburettor she was trying to pull off a bike.” What a perfect match!

The Ogles have thrown themselves wholeheartedly into industrial property, with their portfolio mixed between pure set-and forget investment sheds, and real estate that will one day house their businesses.
“We’ve got four small sheds that are superfund owned that we’ve bought between us and then we’ve just bought two big freestanding sheds recently. There’s also another one on Kremzow Road.”

Their most recent buy is the holding they’ll use themselves in the future. It’s approximately 950 square metres of building on a 2000-square-metre, well-exposed corner site. They paid $1.4 million for this property and are receiving rent of $105,000 per year on a two-year lease, reflecting a 7.5 per cent yield. Simon says they could probably do a little better on the rent, too.

One of their other smaller properties is a unit in a development of 17 sheds, and it demonstrates just how good the returns can be. They paid $500,000 for it three years ago and it’s rented at $42,000 a year, which is an 8.4 per cent yield on investment.

Simon says they like the almost self managed nature of industrial property.

“We love the idea that all the outgoings are paid for by the tenant. Basically, if you have the place spick-and-span when the people move in, then you can put in a lease clause that it has to be returned in that condition when they move on. Other than perhaps a couple of tap washers or something, they’re pretty easy-going investments.”

It appears that industrial is certainly revving up the returns for Simon and Donna.

“On top of that, you’d be going back to the individual commercial real estate agencies’ websites for any of their local listings and any additional information they’re offering.”

Grant says one of the most important elements to understand is whether the return on a property you’re interested in is “net” or “gross”.

“You want to make sure you’re working out your return based on what you’re actually getting in your pocket… so that you can make a qualified decision.

“You want to make sure you’re not paying an over-inflated market value so that you end up paying a higher return or a higher yield on that property in the purchase price.”

Grant’s big tip on a property’s physical traits is to look at utility and usability.

Make sure your investment can be adapted for other tenants when the time for a changeover comes, or you’ll have trouble re-letting.

“Make sure you’ve got a building that’s got good access, good car parking, as good exposure as you could possibly get within a complex, and usability for trucks as well.

“A lot of people forget about what the tenant is doing inside the unit. They might need to drop a container off, so is there a container set-down area in the complex? Is there access for the truck to turn around on-site or is it somewhere they’re going to have to reverse down?

These are little things that some people forget to look at when they’re just purely looking at numbers.”

Grant recommends choosing a proactive property manager and when looking for a new tenant, experienced industrial leasing agents are the way to go. He believes a good industrial leasing manager can find a balance for both tenant and owner in these smaller investment units – it’s a win-win for all.

“Typically the leasing agent is employed by the lessor or by the investor, and while their job is to negotiate the best possible deal they can for the owner, their role is also to make sure they’re keeping that tenant happy.”

THE FINANCIER

Marshall Condon

Marshall Condon

Marshall Condon, managing director at Mortgage Choice South Yarra, says many of the fundamentals between residential and commercial finance are similar.

“Lenders are looking for serviceability of the debt, and obviously that you’ve got sufficient equity to put into the transaction. [With residential], you’ll use your income plus rental from the property to service the debt. With industrial, it’s no different.” There is one big distinction, however, that could make or break a deal.

According to Condon, the bank won’t factor in an estimated potential rent return for a vacant industrial unit in your loan application. This differs from residential, where an agent’s estimate of market rental is usually adequate to include in a finance application.

You can pass on 100 per cent of the outgoings to the tenant, so the rental income can 100 per cent go into your back pocket
Phil Grant

 

“So, you’d have to have sufficient income yourself to be able to service the debt without the rental (when buying a vacant shed).”

The other big variation is the loan-to-valuation (LVR) ratios. While a 95 per cent lend with residential is possible, most commercial lenders pull up at 70 per cent LVR.

“The customer needs to have the 30 per cent deposit, plus the relevant taxes and duties and all the GST, if applicable.”

Valuations will be requested by the lender, with the turnaround time for a report measured in weeks rather than days, so allow for this in your finance clause within the contract of sale. The cost of a valuation will be higher, too.

Finally, the size of your purchase can make a difference. In general, when you buy an industrial property up to

$1 million, you’re in the realm of business banking, which is reasonably simple. Spend over that, and you become a commercial borrower, which means different rules. Loans become two- or three-year terms with a requirement to renew the facility, and when you refinance these deals it’s a full application all over again with fees and costs that can be expensive. Despite this, Condon says changing up from residential would be a successful move for many investors.

“Everyone should consult their accountant or financial adviser before seeking investment advice. My personal opinion, though, is that commercial and industrial is a good diversification to normal business investing.

About Kieran Clair

Kieran Clair is the Editor of Australian Property Investor. He had almost 23 years experience as a registered property valuer, freelance writer and commentator before joining API in 2013. After three years as an award-winning journalist with the magazine, he was appointed Editor in 2016.