The Most Horrific Commercial Property Experience And Lessons Learnt
Commercial and residential property are very different and should never be viewed as the same. So too is the finance process, and a recent experience I had with a client really reinforced this. Tim Russell explains.
I caught up with my parents last week, who are based in the Hornsby area- shout out to the Asquith magpies!
Talking to them about the residential property market, it was interesting to hear their opinions about how significantly prices in the area have dropped over the past 12 months. Dad reckons it’s been about a 30% dip.
I find it really compelling to compare this against the Lower North Shore commercial property market, where I see a lot of transactions - as my office is based in North Sydney. Availability is low, rents are significant and values seem to be holding strong, if not increasing.
My point is, commercial and residential property are very different and should never be viewed as the same.
So too is the finance process, and a recent experience I had with a client really reinforced this. The experience exemplified some of the key differences between residential and commercial finance which often come as a surprise to aspiring commercial investors.
First up, is the interest rate
So this person came to me through a referral partner who didn’t know the guy, other than the fact he was looking to buy an office as an investment because he was hoping to obtain a strong yield.
This person had no time for a meeting and only wanted to know, “What’s the best rate you can give me?”
Now if you’re a broker or a banker reading this you’ll chuckle as I did with this type question.
One of the key differences between residential and commercial finance is that commercial interest rates are individually risk-rated, based on the property and the asset position of the person who is looking to buy. Very few lenders will simply post their interest rates on their website for everyone to see.
But in any event, after understanding what type of office he was looking at, and the equity contribution he had available, I was able to give him a high-level summary.
The second difference is fees
With commercial property, there are fewer buyers out there compared to residential so the banks place a higher risk on these types of assets. Consequently, not only are interest rates higher but so too are the fees. For commercial, you’re looking at an application fee of around 1 – 1.5% of the loan amount, plus you’ve also got to pay for the valuation and the bank’s legal fees. Both of which will range significantly in terms of price, but call it at least $2,000 for each fee.
My ‘friend’ was shocked to hear this, demanded that I negotiate to scrap all fees and when I told him it was not possible, he said he would do it himself.
Well, I thought that was the last that I'd heard of him, but after a few months I received an email saying, “Ok, let’s proceed with an application based on your previous recommendation.”
So I did and he gained approval subject to valuation.
Then came the third significant difference – purchase negotiation and valuation process
With residential finance, if a buyer is interested in a property, but want to de-risk themselves, they have the option of exchanging by way of a 0.25% holding deposit with a 5 day cooling off period. This allows enough time for a valuation and formal approval to be completed before unconditional exchange.
Not so with commercial. Valuations take anywhere from 10 days to three weeks to complete so there is just no way a vendor and their agent will allow a cooling off period to last that long as the buyer has too much time to pull out of the deal.
This means significant due diligence must be carried out by the purchaser and they must unconditionally exchange before the valuation takes place.
Of course, my ‘buddy’ didn’t want to exchange until a valuation was done so tried to do it his own way. Naturally, he continued to miss out on property, after property, after property and took a full 12 months to find something (after finally exchanging pre-valuation!).
Now when he did finally find something, the final difference between commercial and residential property presented itself.
Number four - GST
Unlike residential, if you intend to move into the commercial property, or if it has no tenant, you’ll be subject to GST. This means adding another 10% to the purchase price.
It’s possible to avoid GST by confirming that it is a ‘going concern' ( it must be tenanted). If this can’t be established, however, GST will be added to the purchase price. Now, this fee will be refunded in the next financial year but if you weren’t expecting it and didn’t plan for it, no doubt, it’s going to be a shock.
Guess what my ‘mate’ was expecting?
The moral of my story here is buying a commercial property is a significant decision so you’ve got to take the time to understand both the finance and purchasing process fully before you proceed.
Meet with your broker or banker face-to-face and spend an hour with them to get educated. Don’t go back and forth over email and phone because you’re ‘too busy.’
As for finding and buying a property, if you’re not experienced in this area, to me, it’s crazy not to work with a buyers agent. There is so much involved in buying commercial real estate, therefore significant time needs to be taken in researching and locating the right property.