Commercial Lease Pro

Paul And Gina Smith asked:


 

 

Commercial property includes a variety of property types. Some are obvious while others may not be as well known. Many people who have invested in residential property are hesitant to invest in commercial property because it seems like a more complicated process. If you know what commercial property is, however, and why it makes an attractive investment, you will likely be more open to investing in commercial property!

There are three main types of commercial property which almost everyone is aware of. These include:



l retail property – shopping centers, strip shopping, stand-alone shops

l office property – medical centers, office buildings, strata offices

l industrial property – factories, warehouses, workshops, distribution centres



 

 

 

Other types of commercial property, still fairly well known but perhaps not as obvious at first glance, include:



petrol stations

restaurants

hotel and motels

parking stations

storage facilities

There are also ‘composite’ properties that are categorized as commercial. These are properties that have more than one use, such as a building with a retail store on the ground floor and a residential apartment on the first floor. In large cities you would notice even larger composite properties that include car parking, retail shops, serviced apartments, residential apartments and offices as part of the one property!



 

 

 

What Makes Commercial Property An Attractive Investment?

Other than the different uses for the different types of property, what are the primary differences between owning residential property and owning commercial property?

If buying a home for yourself and family, your main consideration is usually to have a comfortable home in a neighbourhood that’s a desirable place in which to live. It’s a decision you make with your heart and emotions, as well as for practical reasons of convenience to facilities such as schools, shops, medical support, etc.When buying residential property as an investment you have different criteria. You want to know how much money you would earn by renting the property and whether the property will increase in value over time (and by how much). You aren’t as concerned about the residential investment property being located in an area in which you would choose to live personally, because it’s more about the money potential.

Similarly, investment decisions about commercial property are made with your head, rather than your heart and emotions. They are based on the bottom line financially, or the rental income that the property can generate and how secure that income will be.

The tenant and the lease terms the tenant signs are vital factors in deciding whether or not a commercial property is going to be a good investment or not.

In a well structured commercial lease the owner can secure:



fixed term of tenancy

specific rent review periods

specific basis of review, such as fixed increases, review to market, review to CPI (Consumer Price Index), review to an additional, specific percentage, or any combination of the above.



 

 

 

An important difference that makes commercial property a good investment when compared to residential property is that the operating expenses are almost always paid by the tenant. This is spelled out in the lease agreement. Also, as the costs of maintaining the commercial property increase, the tenant is usually required to meet these increases. This helps you maintain your bottom line.

With commercial property investment you have a substantial degree of certainty in regard to the net annual income from the property.

 

Paul And Gina Smith asked:


 

There are important differences between owning commercial property and owning residential property. Having all the information will allow you to make an informed decision.

There is more emotional involvement in residential property as it fulfills the basic function of providing shelter. If residential tenants are unable to pay the rent, even if the non-payment covers several months, you can’t evict them at will and rent the property to another tenant.

Residential tenants have the right to disagree with a rental increase by taking their case to the Residential Tenancies Tribunal. If they can show that an increase in rent would cause hardship, there’s a very good chance the tribunal will disallow the rental increase.

With residential properties the landlord is responsible for insurances, and maintenance and repair costs. The tenant is responsible for paying the rent, contributing to consumables such as water, heating and cooling, and paying for any damage to the property. However, the lease provides for ‘fair wear and tear’ for the length of the lease.

By contrast, leasing of a commercial property is a purely commercial transaction where emotion plays little or no part. Basically, there is no standard lease for all commercial properties and the terms and conditions are included in the individual lease documentation for each individual property.

The terms and conditions of occupation of a property by a tenant are recorded in the lease documentation and, once signed by both parties, are legally binding. In a well documented lease all aspects of occupation and operation of the premises are addressed. This includes the term of the lease, the level of rent, the basis of rent reviews, and who is responsible for operating costs, and repair and maintenance of plant and equipment, such as air conditioning, etc. Once these details are documented in the lease, only in extreme circumstances can the terms be varied.Unlike residential tenants, if a commercial tenant fails to pay his rent he can be readily locked out and any goods in the premises can be sold to recover the arrears in rent and the costs of the eviction.

Some commercial properties include a higher level of plant and equipment, such as air conditioning, fire prevention, security, etc. In a single-tenant building these costs are met by the tenant. In a multiple-tenancy building, such as a strata property, these costs are met initially by the landlord, but will be recovered on a pro rata basis from the tenants.

Most residential tenants prefer a short term lease that allows them the freedom to move. Common residential leases are for 6-12 months, with an option to renew the lease. Commercial tenants usually desire a long term lease that provides stability for their business. These leases can range from 3-20 years, depending on size and type of business.When a residential tenant wishes to vacate rented premises before the end of the rental agreement he can, with the consent of the landlord, secure a replacement tenant and, at that point, the obligations between the landlord and the original tenant are terminated for both parties. The landlord then has to rely solely on the guarantee provided by the replacement tenant.

In the case of a commercial tenant finding a replacement tenant – or sub-letting part of his leased area – the landlord has the protection of the incoming tenant, that tenant’s guarantee, and also retains the protection of the guarantee provided by the original tenant. The original guarantee remains in force until the expiry of the term of the lease agreement with the original tenant.

Most financial institutions will lend anywhere from 80-100% of the value of a residential property depending on market conditions. Loan approval on a commercial property will generally be in the order of 70% – 75%.

Financial institutions rely mainly on the financial strength of the borrower for residential loans, but like to see strong, long-term leases with commercial property investments. Here loan approval is far more reliant on the strength of the secure income from a sound lease than on the personal financial position of the borrower. Having a secure, well-structured lease in place on a commercial property can greatly increase your chance of securing a loan approval.

Knowing the differences between residential and commercial property investment is important in making a good decision on which type of property best fits your investment plan.