EPISODE 4: Growing a Commercial Portfolio - Property Inc

[ Podcast Transcription ]

This is the Commercial Property Investing Explained Series, a free 10 part course brought to you by Steve Polisi. Find out how commercial property really works and start investing like the pros. Your education starts now. Welcome to the Commercial Property Investing Explained Series with Steve Polisi.

I’m your host, Andrew Bean, and I’m here with author of Commercial Property Investing Explained Simply and founder of Buyers Agents Polisi Property, Steve Polisi. How are you, mates? I’m absolutely amazing, mate. I’m actually loving the feedback we’re getting for the show. I’m actually looking forward to this one because this podcast episode’s about how you set yourself up with a serious passive income.

Yeah, it’s been overwhelming, the response we’ve got. It’s absolutely awesome. We love it. It’s just going to keep on making us want to make more of these. Maybe not, but we’ll see how we go.

Learning about how commercial property really works has never been easier with so many great resources around like this podcast and Steve’s book. And he’s giving it away for free if you use discount code podcast on his website. So go to www. policeyproperty. com. Use discount code podcast to get the book free.

All you have to pay for is shipping. What a great deal. All right, mate. So this is episode four, growing a commercial portfolio. So we’re going to touch on two main topics today, which is capital growth and also growing the portfolio. So Steve, there is a huge misconception around commercial property. You just can’t get capital growth with commercial property.

Can you debunk that for us now? Yeah, that’s an absolute myth. Like, I don’t know where it’s come from, but I You actually have the same capital growth as residential normally happens slightly out of cycle. And one of the examples I use is. Say you’ve got a million dollar house and it’s next to a $500,000 commercial warehouse.

For instance, the million dollar house can’t go to $2 million and then the warehouse sit there at 500,000 because all the people in the $2 million house are then gonna look at the 500,000 warehouse go, well, why would I spend $2 million on a property when I can get more rent from a $500,000 property?

So you’ll get that kind of flow on effect there. So they, you do get the same capital growth. It’s just normally out of sync with the residential properties. And it’s one of the reasons why the myth comes about is people always talk a big game in the resi market when the market’s booming, but they don’t talk about when there’s a flat period when commercial is growing.

And it’s just, it’s an unknown kind of source and commercial will normally lag behind the resi market. One of the reasons is actually just because there’s longer lease periods. So there’s a longer period to realize the actual capital growth value. And one of the things we also look for as well, um, when we’re looking for a good commercial markets is booming residential markets as well.

Yeah, there’s always a flow on effect and it’s like certain regions to have a growing population in a residential market. You need infrastructure. So that’s building warehouses and retail strips and office spaces. So that will normally go in there and you won’t realize the capital growth until the residential population then grows and fills those spaces.

Then the commercial will burn. But. Different sectors are going to have different forms of growth. Alright mate, so you just mentioned that there. So how do the actual different sectors grow with capital growth play? Like how do you actually work that out? Yeah, so different sectors are going to have different demands.

So like office space, for instance, not as highly demanded as it was once was, mainly because of COVID and the working from home structure. There’s also prone to oversupply. And the main reason for that is you can build high density office spaces. You can build a 20 story office tower and basically oversupply the market quite easily.

Whereas something like an industrial or suburban retail, you don’t have that. They’re normally one story and that’s it. So you’ve got the land component. So similar to residential, having a good land component will appreciate in value and give you better capital growth. The same as a body corporate warehouse will have slightly different capital growth to a freestanding warehouse because the freestanding warehouse has more value add opportunities and a bigger land component.

And then there’s even some commercials are actual houses. So I bought a vet clinic in Launceston for a client a couple of weeks ago, which is effectively a house that’s just converted. So. That has to have similar capital growth to the resi market because we only paid about a 20 percent premium compared to the normal house price.

Yeah, it’s interesting. I actually, um, read an article yesterday in the paper about a shortage of industrial land, and this was for Sydney. And they’ve actually got a huge amount of properties in the pipeline for multi story industrial assets. And I thought that was really interesting. You just mentioned that office because it can be multi story levels.

That it gets oversupplied. I mean, do you think industrial could potentially be oversupplied in five, 10, 20 years? No, it can’t. And I actually know, so I’m not sure if you’re aware, I’m a chartered structural engineer by trade. That was my first career, very hard to build multi story warehouses. They’re not going to be able to build a 20 storey warehouse.

No, not 20 storey. It’s just not economic. They may find some for light pallet racking and things like that that are two storeys, maybe even three, but the cost per square meter of doing it is just exorbitant. So it’s only ever going to happen in the high density areas, like the capital cities in that inner ring where they need the forced kind of area.

Yeah, very interesting. So mate, can you just explain what forced capital growth is, aka forced depreciation? Yeah, so this is very similar to increasing the value like residential property. So you’ve got all the usual stuff, same as residential. You’ve got development, renovations, things like that. However, commercially you have a few more because Because they’re valued based on their yield and their lease and the type of tenant, you can actually force capital growth by changing those aspects.

Another way is actually splitting up tenancies, for instance, where I think we spoke about this on the first episode, smaller floor areas actually have a higher square meter rate than larger floor area spaces. If you split up the tenancy into smaller four spaces, you’ll actually get a better return, better net yield, and the property will be valued more.

The other one is actually get a stronger tenant. So if you get a blue chip tenant or a medical tenant, for instance, that’ll have a lower cap rate than say an average Joe Blows business. And you can force it that way as well. So you’ve got all those moving parts with the actual tenant, the location, the lease type and the length that you don’t have with residential.

A residential property doesn’t sell for more because it’s got a 24 month lease as opposed to a 12 month lease. Yeah, I think this is one of the reasons why I really like commercial property because there’s so many different ways to add value and it’s actually really easy to calculate it because it’s all done by numbers.

Yeah, exactly. And some people have probably seen on my social media, I’ve got that example is a fish and chip shop and it’s got an ATM machine on the side of it. It’s got a residential property on top of it, and it’s got telecommunication towers on top of the residential property, so they’ve got four sources of income for the one property.

Not too bad. So mate, so why is forcing capital growth such a good strategy, and why most professional investors do it this way? Yeah, so it basically reduces the risk, because if you can get some capital growth out of the property, or increase the value of the property, It just gives you a buffer if the market, for instance, drops 10%.

And even though I don’t think the market’s going to drop at the moment, it is just too hot. You’re not going to lose any money, but then it also gives you equity that you can recycle into another property and help grow that portfolio. And I think that’s the main reason why a professional investor does go into a property with a value add strategy in mind.

So they’re buying the property, right? And they also know where they can take that property. Then recycle that money out of it, refinance it, and then buy another one and keep piggybacking. And that’s going to dovetail nicely into actually our next topic, which was growing the portfolio, which we’re going to talk about a little bit later.

So mate, just in your book, there’s a really cool little market cycle diagram. Most people have heard of the traditional property clock. It’s similar to that. Can you just explain what, how the market cycle fits in for the listeners? Yeah. So very, very similar to the property clock. It’s basically just when you’ve got different periods in the cycle for property.

So you’ll normally have, so at the moment we’re going through a boom and it’s because money’s easy to get. There’s low interest rates. We’re seeing property prices grow up at some point, interest rates are going to kind of go up and then that’s going to slow the market slightly. So then that’s the slowdown period.

This is generally where you see slightly higher vacancies and things like, cause less people are buying, there’s more stock available. And then that’ll actually go into a recession. And I don’t mean a recession is it’s going to go really far backwards. A recession can also just be a flat period where it sits there for a long time.

That’s where tight money there, prices can be down slightly because there are less buyers, but then that’ll come back into the recovery phase. And that’s where there’s lower vacancies, the interest rates start falling again. And then we shift into the boom. So very similar to the residential property clock, it’s just got a few different kind of impacts compared to the residential market.

And when in the cycle, mate, is usually the best time to buy? Ideally, you always want to buy at the end of the recovery phase because the next phase is the boom. So that’s where you can kind of make that capital growth quickly. However, you always want to have that long term mindset. There’s that old saying about the best time of planting the tree is 20 years ago.

The second best time is now. So you don’t want to sit there. I’ve never met anyone who’s made good money in property from sitting on the sidelines. So buying now with the right fundamentals in place, you get the cash flow, which is a good enough return, even without the capital growth. So you’re going to have the cash flow.

And if you don’t buy, you’re going to miss out on opportunity costs. So always have that long term mindset. And there’s always the right time to buy. And different locations are going to be in different periods of the cycle as well. So you should be always be able to buy in a hot market. And you speak to any investor and their one biggest regret is that they didn’t buy more.

That’s always the biggest regret they have. Yeah, exactly. And no one actually knows when the cycle is going to take off. I’m yet to meet anyone who’s picked the market perfectly. But over the last 30 years, most of the properties have quadrupled in value. So as long as you bought a really good quality property, you’ve reaped the benefits.

And then different markets will have different growth cycles. So yeah, if you bought Sydney five years ago, you’ve done slightly better than say, like a Brisbane. However, the next five years, Brisbane might outperform Sydney. So just buy to the fundamentals, your budget and what your risk profile is. And then mate, where would you suggest the three main sectors are currently sitting in that market cycle?

All right, so just just in case you’re listening this at a later date, we’re in May 2022 at the moment. Industrial has been very hot the last couple years. My prediction was about 50 percent the way through the boom. So most industrials are between that five and six percent cap rates. I can see that shifting down to about four percent cap rates in the coming few years.

Suburban, very similar. I think we’re about 50%. And a keyword suburban there. So I’m not talking about CBD retail, which I actually think is going to have a quite a flat period. So that’s basically at the end of the boom and we’re in the slowdown recession phase. And that’s just from the working from home culture.

They’re not getting the same foot traffic and road traffic as we were. However, the residential suburban market is actually doing really, really well because they’re all the working from home people are now visiting their local shops. And then office is the one which is the huge unknown. Everyone talks about the office and whether we’re going to go back, whether we’re not going to go back.

I actually think we’re midway through that recession and the price is going to stay fairly flat for the next five or 10 years. However, interestingly enough, about 70 percent of the purchases in office space at the moment are from overseas investors. So I actually think there’s some cultures and countries are looking at Australia in the post COVID world, thinking office space is going to be where people are going to want to live and work remotely from.

And this market cycle diagram is quite interesting to try and kind of get commercial property to have a relative like property clock. You need to actually use a sector clock. So you’d have your location and then you’d have the sector clock on where the property that sector is in this actual property cycle.

Yep. Spot on. All right, mate. So would you say that the market cycles are the same all over the world or they are specific to the general location where they’re at? It’s going to be specific to the location. They’re all going to follow the similar kind of structure, but even Australia, for instance, has nuances like different capital cities, different regional towns act at different times.

So other countries are going to be the same. And like one of the ones I always refer to is like Perth, for instance, Perth for me is its own little country. Like it’s geographically the most isolated city in the entire world. And very dependent on the resource sector. So that is gonna have a completely different cycle to the Sydney sector.

Yeah, that’s it. And as terms of the, the whole world as a market, obviously right now the e-commerce boom is happening everywhere around the world. So industrial type properties are going to be doing quite well. And possibly office assets that might be a little bit like traveling, not as great because of what’s happening with Covid.

So they are all similar, aren’t they? But you do, once again, you need to drill down to your local market. It to check the supply and demand on there and, and the investor appetite and what kind of cap rates you’re paying there. So you do need to do a lot of research. We’re just kind of generalizing it here.

Yep. But you do need to do your own research. Yeah, exactly. Right. And even looking at future demand as well, because you, if you’re not checking things like oversupply in the market, they might be building 200 warehouses next door to yours. So. They’ve got the valuable land for it that could actually put pressure on your property where you don’t get the capital growth that you expected.

Yeah. So mate, how does the market sentiment come into play with commercial property? All right. So emotions are everything with property. Like the price of goods is actually an emotional, what we put on the value for products and services and property. So emotions are always going to play. Everyone knows now during the boom, like everyone’s emotions are high.

There’s a euphoria. People have got that fear of missing out, which is a big one. However, that disappears sometimes as well. All right, mate. So in your book, you have this really interesting diagram of the market emotion. It’s going to be hard to explain on a podcast. So if you do want to understand what we’re talking about, grab a copy of Steve’s book.

You can get it for free if you put in the podcast discount code on his website. But Steve, can you try and explain this the best you can, mate? Yeah, so like I said, we’re in that FOMO kind of moment at the moment where everyone’s making money, everyone loves property at the moment, everyone’s boasting about how much money they’ve made.

However, at some point that stops. So the market slows down and absolutely stops for a few years or even goes backwards and then you actually have the opposite effect. You start getting like denial that the market’s going to move back or you get the fear mongering. So people start talking about, and we’re seeing that in the media now at the moment, the fear mongering of prices are going to drop, people are going to lose lots of money.

Then there’s a bit of a panic sell. So that’s at the bottom of the sine wave. That’s actually sometimes where you can get some really good opportunities for commercial because When not a lot of people are buying and a lot of people are selling, you can really pick yourself up a bargain and then as the market starts to come good again, that’s where people start getting the hope and optimism and then we move back into that excitement and euphoria phase.

All right, mate. So what are the growth factors that need to be present for capital growth to actually occur in commercial property? One of the big factors is actually the economy. A strong or strengthened economy is fundamental for rising commercial prices. As the commercial kind of market grows, demand will increase and that’ll give you a price.

So warehousing will generally need more for storage, supply and fabrication. And then this will be followed by like a rising demand for retail spaces. Consumers need to use these goods that were fabricated and sold. And then normally we’ll have a confidence in the office space, but with COVID, that one’s kind of a little bit out the window at the moment and a bit of an unknown.

And in contrast, an economic downturn basically could actually make prices go backwards. What are some of the economic factors that we need to look out for? All right. So the big ticket items is one’s the gross domestic profit. So GDP is a good indicator, wage growth, unemployment rates, household savings rates, migration rates, changes in taxes and tax rates, population growth.

You can see there’s a few and like, I’m not pretending to be an economist, but. If you can look at all these numbers and see some positivity in the market, you could be onto a winner. Yeah, it’s very interesting that you listed them like that because a lot of these we can actually tick, we’re actually seeing them, but there are a few that are actually lagging like wage growth.

I know that’s a big one, but a lot of these things like migration rates, how does that actually really play a big factor in commercial property? So migration rates are similar to kind of like the population growth. If you’re having more people in the area, that’s more services that you need. So that’s more warehouses, distributors, fabricators, storage, spray painters, panel beaters, kitchen fabricators.

Then there’s more retail services. So you need more hairdressers, medical centers, barber shops, bakeries, and things like that. So they service the local area. And then in some commercial actually services globally. So they’re the ones that sit by like airports and ports, for instance, that the international kind of sector will have an impact on that.

So it kind of, uh, works back into the population growth. So you obviously want a lot of a large population around your commercial property, especially if that area is a growing population, that’s even better. Yeah, exactly. That’s mainly true with the service based industries. So if it’s servicing like a residential area.

That’ll work really well. Whereas like internationally, if you’re next to an airport and we’re doing exports of farming goods or even just a product, that’ll impact it there. So the population growth on that aspect won’t be as important. You’re exactly right. Mate, so interest rates, they could be a huge factor in affecting your commercial property.

Can you explain how that works? Yeah, so lending interest rates can directly affect the commercial property’s price as it’ll change the cash flow on the property. And if we have a remaining cap rate, It’ll actually directly increase in capital growth. Yeah, that’s right. And I guess, um, you know, when interest rates go down, there’s a flood of money that comes into that market.

Money is cheaper, so there’s more interest in borrowing money and lending is easier. Obviously, it’s cheaper, so people actually feel like they’re richer, and they want to actually put money into markets as well. So it can really drive down cap rates of commercial property and make the values go. up. Yep.

Exactly. All right, mate. So how about like a government spending, like infrastructure projects? How does that affect commercial property areas? So, so infrastructure projects is basically commercial because to support infrastructure such as like roads and freeways and new buildings. You need commercial properties.

You need the industrial properties. You need the fabrication. You even need the office space. If they’re actually doing good infrastructure projects, that’s normally going to increase access to a region, which means there’s going to be more kind of development, more population growth, as we mentioned before, which will then further increase the demand for your type of commercial premise and get the capital growth that way.

And mate, what about like the individual aspects or attributes of an actual commercial property? Like how does that affect commercial property growth or a downturn? Yeah. So each property is going to be different. So like, you’re going to have to look at the age of the building, what service it kind of supplies in its location.

foot traffic and road traffic of the property. And then even something similar as like council zoning changes, like that can instantly affect the value. Like if you have a property that’s zoned from low density commercial and it goes to high density commercial, that’ll straight away get developer appeal.

Yeah, that’s right. Like if you had a property. And it was once like residential land, and then it got rezoned into industrial land. Then depending on the market, it could be way more valuable than that residential land. Like if it was like a rural residential. Mate, so what about the length of the lease?

How does that affect the value of a commercial property? Like using your capital? Right. Yeah. So with the length of the lease, like it’s effectively because it’s supply and demand, that’s going to increase the demand for that property. Because if you’ve got a property that’s on a fresh five or 10 year lease, you’re going to have way more buyers, which is more competition similar to like a auction for a residential property.

You just get people with, and the cycle of emotions come into this here as well, where more people want it. So they pay a premium for it. Even if it means it doesn’t actually going to perform any better to something on a shorter lease, that’ll increase the price of the property and effectively give you capital growth that way.

And what about securing a better tenant? Same thing. If you get a really good blue chip tenant or a tenant that’s in demand, like a Bunnings or even like an IGA or Medical, for instance, you’re going to have more buyers in the market, which is going to push up prices when you’re competing against them to secure the property.

Yeah. So this is actually a really great value add if you have the means and the appetite to look at vacant commercial property where you know it’s in a great. location for a specific type of tenant and that’s a desirable type of tenant. If you can kind of work backwards and find the tenant first and then buy the property and then put the tenant in on a nice strong lease, you can really easily force capital growth onto that property just by doing that one thing, just tenanting the property.

Yeah, exactly right. But again, you need to know the market very well to do that. So you have to basically have boots on the ground, be speaking with Property manager in the area, find out what’s in demand. If they’ve got anyone waiting for properties, but doesn’t even have to be vacant as well. Andrew can actually be one with a tenant that, you know, is going to leave.

So you can actually buy that property at a premium because no one wants to touch it. Cause it might only have say 12 months left on the lease. And the tenants indicated that they’re not staying on. So you can also do it that way. And avoid the GST on the purchase as well. Yeah, that’s right. It’s, it’s, there’s so many different ways that you can create value and add value to commercial property.

It’s almost too many ways to actually be able to talk about it in a podcast. Right. What about inflation? How does that affect commercial property? Yep. So inflation basically is usually going to directly increase the rent because as the cost of money changes, the rent’s going to go up as well. And basically increasing rents increases capital growth because with the remaining cap rate, if you get, say.

3 percent rental increases on the property that equates to 3 percent capital growth just from the rental increases. So, if you can get more, if you can get say 5 percent rental increases, that’s 5 percent capital growth just on the actual rent itself. And we’re not talking about even cap rates tightening, we’re just talking cap rates remaining the same.

Yeah. So, it’s basically you’re just increasing the rent that you’re deriving the net income from that property. because of inflation. And that could be from your rental review in the lease. It could be a CPI. I think we’ll probably talk about that in a later podcast, but you could have rental increases like Steve said.

And the more that more income you can get from that property, the higher in value that property is going as well. Yeah, exactly right. And then also if you get cap rate compression, you can make even more. And like just cap rate compression, as we mentioned before, like say a 2 percent cap rate compression.

That’s not 2 percent difference in capital growth. Like if you have a, say a 900, 000 commercial property on a 7 percent cap rate and it compresses to a 5%, that property is worth about 1. 3 million. So you’ve actually made 400, 000 just from the cap rates compressing. Yeah, it’s ridiculous. And you really have to put these numbers on a spreadsheet and really play within yourself to understand.

The power of a capitalization rate and like in my mind, that’s why commercial property is so powerful is because it’s a value and sold and purchased and bought on using a capitalization rate, not just a, Oh, I reckon this is how much it should cost kind of comparable. Yeah. And you’re, you’re always going to be in line with the market as well, because, because the prices are going up with inflation.

The costs and goods and services are always comparable. Whereas residential, the price can go up and the rent can remain the same quite easily. That doesn’t actually mean it’s any easier for investors to get a return on investment. It just means they’ve actually got more negative gearing. Yeah, that’s right.

And we all know that negative gearing is not helpful for growing your portfolio, which is exactly what we’re talking about now. So mate, why is growing a commercial portfolio so much easier than growing a residential portfolio? You know, I wouldn’t say that it’s easier. It’s just faster. So like one point to note is you’re going to need a slightly high deposit with commercial because you need that 20, 30%.

So it might take a little bit longer at the start to save the deposit or use the equity from another property to get into it. Whereas residential at the starting portfolio, you can actually get away with 90 percent loans with lenders, mortgage insurance, not saying commercials for everyone. But once you do have one, you can expand the property portfolio way more quicker than residential.

Yeah, I guess it’s a matter of opinion, but in my mind, the reason that I would say that building a commercial portfolio is in theory easier. Yes, you need a higher deposit initially, but if you know what you’re doing, you are compounding cashflow and positive income from each single property, which in theory is making your serviceability better and better whereas in the opposite hand, we all know that with residential.

More than likely, you’re going to have some kind of negative gearing in that portfolio. So your serviceability is getting less and less and less, and it’s getting harder to borrow money. And eventually, you do actually get tapped out where the banks will not lend you any more money based on your current serviceability.

And in theory, in commercial property, investing In general, it’s hard enough. You know, why would you want to be putting yourself at a deficit? You want to have positive cash flow coming in and making it easier for yourself every single time you purchase a new property and it’s like a snowball effect. It should just be getting easier and easier and easier.

Yeah, you don’t have the same glass ceiling as you do with residential because most people get tapped out on their serviceability. Whereas commercial, because there’s such high positively geared properties, you can actually keep buying and buying and then you’ve even got other lending options, such as like lease stock loans, where they’ll give you the property loan based on the premise of the strength of the lease.

But residential, you’re purely relying on capital growth. That’s it. Like you’re not using the cashflow. It’s not actually helping build a passive income commercial. You can actually win on both fronts because you get the capital growth as well as the cash flow. So if you put them together, you can actually grow the portfolio twice as fast.

I want to stress that a commercial property is not a speculation play. We’re not speculating that it’s going to grow in capital growth. We’re hoping it does, but we’re not. banking on it. We’re not counting on it. We’re actually looking at each individual property and assessing the cashflow. If it works, if it actually stacks up at that point when you’re buying it, then it should stack up in future as well.

And then the capital growth is just a cherry on top. So you’re investing for cashflow first and appreciation, which is capital growth second. Yeah. It’d be it again. It’s going to be person dependent. Like I’d still go out and say. Buy a property that’s got really good capital growth prospects as well because you know, it’s in really high demand.

So even though the numbers make sense now, if you know the vacancy rates are really, really tight, that’s going to equate to capital growth, even though it comes through the commercial cashflow anyway, because the cashflow increases because it’s in demand and you get the capital growth that way. So if you can win on both fronts, you can really accelerate the portfolio.

Yeah, a hundred percent, but you’re not just speculating. I’m not buying into an area, like a residential area saying, I think it’s a pretty good market. It’s booming. I think it’s going to grow. That’s not what we do in commercial property. The benefit of commercial is even without capital growth, the numbers still make sense.

It’s still a really attractive investment. Yeah, that’s exactly what I was trying to explain. Yeah, that’s exactly what I meant. I hope you’re enjoying the show. We’ll be right back after this short. Stay up to date with all the hints, tips, and tricks in commercial property by following Policy Property on Facebook.

Go to Policy Property, hit that follow button, and never miss a beat with Policy Property. All right. So, how is it actually possible to pay down a commercial property in 10 years? All right. So, this is just what I basically alluded to. The numbers are really attractive. by themselves. So if you, for instance, have like a six or 7 percent net yielding commercial property and you use that passive income and you actually put it back into the debt on a 70 percent loan in 10 years time, you’ll be debt free.

And this is another one of those light bulb moments, Andrew, which we spoke about before is people don’t believe it when you say that to them, that in 10 years, you can be debt free on the property and have a quite a large passive income because with the rental increases and no debt. The passive income is actually huge.

Like on a million dollar property, at the end of the 10 years, you’re about 85 grand a year positive at the end without any debt with small rental increases. So it’s, again, it’s one of those ones you need to actually look at the numbers. And I actually, again, on my website, I’ve got a resource tab and I’ve got a pay down calculator.

You can have a play with the numbers yourself. Once you look at that and you go, okay, if I can buy one property and have it paid off in 10 years. What happens when I actually buy two properties and pay them off? Yeah, it’s really interesting. And it’s one of the best ways to kind of get to where you want to be is use the net income, the cash flow of your property to either pay down your debt, which is you’re creating equity in your property, or use that to buy more commercial property, which then snowballs into more cash flow.

Yeah, exactly. Right. And so actually having multiple properties can also reduce risk with commercial as well, because if you start owning two or three of them, and One of them goes vacant, you’re still very cash flow positive on the property, whereas if you just own the one and it goes vacant, you need to basically fund that mortgage until you get a new tenant.

Yeah, that’s right. So Steve, you mentioned the pay down spreadsheet, so I just kind of wanted to try and explain that to the listeners. over the podcast. I know that’s going to be a little bit difficult, but if you do want to understand what we’re talking about, do go to Steve’s website and find that resources tab and download the pay down spreadsheet.

So Steve mate, can you just start trying to explain the spreadsheet to us? So let’s just use say like a million dollar example. So a million dollar property, 700, 000 loan on it on a 70 percent LVR. And you’re going to have usual purchasing costs on the property. But let’s just say you get a 6 percent yield and you’ve got a loan rate of 3%.

The interest on that mortgage, that 700, 000 mortgage is going to be about 20, 000. So with the rental kind of income that you’re getting from the property, you’re going to be left with about 39, 000 cash flow at the end of the year. So close to about 40, the million dollar property. If you put that back into the property, that 700, 000 debt, then becomes 660, 000.

So then you’re actually going to have lower interest on your debt for the next year. So then if you do the same thing and you put the next cash flow, the next 40, 000 into the remaining debt again, that goes from 660, 000 to 620, 000. And then what happens is the cash flow increases because your interest repayments are going down as well.

So if you just go year on year on year. You’ll actually find in 10 years time, you’ll actually be debt free and you’ll be left with an 000 passive income. And mate, what happens if you decide to put the additional, uh, contributions into property debt like a, like an SMFF? Yep, so this is a really way to accelerate it because Like with residential, the bulk of the interest repayments at the start as the debt gets smaller, it accelerates the pay down.

So if you can put say 30, 000 extra year and year into it, you can actually pay the property off in eight years or seven years. So that’s going to act very similar to a self managed super fund or just anyone with a simple retirement strategy. They want to buy one property and have it paid off. in a short amount of time and they got a bit of extra savings with work and they’ve paid off their principal place of residence.

It’s a really attractive simple way just to have a nice low risk property that’s debt free. I mean like in like eight to ten years to have a property paid off it’s kind of unheard of in residential kind of markets. To be able to do that and to be able to actually show them how to do that on this spreadsheet, that’s really valuable.

Yeah, to put into perspective, it’s like if you’ve got a neutrally geared residential property, that property just to remain on par with commercial has to double. So just for it to be comparable, it has to double in value. To be the same, but with commercial, then you’ve also got the rental increases in the capital growth and the cap rate compression.

So you can actually make twice as much if the commercial property doubles as well, which we spoke about the myth of that capital growth. If it doubles as well, and it’s paid itself off in 10 years, you actually make twice as much as residential. Yeah, that’s right. All right, mate. So like moving on to like a loan to value ratio.

for your commercial portfolio, what kind of LVR would you suggest is risk averse? And where do you want your LVR to sit for your entire portfolio? Yeah. So this is going to come down to the individual and there’s a number of factors, the first one’s your risk appetite. So how much money can you actually risk?

Like how much equity or cash do you have versus how aggressive you want to be is going to be part of it. What your goal is as well. If you’re in the accumulation stage, a higher LVR makes sense because you can grow the portfolio quicker. Whereas if you’re kind of coming towards retirement for instance, you might not want to be highly leveraged.

You want to like a 50 percent lower LVR just to minimize the risk. And then that’s going to flow into what time frame you’re doing it over. Like if you’ve got a 10, 20 year plan, you can obviously handle much higher LVRs because you’ve got time on your side. Whereas if you’ve got a shorter time frame, you’re going to have a lower LVR.

So it’s just going to come down to the individual of what you’re trying to achieve over what time frame versus what your risk profile is. And just for the listeners who are completely new to investing, can you just explain what LVR is? LVR is just loan to value ratio. So it’s just effectively the amount of debt you have on the property versus the property price.

So a 70 percent LVR on a million dollar loan is actually 700 grand on the property. So a 300 grand deposit. What about non recourse finance, mate? Can you just explain, uh, what that is? All right. So non recourse loans are basically loans where you secure the property against other assets that you have, like typically other properties.

So if you default on your loan, the lender’s got the right to seize whatever asset you put up as collateral and sell it. So it’s sort of similar to cross collateralizing with your properties. You need to remember property prices aren’t always guaranteed to go up. So you do need to stress test your portfolio to ensure you can handle the bad periods.

The best way to actually do this, Steve, is you want to have recourse against the only, like the property that you’re actually lending on. So you don’t want it to be like have non recourse finance against multiple properties. If you can do it, you want to have it against one property, which is usually 60 percent LVR, you can qualify for non recourse finance.

Yep, exactly right. But every lender is different than the second tier lenders and third tier lenders. Private lenders are all going to have their different rules and assumptions. Uh, sometimes business lines and leased stock lines and no doc lines, they’re, they’re all got known nuances. So have us chat with your mortgage broker and find out what the one’s best suited towards your risk profile.

And also I should mention it here, Steve, it’s actually a really good strategy to get the highest. lending that you can possibly get. So say you get like an 80 percent lend on a million dollar warehouse, let’s say. They’re hard to find, but you can actually do that. And then you add a little bit of value to the property and then you refinance it into a non recourse loan.

Yeah, exactly right. And then basically it just accelerates your portfolio because you get more leverage. But again, higher LVRs, they do come with risks, same as residential. So it’s just about assessing your risk where you find, but the banks are effectively doing that anyway. And that’s why they don’t give you a 90 percent commission.

Commercial loan. They want to make sure that if the tenant leaves and you can’t handle the mortgage anymore, they can offload that property and get their money back. So having a 30 percent safety margin, for instance, is quite low risk for the banks and they can offload the property and get their money back quickly.

Yeah, that’s right. And so mate, for like your personal investor, how many months of reserves, like AKA a buffer, do you like to have up your sleeve? Yeah, so this again is going to come down to your personal circumstances and it’s, it’s actually one of the most common mistakes I see. They don’t have enough cash reserves for the bad times if the property does go vacant.

My personal one is I actually have 12 months worth of interest rate and outgoings on each property. So as I get towards say six months left of the lease finishing, I’ll have 12 months worth of funds sitting there. that I can handle that vacancy period. And one of the tips I actually use is with my multiple properties, I actually stage the leases.

So I won’t buy two or three properties that have leases ending at the same time. I’ll have one that has like ends in 2024, 25 and 26 for instance. So I actually only have to have one buffer amount. I don’t have to have three buffers all at the same time. But again, assess it on your own personal circumstances and what type of property you’ve got as well.

If you’ve spoken to the tenant, now they’re going to sign on as well. And that can change as well. And then just generally how much cash you have. Like people forget, you can accumulate quite a lot of cash with a commercial property. And I had this conversation a couple of weeks ago with a resi client and I was saying commercial is too high risk because if you lose your tenant, you basically can’t afford the mortgage.

But my argument to that was if I buy a million dollar property on a five year lease and it’s 40 grand a year positive, in four or five years time, I’m actually 200 grand up in cashflow. Whereas they’re buying a million dollar property that’s 10 grand a year negative. They’re 50 grand down. So if I was to not buy another property, 200 grand will get me by for 5, 6, 7 years of mortgage repayments quite easily.

So it actually can be lower risk. And mate, in your opinion, what kind of like timeline should you be working towards in your, you’re actually growing your portfolio? Yep. So this is where you just need to assess what goals you’re trying to achieve. So your strategy is going to come down to what you’re trying to achieve.

over what time frame versus what your age is and your risk profile and also against what your borrowing capacity versus serviceability is. And what I mean by that last point is there’s sometimes why residential is right for the investor at the start. If you’re a young 22 year old and you’ve only got 60 grand worth of savings, it may be better for you to move into residential and have a 90 percent loan for instance.

Get some capital growth there to then extract that equity and then move into commercial. Yeah, that’s right, because you can buy more property, have it higher leveraged, and then have more properties working for you than just trying to get the one and having all your eggs in one basket straight away.

Yeah, like you could have three 90 percent loans, so three 10 percent deposits versus one 70 percent line of commercial. If you get capital growth, you actually make three times as much in the capital growth aspect compared with the commercial. You will have lender’s mortgage insurance and things like that.

But again, it’s just about assessing your, where you’re adding your portfolio. That residential doesn’t make sense for someone who’s 65 and about to retire because they don’t get anything from that. They need the passive income. So commercial makes more sense, even if they don’t own any other properties in their portfolio.

Yeah, it just really makes sense to where you are in your So mate, why, in your opinion, is property always or generally You basically, you can’t get in and out of the market quickly. So it’s not like shares where you can just buy and sell. The entry and exit costs are actually quite high. So unless you’re going to be a flipper, you need to have that long term mindset because you’re going to pay stamp duty on the purchase plus the other acquisition costs, which can be about 5%.

Then you’re going to have selling costs. So if you sell the property, you’re going to have most agents charge about 2%. Then the property you replace it with, you’re going to have another 3. 5 percent stamp duty purchasing costs. So you can actually be 10 percent plus in losses just from transferring the property to another one.

So I always keep that long term mindset when you’re buying the property because you’re, you’re buying this property to build a passive income. So if it’s giving you that passive income. Why would you be intending to sell it anyway? Yeah, I mean, when you’re buying on property as well, in general, commercial and residential, there’s a cool little saying that I like.

It’s not about timing the market. It’s how much time you’re actually in the market. Because after a while, after 10, 12, 20 years, where your property has completely, you know, you’ve seen a few property cycles, like it’s not guaranteed, but it’s generally your property will be worth more in 10, 20, 30 years than it is when you buy it.

Yeah. And no matter where you put your money, it’s very unlikely that like shares will outperform over 20 years. Like they’re going to go up and property will go down. You’ll have a positive outlook on it. Or if they all go down, it doesn’t matter anyway, because everything’s going down at the same, same rate.

One point to note is I remember like a lot of my clients, Two, three years ago, for instance, and we’re trying to buy properties at 7 percent net yields. And I’d find one that I thought was a really good property at say 6. 9 percent net yield. And they’d turn it away and they didn’t end up buying. And then they got analysis paralysis and they walked away.

If they bought it at 6. 9%, that same property is now at 5 percent two years later. So kind of focusing so much on those tiny nuances of purchase price now. You can actually miss out quite a lot of the opportunity costs. And so mate, what type of results are actually achievable in 10 years with buying say one commercial property?

It depends what your purchase price and kind of what your buying capacity is. But for instance, like I’ve got a property plan on my website you can download. It’s a sample kind of 10 year plan. Where you start with a 500, 000 property and then all we do is we get 3 percent rental increases on it. And we actually put a little bit of extra contributions in, so 10 grand a year.

In 10 years time, basically from the cash flow, the extra contributions and the 3 percent capital growth, it actually means you can buy another property after three years. And then after three years, you’ve got two properties. And then at year five, you then buy another property and then so on and so forth.

You actually end up with about four properties. And about a 2. 5 million portfolio with over 100K passive income just from buying the one 500, 000 property now. Again, if you can show me in residential how to get 100K passive income from just buying a 500 grand residential, I’m all ears. It’s pretty amazing, isn’t it?

Mate, so I mean, this can be a little bit overwhelming if you’re not a numbers person. person. I mean, and that’s okay, but please don’t overlook having a plan in place. There’s plenty of people that can help you with planning out your property strategy and putting a plan in place. Like Steve, you do property planning services, don’t you, mate?

Yeah. So I’ve got an online portal where we can actually forecast how people’s portfolio is going to perform and then weigh it up with what they’re trying to achieve over what timeframe. And then we can calculate. When they can buy the next property, what their assumptions need to be. And we can also stress test the portfolio.

So we can actually put higher interest rates and lack of capital growth and just see all the different results you can get from the property and what’s actually achievable over the time frame they’re trying to look at. And one of the things with property investing in general, but specifically commercial property, you need to be putting this on a spreadsheet like a property planner and things like that and planning it out.

Just think about it like you’re going to a destination in your GPS, you put in the location you want to go and then it works backwards and it takes you there. It’s the same thing. You go to Steve, you tell him what you want and he can work a plan backwards to help you get there. Yeah, exactly. I mean, we get to see what’s achievable and, and as we’ve kind of discussed on the podcast, the numbers actually blow your mind when you actually look at it.

It actually looks so easy. It actually is one of those ones where it looks too good to be true. And then. I actually think that’s why some people don’t buy. They, they think there’s a catch. Realistically, you want to be able to use commercial property to give you the choice of having to work. You’re exactly right.

People think it’s like, it’s some kind of a catch, but it’s not like you could easily find a commercial property that will be able to pay you like a 50, 000 to 40, 000 income over time. And you could essentially buy a couple of those and retire reasonably. early in your years. So it’s a really, really good way to get your freedom back and choose if you want to work.

Yeah. The biggest feedback I’ve got from the clients that I’ve developed the passive income for is they actually call me the lot of times they stay in the same job, but they just say the job’s different knowing they don’t have to be there. They stress less at work, they don’t have to work as hard effectively or long hours, and they actually enjoy the job that they’re doing again.

So you’ve got the choice of changing jobs, but even keeping your same job, you’ll look at life a little bit differently, I think. Yeah, it’s just about having choice, whether you want to go to work or not. It’s just a beautiful thing. All right, mate. So what are some other surefire ways to grow your portfolio?

This most of the time is the value add type stuff. So adding value where we’re actually going to do a podcast on adding value to the property. So there are value add techniques of like putting in those ATM machines and subdividing tenancies and things like that. But the simple one is actually just buying well.

So just buying a property that you’ve got at a really good price, that’ll help you there because you’re going to get some instant equity. And then the other one is actually increasing the rents. So if you can buy something that’s say below market rent, and then you get to the end of the lease term. And you push up that rent, you can really accelerate it that way.

So all those methods are just simple ways just to, to squeeze out that 10 year plan into say a seven or eight year plan. One of the best ways and the most cost effective ways to add value to commercial property is exactly what you just said is buying under rented property like Just being able to identify an under rented property and then if you can buy it at the right price and just move the rents up, it costs you no money to do that except getting that lease created and executed.

And then you’ve really significantly added value to that commercial property. And I’m sure Steve has a couple of different spreadsheets that can help you calculate that. but it’s just such a great way to add value to grow your portfolio. I can’t stress that enough. Yep. I agree completely. All right, mate.

Well, that about wraps up episode four. Steve, can you just give us a recap on where the listeners can go to download the free giveaways? Yep. So just go to my website, www. policeyproperty. com. There’s a resource tab where There’s plenty of spreadsheets. You can go have a play with all the ones we’ve spoken about on today’s podcast.

And you can also go to my purchasing my book, but use the code word podcast and you’ll get it for free. You just have to pay for shipping. A quick disclaimer here, guys. So this is just information is generally in nature. Steve and I are not accountants, economists, or anything like that. Do seek. guidance from professionals when you’re purchasing any kind of property, go to Steve and he’ll give you a good hand finding a nice commercial property as well.

Stay tuned for episode five where we explain leases, lending, and finance. This should be really fun. All right. This has been author Steve Felici and Andrew Bean on the Commercial Property Investing Explained series. Thanks for listening, everyone. Love it. Thanks, mate. Thanks for listening to the Commercial Property Investing Explained series.

This show has been produced by the Commercial Property Show Network.