EPISODE 5: Leases, Lending and Finance - 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… with author of Commercial Property Investing Explained Simply and founder of buyers agency Polisi Properties. Steve Polisi. How are you doing, mate? Not too bad, Andrew. How about you?

I’ve heard you buying some storage space. That’s it, mate. Gee, that intro is a mouthful. I get a little bit better at saying it every single time. So, uh, looking forward to, uh, Just be really fluent with it at the end. That’s right, we’ll have to do another 10 episodes then. Yeah, fair enough. So mate, in this episode, we’re actually up to episode number five and we’re going to be talking about arguably kind of the most important aspect of commercial property and that’s actually the lease.

So we’re going to be talking about the lease on a property, the different types of lending and how commercial property is financed. 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. stevesbook. com. policyproperty. com. Use discount code podcast to get the book free. All you have to pay for is shipping. What a great deal. So mate, why is a lease so important in a commercial property? So firstly, a lease is basically an agreement that allows use of the premises or building by the tenant to conduct their business and in return, they pay for the premise.

It’s important to the landlord obviously because it’s going to keep the tenant there long term so they’ve got a commitment and it’s important to the tenant because they can stay on without having to worry about moving premises. The term I use for lease is normally it’s the rule book between the tenant and the owner.

So it sets kind of the standards of what the expectations are for each party. One of the reasons why I’ve actually grouped this podcast together with leases and lending because we’re going to explain basically they’re symbiotic. So you need the lease a lot of the times to get financed. Yeah, I mean, I guess one of the things that people need to understand when you’re buying commercial property, you’re buying a lease.

The reason that property is so valuable is because of the lease in place usually. Usually a lease can make the place a lot more valuable or a lot less valuable depending on the lease period on that tenancy and also the strength of that tenant as well. Yeah, so who the tenant is actually plays a part of it as well and then their options and all those things like that.

Yeah, that’s it. So, mate, why is a commercial property lease so different to a residential lease? Basically, it’s much, much longer. Like, residential leases are typically, what, 6 12 months? Whereas commercial, you can have 3 years, 5 years, 10 years, 30 years if need be kind of thing. So, there’s also less rules about commercial leases.

Whereas, like, with residential leases, it’s someone’s home and shelter. So, it’s a lot harder to kind of evict someone like that, but Because commercial is effectively just a business, you are in control. If they break the lease, you can effectively change the locks and kick them out. So, it’s a legal contractual obligation from both parties.

And what about how it’s valued, mate? How is it different in residential to commercial? Most of the value of a commercial comes from the actual lease. So, the length of the lease and the security of the type of lease and who the tenant is. Is effectively going to basically increase or decrease the value of property.

Vacant property will often sometimes sell for cheaper than something with a 10, 20 years. Like a medical tenant, for instance, that’s got like a really expensive fit out, that’ll command more rent than a say, a standard retail, which is just like floored space and some painted walls. The lease basically stipulates the worth of the property, the return of the property, and how long you can have the tenant for.

I guess on the other hand, with a residential property, it doesn’t really matter if you have a 6 month, 12 month, or 24 month lease. If you could, it doesn’t actually make the property more valuable at the end of the day to the end buyer, so. It also doesn’t affect your finance like commercial does, so we’ll have a bit of a chat about this later.

Residential, they don’t care if it’s tenanted or not most of the time like there are some exceptions, but that’s normally distributive serviceability, but they’re just going to take kind of market value anyway. Yep. So mate, can you talk us through the lease process? It’s worth noting, Andrew, though, that most states will have a different standard lease as well, but there’s generally four steps.

So one’s basically creating and signing an agreement to lease document. So that’s just a document. A lot of the times if you’ve got like a new construction or the tenant hasn’t quite moved in yet, they’ll stipulate that there’s a plan to kind of move into the property. Then you’re going to have a draft lease and that’s submitted by the landlord.

And the solicitor will basically just outline the standard criteria of what they expect from the tenant. And then that’s where the negotiation is starting. You have the back and forth. You’ll also have to have details such as mortgages and covenants, easements, zoning and outgoings that you provide for it.

And you also have to do registrations and survey costs and things like that. And then once you’ve both agreed, you’ll then have the finalization of the lease where both parties will finally agree. And then at the end of it, you actually need to register a lease with the state that you’re actually in. So that’s another important step for finance.

A lot of times I need a registered lease to be able to provide finance. Actually, um, you can have an unregistered lease though, can’t you, Steve, as well, right? You can, but I’ve actually had some lenders recently who actually won’t give borrower against the property unless it’s registered. Yeah, so they won’t give lending against it because it’s not a registered lease and it’s just kind of a handshake, you know, agreement on a bit of paper, really.

Yeah, exactly right. All right, mate, so what would usually be included in this lease? So this is going to need everything where between the parties you want to agree on. So that’s going to be who the tenant is, the description of the actual premises, and what use you’re going to have for it. And then you’re going to have a guarantees on the lease as well.

So you can have bond details and who the guarantor is, start date and end date, length of the lease, the options of the lease as well. And then obviously the rent, how much rent they’re going to pay. What rental increases you’ll have at each review, and then you’re going to have to stipulate details of the outgoings, who’s responsible for repairs and maintenance, as you know, Andrew, most of the time that’s covered by the tenant, the trading hours that they’ll typically operate or can operate at, and then any additional stuff like Okay.

Fit out costs, rent free periods, who’s responsible for insurance and things like that. So besides the retail leasing act, so if you own a retail property, there are some rules. You can actually agree on anything as part of a commercial lease, because what makes it actually quite fun. Yeah. So mate, uh, what are the different types of leases?

You’re going to hear these terms quite a lot, especially if you’re researching properties online of different types of leases. So, first one’s gross lease. So, that’s where basically the owner pays all the outgoings. So, a lot of times we’ve spoken about in previous episodes, we talk about net rent. Gross rent is just the money that the tenant will actually give you.

So, that’ll be the gross rent. So, gross lease is they don’t pay the outgoings. They’ll give you a gross amount of money and then the owner is responsible for paying the outgoings. So, the maintenance. The council rates, water rates, all those types of things. So to work out your net rent or net lease, you have to do a calculation on that one.

So gross leases is just a big lump of summer money. Owner handles all that kind of outgoings from there. The risk with that is as outgoings potentially go up. It’s going to erode your net yield because outgoings go up, you’re getting the same rent from the tenant, you’re actually going to lose out on your net return there.

So just be mindful of that when you are looking at gross leases. The other one and the most common one we normally speak about is net leases. So that’s the power of commercial one where tenants pay all the outgoings. They pay the council rates, the water rates, the maintenances and insurances and things like that.

That’s the best one as well because as I just mentioned, if those rates do go up, you don’t bear the brunt of it. So your net yield will actually remain the same as those costs go up as well. So that’s the power of commercial. The other one you’ll hear sometimes agents talk about and that’s triple net leases.

And that’s typically where the tenant pays taxes, insurance, and maintenance. So in America, that was categorized because they’re the three main outgoings of the cost. So that’s where the term actual triple net came from. And then the last one you’ll occasionally hear about is absolute net leases. So, this is where the tenant’s responsible for absolutely everything.

So, that includes all those ones I’ve mentioned before about maintenance and insurances and things like that. They also pay things like land tax, management fees of the property manager, building structural repairs and things like that. So, that one if you can get it is quite a good. They’re normally for more so the, the larger tenants in the freestanding buildings where they’ll look after it like the Bunnings and the Woolworths and ones like that where they’ll have to look after it kind of thing because it’s such a ginormous structure.

It’s quite interesting that you mentioned the absolute net lease, so you don’t hear that one too often. And I guess what people need to remember as well is when you’re looking at a lease, you need to understand if it is a gross lease or a net lease and doing your figures off the net figure, not the gross figure, because you can really get yourself in trouble if you’re using the wrong figure there if it’s a gross figure.

Yeah, you’ll quite often get some leases that stipulate like absolute net lease where they’ll look after things like the structure and things like that. But in reality, I always find it’s an area of contention. Like if you’ve got like, I don’t know, some corroding steel members that are holding up the building, the tenants normally going to come back and say, look, I’m not responsible for this.

Like, it’s not my fault. You’ve got a building that’s kind of coming down. So it’s always a convention. So I always just look at it like that. Like worst case scenario, you’re going to have to look after the big things, but they’ll look after the maintenance and the outgoings and those things. Yeah. All right, mate.

So can you explain the different lengths of a typical lease period and the types of businesses that would usually be involved in like a shorter lease to the longer lease? All right. So this is a fun part of commercial where you can actually get some really long leases. Most of the stuff that the everyday armchair investor, you’re going to look at like three, four, five, seven year leases.

with the same as the options. So like a three year plus three year plus a three year. Normally, the smaller the lease term, the smaller the business. So you’re going to get the small, like if you are getting like an industrial space on a three by three by three, it’s going to be like a small sole trader or a little business like a mechanic or storage distributor fabricator or something like that.

And then as you start getting into the larger businesses, they’re more locked into the space and they want to stay there longer term. So they’ll start actually signing the longer leases. If you get into the kind of the higher ether of kind of properties, like the national chain tenants and the shopping centers and the big hardware stores, petrol stations, they’ll actually typically signed like seven to 20 year leases.

So it’s just normally it’s security for them. Like it’s great as an owner in commercial space to have a long lease because it feels like you’ve got security. But most of the security is actually for the tenant because they’ve got a big fit out cost. Sometimes, especially in retail, the location is very important to them.

So I don’t want to have to be kicked out at the end of the lease. So they’ll actually sign. Long leases. These are fun fact for you. So in 1759, Arthur Guinness, who founded Guinness Brewery, obviously, he signed a lease on a brewery in Dublin for 9, 000 years. That’s crazy. But like I said, you can write a contract for whatever you want.

There’s no limit on what time frames you can have for a contract. What was the, uh, the rent on that lease back then? Oh, 1759 surely was probably what, one pound a year or something. I mean, from the perspective of like an investor, if you’re looking at a property that has a longer lease, um, usually that tenant will have a quite a reasonably large fit out and they have to have that longer lease because obviously they don’t want to sink that amount of money into the property and then get booted out.

And I guess, Steve, would you say that the shorter the lease, the riskier it is? Or how would you actually look at that, a risk perspective? Normally the length of the lease will really help you with the finance. That’s the piece of it. And I have this argument with a lot of investors where they’ll turn away a deal because it’s got say two years left on the lease, but they’ll be looking for something that might say, have a four year lease going on.

I want the security having four years in four years time or two years time. If the tenant leaves, you’re in the same position. You’re just pushing the problem downhill by two years. The fundamentals of the property still needs to stack up. Like it still needs to be in a good area, a good location, have really tight vacancies as well because.

Whether the tenant leaves and they will like not many investors get a tenants who’s there for 50 years. Like whether it be in two years, four years, 10 years, 20 years, they’ll leave the bare fundamentals of the property still needs to stack up. So in this hot market, especially I use it as an opportunity to actually look for someone’s shorter leases.

And then part of the due diligence process is you call the tenant and find out what their plans are, how their business is going, and then see if you can actually offer them to extend the lease. And then normally just give them some form of incentive, like slightly lower rental increases or something like that.

But yeah. For the everyday investor, focus on the property itself and not just the lease. And I guess you have to also weigh up whether or not that lease is actually ending or they’re going into an option period as well. Like, it’s not just like a one metric on a lease is a deciding factor. You have to take everything into account, don’t you?

Yep. Spot on. All right, mate. So speaking of options, can you explain what an option in a lease is? Okay. So you heard me mentioned before about like, say you’ve got a three by three by three. So that actually means that the tenant. Has rights to that property for nine years. So at the end of the three years, they still have the choice to leave so they can pack up shop and move on and things like that.

However, they get to then if they do want to engage the next lease, sign on for another three year lease period where they’re locked in and then so forth on the next three year one. So it’s a commitment for them that they can be there for nine years. However, they don’t have to be. They can leave at any of those periods, but each time they basically renew the option, they’re in locked in for the whole three years.

Perfect. And I guess the options in a lease is actually more for the tenant. It doesn’t really protect the landlord at all. It really is just protection for the tenant. Yeah, no, exactly right. All right, mate. So we did just speak about this, but what are the pros and cons of a different lease periods?

Obviously, if you’ve got a short lease, they can leave and you can have a vacant property quite quickly. So a 12 month or two or three year, you could be looking at a tenant quite quickly. The benefit though, is if the market’s moving quite quickly, which we’re actually seeing at the moment, rents are going up quite a lot, like 10 percent in the last year.

By having a shorter period, if they’re getting to the renew option where you then do negotiations on the market rent, You can bump the rent up quite quickly, whereas inversely that like, if you’ve got someone on like a five year lease and they’re, they’re not having high rent rental increases, you have to wait till the end of the period before you can get that.

So it can increase the cash flow. It can also give you an opportunity to do some value add to the property. You might renovate it or. Try to split the tenancies or something like that. Or if you wanted actually the tenant to leave, like sometimes you’re actually buying something with development potential.

So it’ll give you that option there as well. On the flip side, you’ve got obviously the long leases where you can’t do anything with the property. You’re kind of locked in for the long haul. with the contract that was stipulated at the start. However, the benefit of that is obviously finance. Like lenders love you because you’ve got a long contractual lease between you and the tenant.

So finance is a lot easier and just peace of mind where you don’t have to ever worry about having a vacant property in the future. You can just get on with your life. I mean, this is why actually I like self storage, like some people look at self storage and say, oh, they’re month to month leases, that’s risky, but it actually gives you the opportunity to take advantage of the market sooner.

So like, say you can identify an underperforming facility, like the rents are really low. Well, pretty much in a month, I can bump those up depending on when that tenant has come in and I can reap the rewards straight away. But if I bought a, an industrial property that had a five year lease on it, and there’s a lot of inflation, like in the market right now.

I can’t take advantage of that inflation at all, even if the property was under rented because I’ve already signed a long term lease. So it gives you that flexibility of being able to capitalize on your research, being able to identify an under rented property. And that’s, you know, the best way to get huge gains in commercial property is just by identifying an under market rented properties.

Self storage is effectively like a multi tenancy property. So instead of buying like a little retail strip of 10 shops. You’re buying a retail strip of a hundred shops, for instance. Just FYI for the listeners, stealth storage is a very specialized asset. And Andrew, you’re aware that you know this inside and out and not many people do.

Be careful when you’re looking at them. They are quite specialized. Yeah, I’m not saying go around and just buy self storage facilities. If you don’t know what you’re doing, please don’t take that. That’s just a reason why I personally like self storage because you can take advantage of knowing the market.

So mate, when is it beneficial for the tenant to have multiple options? All right. So basically always because it gives them first pick of actually continue it on. It also gives them options to sell the business because if they ever want to sell the business, if they’ve only got say two years left on the lease, I’m not as a business owner, not going to buy that premise or buy that business from them because if I get kicked out at the end, what’s the point I’m going to lose all that feed out costs and things like that.

So it gives the option that you don’t have to stay on as a tenant. But then you can also sell it on and they’ve got some security long term that they’re actually going to be there and not have to worry about moving out. There’s also some cost savings as well. So obviously every time you do a new lease, there’s some legal costs.

You got to draft up a new contract and have solicitors involved and discussions there. So if you had like, say, two year leases every single time, you’re going to be up for a few thousand dollars every couple of years. But by having a long lease term in terms of like a three by three by three, you don’t have to do much then for nine years.

It’s just a set and forget type scenario. Yeah, all done, ready to go. All right, so if a tenant actually wants to renew their lease at the end of their lease period, what’s the process they go through there? Yep, so obviously they’ll tell the owner or the managing agent. Most contracts you’ll stipulate about a six month term that they have to tell you prior whether they can engage the lease or going to be leaving.

However, most of the time, you at least want to start those discussions 12 months prior just to get prepared and to give yourself more time if they are going to leave to find a new tenant. And I guess one of the things that you can do here as well, it’s a sweet and a deal if you do know a tenant lease or you will know when a tenant lease is coming to expiry, you want to start spending a little bit of money on that property probably 12 months out.

To make sure that they see you as a loving, respectful landlord that wants to spend money on the property because obviously sometimes landlords get a bit of a bad rap when they’re cutting corners with costs and things. So if you can make it seem and you should be taking care of your property, you can take care of your property really well and show that tenant that you care about them and the property.

They’re more likely to sign on and stay. Yeah, I’ve got a little bit of a rule. Never try to annoy your tenant because it’ll come back and bite you. They’ll find something to complain about or try to break the lease early, for instance. Yeah, that’s it. I mean, their success is your success. So you just want to make sure that you’re doing everything you can to make them as successful as possible.

Yeah, especially in certain spaces like retail, that is absolutely critical. Whereas something like industrial, that’s a little bit more kind of set and forget because it’s some concrete tilter panels and a roller door. But something like retail where there’s foot traffic, presentation of the property, value add opportunities with signage and things like that.

You really want to work with your tenant well. Yeah, that’s it. So mate, what actually happens when a tenant wishes to end the lease early or, you know, does a runner? That happens sometimes. Like businesses don’t survive and they do want to leave, but that’s also why we have bonds and guarantees on leases.

So they just can’t leave you high and dry, which is good. However, if they’ve got a genuine reason or they are going to leave, you can actually get them to pay the fees, like your property management fees to basically market the property, give any incentives on the next tenant. And this is quite strong as well, because you’re still receiving the rent, but then you get to be really finicky about who the new tenant is.

So it’s not always the worst thing. People get the phone call that the tenant wants to leave. A lot of times it’s actually a positive because you’re going to get a fresh lease from a new tenant. And you can also have a bit of time to actually choose who you want and who you don’t want to kind of have into the promised premises.

The thing I find and you kind of mentioned about like doing a runner, I normally find with tenants if they are trying to break a lease, they’ll then start complaining about things. So that’s, they’ll try to look for a reason how you haven’t upheld your half of the lease. And like, the most common one you get is like, especially in like office buildings, for instance, they complain things like the temperature.

They go, Oh, we can’t work here. It’s 28 degrees during the day or the property’s not clean or the next door neighbors are noisy or there’s, Oh, look, there’s mold here. We don’t feel safe. For instance, so they’ll always actually try to find things. I’ve actually personally, I had one of them, I own a cafe up in Brisbane as a landlord and the tenant basically wanted to break the lease early and then was just looking for any excuse to get out of the building.

So what actually happened, they actually had a break in about 12 months ago and then that was what they used to try to get out of it. They said, Oh, we don’t feel safe as a business. Someone can come in any time. We’re mentally kind of scarred from this event, et cetera, et cetera. So they actually started using that.

So it’s not always rosy, like we mentioned with commercial, there are those kinds of back and forth, but this is where clear and well worded leases are really, really important. They stop the stress of all these disagreements because you can follow it down to the letter of law and it is a contract between you.

If they do do a runner, like I mentioned, that’s why we have guarantees and bonds. So you’ve got normally like a certain type of guarantee on the lease, which we’ll talk about later. And a bond is just like a residential bond where there’s a normally one to three month kind of payment. So if they do leave you then as a minimum got one to three months worth of rent coming in before you have to find a new tenant.

And so what was the outcome there with that cafe? So they’re still there, but it’s not a nice relationship, as we mentioned before, Andrew. Fair enough. All right. Well, uh, so what’s the process when you have to evict a tenant? You might be going through that soon. Yeah. So basically if they’re not kind of following the letter or the law of the contract, you’ve also got the right, much like they do to then say they’re not holding up in the bargain.

Get solicitors involved though, because it is a contract. And just go from there. One of the points to note is that a lot of people like it’s normally when you’re evicting the tenants, so they stop paying rent. And I want to make a good point of this is be weary when you’re giving rental concessions though, because I find a lot of the time tenants don’t just say like pay rent constantly and then just one day turn off the light switch and say, no, we’re not paying rent anymore.

They normally ask for some rental concessions and things like that. 9 times out of 10 when I find kind of landlords give rental concessions, the tenant still leaves anyway. You’re just pushing the problem downhill. Be aware you bought this commercial property as a business and to help your financial wealth.

You didn’t do it as a charity and I’m not saying be heartless, like you can be compassionate but it is your financial future as well. So you need to treat it like a business as well. So I actually had on one of my other properties, I gave a rental concession a few years ago and then I think they had about 6 months left on it and they said, Oh, thank you.

Maybe I will renew to swing in a little rental concession. gave him the rental concession and basically wrote out, cool, you can pay this rent till the end of the lease. And then at the end of the lease, I went, cool, thanks for that. And I left anyway. So they’ll just trying to milk me for as much money as I can.

So there’s all those little tips and tricks you need to kind of read, but don’t be ruthless. You can be compassionate, but just be aware it is your financial future. So treat it that way. I guess you’ve got to remember that you have to be careful to how you’re conditioning the tenant as well. Like you’ve every single like second month, they’re saying, can I have a concession?

And they, you say, yes. They’re going to keep on doing it. It’s a difficult thing to say no all the time when someone’s clearly struggling. And this probably would have happened a lot through COVID as well. It’s a type of road that you have to be very, very careful walking because you don’t want to be seen as a money hungry who doesn’t give a rats.

But you also want to make sure that that business can keep operating there because it costs actually more money to replace a tenant than it does. And just keeping the tenant happy and keeping them in place. Yeah. Some businesses have like. Quiet periods as well. So like if you’re buying in say like a holiday destination, winter is normally a tough time and they know the good times coming in summer.

So it’s actually one of the reasons why I like a property manager is that it puts a bit of a wedge between you and your tenant. So they can’t play on the heartstrings as easily. Like they have to go to the property manager. And I’m more than happy for the property manager to play you off as evil landlord and they play the nice guy.

So they use, they can still maintain that relationship and you can have a little bit of better negotiating power there. Yeah, then the worst thing you can do is when a tenant comes to you and they know you’re the owner and they ask you for something on the spot and they want an answer straight away, it’s a lot easier when you can defer that to like your partner or like I’ve heard of people also if they’ll be managing their own property.

They don’t tell them that they’re the owner. They tell them that they’re the managing agent or the manager of the property. So, they just don’t have that heat on them and they can actually take their time to make decisions and not be put on the spot. So, the funny thing is the two stories I just told, both of them were contacting me directly.

It was though early on properties in my commercial portfolio. So, I did the nice thing of introducing myself as the owner, anything you need, let me know kind of thing. Here’s my mobile number. Both those properties are the ones that went bad. All the ones with the property managers are just tracking along smoothly.

Fair enough. All right, mate, so can you explain how a tenant can assign a lease? This is normally in regards to say, if the tenant is selling their business. So even if they sell their business, their commitment to you still is upheld. So they still have to pay. So if the new business stops paying the rent.

They’re responsible so they will keep paying for you and that’s basically to stop businesses who know they’re gonna kind of dissolve or basically liquidate their assets selling on the business and then wiping their hands clean of the commitment that they’ve got you on a long lease. So that’s the power of them assigning the lease to someone else is they’re still responsible for it which is great and you’ve still got the commitment you’ve got a new tenant paying rent.

But you’ve also got someone guaranteeing the new business as well. So it’s kind of like a, a guarantor on a residential property loan, but for a business at least. And you have an option of accepting that new assignee of that lease, right? Yep, correct. So it’s, it’s like, it’s a contract. You can reject the thing.

Most of the time you will accept it because there’s probably a reason why, but you can always inquire. You can find out what their reason for sale was and you can ask anything you want. They don’t have to tell you, but you can even ask like what they sold the business for, who the new tenant is and all that type.

thing, but most of the time, there’s a valid reason for it. Yeah. All right, mate. So in commercial property, there’s security bonds and guarantees and all that kind of stuff. Can you explain how they work on a commercial lease? Okay. So similar residential, you’ll have like a bond. So it’ll be like two to four weeks rent.

And that’s just the thing to cover like maintenance and things like that. With commercial, it’s more just security of them actually paying the rent as well to ensure they actually keep getting the rent from you. So, a security bond or guarantee is just a form of effectively security that they’re going to uphold the lease.

We can go through some types if you want, Andrew. There’s quite a few. Yeah, let us know what are the different types of guarantees. Okay. So, first one, you’ve got bank guarantee, personal guarantee. Parent company guarantee and cash deposits. So, the first one I mentioned, bank guarantee, that’s basically a formal insurance by the tenant’s bank that amount of money will be paid to the landlord.

So, the periods for these can be anything as well, Andrew. Like I said, everything’s negotiable. Typically, like a bank guarantee will be like one to six months. However, you can also get it for the whole lease. So that’s quite common as well. The good thing about bank guarantees, it’s provided effectively by a third party and the bank is required to honor the drawdown request if you actually need.

They don’t have to go check it by the tenant. And then the other good thing is they actually, they survive the tenant’s insolvency. So like if the tenant does disappear and they basically go bankrupt, the bank guarantee is there to keep paying out the lease for you. So it’s a really strong way of security.

The next one I mentioned was personal guarantees. So Similar to the bank guarantee, it’s a guarantee on the lease. However, the normally the owner of the business or someone involved in the business will put up their guarantee like basically personally. So a lot of the times they’ll put up a property in terms of like their house or their mortgage.

They’re a little bit riskier because if they actually do go insolvent or bankrupt, it’s a lot harder. To kind of get it. So if you are accepting a personal guarantee, just check what kind of assets and net worth they have, because that’s actually going to be the strength of the personal guarantee. If the difference with the kind of bank guarantee and the personal one is if it does go bad, you can’t just kind of go to the bank and get your guarantee.

The personal one, you normally have to start legal proceedings. So you have to take them to court and try to get the money that way. If they refuse to pay you because they’re in control of it. Another one is parent company guarantee. This is normally if you’re, say, buying into a franchise. So if you buy in some form of retail franchise, where like an owner will own that they’ll be a franchisee, the parent company guarantee will be the top level franchise.

So they’ll actually guarantee it. They’re quite strong, obviously, because they’ve obviously got a lot of money and they’re going to be more, more inclined to pay you out because they don’t want the bad press for instance. But be cautious though, if the parent company is like a foreign entity, trying to enforce it if they don’t pay is very expensive and To be honest, near impossible because it’s like you’re going to be going back and forth overseas.

So, look at getting a company or corporate guarantee or the bank guarantee first. And then the other one which I mentioned at the start is this, the cash deposit. So, that’s similar to a residential where they basically just give you a lump sum of cash. Normally, one month to kind of six months. Most of the time, it’ll be three months for a commercial.

And they’ll either put that in, say, the property manager’s trust account. Although you can keep it in your personal account. I find a lot of investors actually prefer it in their personal account because then they can kind of earn interest on it. One thing I’d want to note though, and I actually find this as part of due diligence and we’ll talk about in the next couple episodes is make sure you transfer these at settlement.

So like I find they always forgotten. Like you’ll worry about the parent guarantees and the bank guarantees. The cash deposit’s always something that gets forgotten. So just ensure that that settlement date that is transferred into the RO quiet account. And I guess people need to remember as well, or they need to know that you don’t need all these guarantees.

You’re gonna have one of them, one of them’s fine. We definitely don’t need all of them. All of them would be great. What about the director’s guarantee? Matt? I didn’t hear you talk about that one. So, uh, the director’s guarantee is basically the same as the personal guarantee, how it’s the director of the company, so.

Similar to personal guarantee, unless they’ve got kind of net worth, it’s basically useless. So just check who the director is and what their kind of past experience is. Yeah, actually a couple of times I’ve seen that there’s a director’s guarantee in a lease and I’ll actually go and like on Pricefinder or one of the portals where you can actually search their name.

To see what they hold, they don’t hold anything that director’s guarantee is essentially worthless. So if they own a property, it makes it a lot better of a secure guarantee, but definitely, preferably you’d prefer a bank guarantee or a cash deposit guarantee. Cause it’s at the end of the day, you don’t really want to be going after someone, try and recover any cash to you.

Yeah, exactly. Most of the time you’ll, the cash deposits, the normal one. So like the bond is the typical one. And then you will on a smaller asset, you will have a personal guarantee, but then on the larger ones, you’ll kind of get the bank guarantees and the parent company guarantees. But again, this is a power of commercial.

You can have guarantees that it basically they’re going to pay the whole rent. So if I signed a five or 10 year lease and they’ve got a few properties that they own themselves, and for whatever reason, they stopped paying it. Theoretically, you can go after those properties and get, make sure you get your money back.

Let’s see. All right. So, mate, how does commercial fit out come into play in a commercial lease? So, this is the one you really need to pay attention to as well because obviously, fit outs in some properties are really, really expensive and then there’s sometimes a combination between who actually owns them.

Sometimes the tenant owns them, sometimes the owner owns them as well. So, as they’re expensive, you need to stipulate in the lease exactly who owns what. And then also what condition the property is going to be left in at the end. So that’s, you might hear some people talk about a make good clause and that’s going to be got to do with the condition of the property because sometimes you’ll actually want to leave it as is.

Like if you’ve got a retail shop and they’ve got nice furnishings or it’s like a cafe and it’s got a kitchen, you don’t necessarily want them to rip that out and just paint it and make it an empty shell again. In that situation, if the tenant did own that, there might be a discussion about buying that off them, for instance.

But a good point to make is the quality of fit out is actually quite important because that’s going to be how attractive the property is and how long they’re actually going to stay there. Yeah, that’s it. I mean, these fit outs can create huge value in the property as well for the incoming tenant. So you’re exactly right.

It can get quite complicated as to what percentage or what fittings they actually own. We definitely do need to read through it. And what can happen as well occasionally is when. A person buys a business and they’re inheriting a premises, they might think that they own some of the fit out, but then when you actually buy that property, it might stipulate something different where you think you bought some of the fit out.

And that does happen quite often where there’s this discussion where, no, actually I own it. They think that they own it. So it, definitely you need to check it out and make sure you know what. What you own and what they own, especially for this, something like a renovation goes on. So if you have like a commercial kitchen and then you own the property for 10 years time, and then the tenant says, Oh, look, we want to renovate the kitchen and put new work benches and things like that.

That’s obviously an area of contention as well, because you might own the kitchen, but then they renovate it. You don’t want them at the end of the tenancy period to then rip off the kitchen worktops going on. We actually put those in, so we own them. So make sure you stipulate it, get a lawyer, conveyance, a solicitor to actually go through and actually make sure that everything’s kind of clearly laid out, the responsibilities and ownership.

Yeah, that’s it. So mate, can you explain the methods we use to increase rents and also touch on how this increases the value of the property? Okay, yeah, good question. So Normally, you’ll see in leases, um, a few methods. So one will be the consumer price index, so CPI increases, which is effectively inflation.

Or you’ll see kind of one to 5 percent rental increases year on year. And then that’ll change depending on kind of the previous terms of the leases and like who the tenant is and what the market’s doing. It’s best if you’ve got rents that go up evenly over time rather than like a big chunk. And as we mentioned, like you can get capital growth from increasing rent.

So if you buy something where it’s below market rent and then you increase the rent or you have high rental increases, so it goes up, you can increase the value, but you do need to be mindful. A lot of tenants don’t like just getting a huge rental increase. So I’d spread it out over a long time. It’s really critical.

When you’ve got like say 10 to 20 year leases, if you get the rental increases wrong and say the market, so say you’ve got say fixed 3 percent rental increases and the market’s growing at 5 to 10 percent rent, you’re going to lose quite a lot of money. Most of the time though, on my, like the everyday armchair investor, I see them, they, people go, Oh, I’m not buying this property unless it’s got a 5 percent rental increase on it.

It doesn’t matter. Like if you’ve got a three year lease, the difference between getting 3 percent and 5 percent is not much money. So focus on the fundamentals of that property and then. The market’s always going to dictate it anyway. Like if you get to the end of three year lease, you can do a market review and then you’re going to put it to market rent.

If for instance, say whatever reason your rental increases is far outweighing the market increases, I can almost guarantee you, you start going to get a disgruntled tenant. And they’re probably going to ask for you to reduce the rent, even though it’s part of the contractual lease. And most of the time you probably will, you probably will reduce it because like we’ve mentioned before, having an annoyed tenant isn’t actually the best option.

You actually just want to be fair with them and make them want to stay there long term. And you got to remember as well, yeah, exactly what you said there, mate, it’s correct. You know, you don’t want to be. Having huge increases that is actually outstripping all of the other rental properties in the area because yeah, you just kind of want to keep them on par or just below the other premises that they could potentially rent.

Hopefully, it’s a really tight, you know, low vacancy in that area. So, you don’t really have to worry about them moving out, but you still don’t want to be, you know, having a 5 percent increase year and year and year. And then eventually that property is way overpriced. And this is something you also have to take into account when you’re buying a property as well.

You need to make sure that it’s rented at the correct price because you don’t want to be buying it saying this is the actual rental figure and then that tenant moves out and then realize when you go for a market review that it’s been over rented for by a couple of thousand dollars and it really does change the value of that property and you’ve overpaid.

It’s quite a lot as well like a 10 percent above market rent doesn’t sound like that much in the grand scheme of things but on a million dollar property if that tenant leaves and you have to drop the rent 10 percent that property is now only worth 900, 000 so you actually lose quite a bit. a lot of value.

So pay particular attention around it. Obviously, try to buy something that’s below market rent, never over market rent. And for whatever reason, if you are buying something that’s over market rent, make sure you do your calculations when you’re buying it on fair market rent, because that’s probably what you’re going to get long term.

Yeah. And you could also use that as a negotiation tactic as well. So the prior I see you’re putting in for your offer. So you can tell the agent, look, this is the fair market rent. This is the other rents in the market. This is actually property is over rented. That’s why I put in this figure because the property is not, shouldn’t be rented at that level.

Yeah. You can also use it as a negotiation tool with the tenant as well, surprisingly. So if they’re paying above market rent, you can actually approach them and say, Hey, look, I want to reduce your rent, but As part of this reduction, can you sign a longer lease so you can actually bring them back to market rent but increase say a three year lease into a five year lease which will also look good in the bank size as well because of a nice strong like fair market rental period will always pay dividends in the long run.

I hope you’re enjoying the show. We’ll be right back after this short. Break. Stay up to date with all the hints, tips and tricks in commercial property by following police property on Facebook. Go to police property, hit that follow button and never miss a beat with police property. So mate, how do we find what the CPI is per quarter?

Alright, so basically just, just go to the Australian Bureau statistics. They publish it every quarter and you can have a look at their, the property manager will be on top of this anyway. So you don’t have to really worry about go to the ABS website if you’re interested and track it from there. We’re obviously saying good inflation at the moment.

So that’s actually pushing up quite a lot and actually making it why it’s attractive to have actually CPI increases as opposed to a fixed increase at the moment. Inversely though, in the opposite market, if you’ve got low inflation. A fixed increase is obviously going to give you more. Yeah I mean there’s all different kinds of ways you can do it.

We can have CPI plus one or a fixed increase and it really depends on how it was set up at the start. But there’s quite a few different methods of how you can actually increase the rents. And just speaking about the fixed increase, Steve can you explain that to us as well? Yep so that’s just where every single year it’ll increase or every quarter I should say like two percent, three percent, five percent.

So You can also have a mix like you mentioned as well. So you can have part mix. So you can have like 50 percent CPI and then 50%, 3%. And then other times as well, you’ll get the mix of these and sometimes it’ll come down to say the tenant having to fit out. So like they might go out and spend 200, 000. On the property, you’ll give them cheaper rent just to help with their cash flow for the first year or whatever it may be.

And then after that, you actually have larger percentage fixed increases to bring it back to fair market rent. So you might have say 10 percent for a few years just to get it kind of back up to market rent. So all of this is negotiable. Same as like you’ll do a market review at the end of each lease term and you can go from there.

Another term you might actually hear is ratchet clause as well. And that’s where. They basically can’t go backwards in the rent. It’s like a, like a ratchet effectively where what they’re paying is locked in and it can only go up. However, during COVID obviously like there’s been some kind of allowances for rent free periods and things like that.

And even with the banks, they’ve given rent free periods as well. Another one actually we mentioned is turnover rent. So you’ll sometimes see this if you’re buying say a property in a shopping center. All the shopping center itself. And the reason why you have turnover rent is that’s got to do with the amount of profit and revenue that that business makes.

And this, it might sound a bit silly of like, Oh, why do I want a business that doesn’t make much money? But in a retail shopping center, for instance, you need a good mix of tenants. Like you can’t have just all tenants making lots of money. Cause you’ll never get any foot traffic. So that’s where like. The bakery might not make as much as say, the cafe or the jeweler or whatever it may be.

But by having a turnover, you can make a fair method where everyone pays a certain amount of rent based on the revenue. And the aim of that as a landlord is actually to increase foot traffic and traffic to the area by having a nice mix of tenants. So just to explain that one more time, it’s they’ll look at the turnover of your business.

And they’ll apply a percentage of that turnover as this should be the fair market rent based on your turnover and profit of your actual business. This is pretty common with your big chain supermarkets, I believe. Yeah, exactly right. But part of the tenant, they’ll actually have to give you like an audited financial statement to show their monthly, what their turnover is.

So it is actually fair and legit. Yeah. And I actually, the ratchet clause, you do see that occasionally in old leases, but I believe the ratchet clause is now illegal. Yeah. Spot on Andrew. You’re actually right. They actually did remove it. All right, mate. So which rental increase method do you actually prefer?

All right. So So funnily enough, when I look at a property, I look at the fundamentals of the property and not just what the rental increases are. In different markets, you’re going to prefer different types of rental increases. So in the market we’re seeing now where we’re getting really large CPI and inflation, that’s obviously a strong point because it’s going to keep you in line with the market.

Whereas on the flip side, obviously, if we’re in a quieter period in terms of the economy, having like a fixed three to 5%, I won’t not buy a property. Again, if it’s a short term lease based on the rental increases, but I’ll prefer anyone that keeps it fairly in line with market rent. All right, mate. So I think that pretty much does it for the, uh, you know, the contents and everything you’re going to have in a lease.

So let’s move on to lending. So why is lending on any kind of property so important? So finance is such an important piece of the commercial puzzle. Like this is where your whole portfolio is based on. Same thing for residential. Like everyone always gets stuck with the lending part of it. So buying property doesn’t happen unless you’re a high net worth investor, does not happen unless you have kind of good lending and good borrowing capacity there.

So lending extremely important because it’s actually what’s going to progress you through your portfolio. So like lending, it’s just one of those things that if your serviceability gets reduced, it just makes it so much harder to buy property. And it’s just. You might have the deposit, but you don’t actually have the serviceability.

Like it does happen. Like when you go down to one salary, depending on where you are in your life, when you’re having kids and stuff, you’ve got to make sure that you are maintaining your serviceability and you’re a good person to lend to. I mean, there are a lot of different ways that you can make yourself favorable to actually lend to by what you’re actually spending, what you’re actually spending on in the bank statements.

Now they categorize what you’re actually spending your money on. And the banks do look at that when they’re looking at finance. So what are the three different ways a valuer could use to value commercial property for lending? So the valuations this point out is they actually cost money as opposed to residential valuations.

So with the residential one, most banks will effectively just do like a desktop valuation where they’ll look at some comparable sales and things like that where commercial you actually have to pay for it to look at it. However, if you’re looking at it yourself, there’s normally three ways you’ll kind of look at it.

One’s the income method, the next is comparable sales and then the other one is replacement cost. So the income method is what we were kind of talking about earlier in this podcast of how you value a property based on the strength and the net rent of the lease. So that’s basically the cap rate and net yield way of valuing the property.

So you look at it, compare with other properties, what they’re renting for per square meter, what’s yours renting for, and then work out a value based on that. Then you’ve got the comparable sales method, which is like residential where you try to look for like properties and you don’t actually look at the rent coming in.

You’re actually looking at like the bare bones structure of the property. That one you can normally look at a little bit longer periods of time as well, because you can look at something sold for two years ago and look at like, The bare bones of this property sold for this. I should be getting this, whereas the income method that can change drastically, like if the rents jump up 10%, you can basically increase the value quickly.

So replacement cost method, I use it as a backup verification, normally on newer properties. So you determine the land value, then work out what the cost to replace the building is and then just take off a small buffer and then that’ll give you a kind of good formula. So. That’s basically going to be like the land value plus the build cost minus what depreciation you think you’re going to get on the property and that’ll give you the estimated kind of valuation.

And then another one I always get asked about is what happens if the property is vacant? How do you value a vacant property? So that you just actually going to have to look at what rent you’d expect to receive in that market and then try to work it back from there. I’d always put a bit of a buffer for a vacant property because you do need to allow for the time it’s actually going to take to get a tenant as well, which is a cost, especially if you’re maintaining a loan during that period.

Yeah. And what you can actually do there as well, you can negotiate the leasing up cost to be taken off the actual value of the property. If you’re in a hot market, you might not be able to do that, but if it’s not a really hot time to buy a property, you can definitely use that as a negotiating tool.

It’ll depend what and where you’re buying as well. So like some areas of Australia. Vacant properties are actually in more demand than tenanted one because there’s plenty of businesses that actually want to buy the space and move into it themselves. But most kind of blue chip areas, the vacant properties will sell for generally 10 to 20 percent less than the tenanted ones.

One of the reasons for that is basically you have to pay GST on the purchase price. So there’s 10 percent there that you have to pay. So there’s a bit more cost there. The other one is actually less willing to lend to it. So you actually need bigger deposits. You’re not going to get say like an 80 percent loan on a vacant property like you can with a tenanted one.

So there’s a lot more money in the deal to actually be able to get it over the line. Yeah. So what about GST? Do we want to talk about GST there? I get asked this all the time of do I pay GST? So if you buy a tenanted property, The answer is no. You don’t pay GST. It’s purchase is what’s called a going concern.

You do need to be registered for GST, so have a chat with your accountant there. But as I just mentioned, we say like a vacant property. Once you pay the GST, if you are buying it as an investment property, once you do get it tenanted or you can actually claim back the GST back on your first BAS statement as well.

So it’s only normally owner occupied purchases that you actually have to pay and fill for GST. Most of the investment ones, you don’t pay. You’ll either get it back or you don’t pay it on the purchase price. I do know that we haven’t explained this yet. When you’re buying a commercial property, why do you need a BAS statement?

So it depends on what structure you’re buying under. But like, if you’re purchasing under a company or trust, the BAS statement is just an accounting method to track kind of tax and things like that. Whereas, Because the tenant is paying you GST, so when they pay their rent, they’ll pay their GST. So you need to be able to process this GST and that’s the financial way that your bookkeeper or accountant will actually look after it in terms of the ATO.

So mate, can you explain the difference between good debt and bad debt? You sort of alluded to it before about looking good in the bank size, Andrew. So you want to minimize bad debt. Bad debts, things like car loans, credit cards, even a home loan for an unoccupied property is considered a liability in the bank size because it’s money that you have to pay every single month out of your own pocket.

So try to reduce those types of bad debts as much as you can so you have a better borrowing capacity. And then good debt is obviously things that you think is going to grow in value. So property investments. Assets like collectibles and gold and shares and things like that, that can be good debt. So much like residential, any form of investing, you want to obviously increase as much good debt as you can and then reduce the bad debt.

These terms were coined by Robert Kiyosaki back in the day when he wrote Rich Dad Poor Dad. And it was very, very controversial back then about how he called your home or your house that you live in a liability. I mean, his way of thinking was it was an asset is actually something that puts money into your pocket and a liability is something that takes money out of your pocket.

So it was very easy for back then when he was talking about it, the book is written as him as a child. It was very, very easy to understand, okay, does it pay me money? Does it cost me money? That’s a liability and that’s an asset. It’s very interesting, great book. I love that book, by the way. So, but, um, you can still obviously like if you own your home, they can still increase your financial wealth.

It’s just at that moment in time, because it is costing you money. It’s a liability because it’s something where if you lose your job or you want to quit your job and travel, for instance, it’s something that you then need to look after somehow. It’s money that you need to budget for. Yep, definitely. So mate, as a buyer’s agent, what advice do you give your clients around securing finance?

All right. So I normally say speak to a professional, but there are a few ways you can do it without just going to a broker. So a lot of the times people just go to their, their existing lender. So that’s a lot of the old school mentality of you walk into your local branch and speak with the lender that you’ve done your banking with for 20 years.

Another method you can kind of do is actually investigate the mortgage market your own. However, I always recommend speaking with a commercial broker. They investigate the whole market for you and they typically don’t cost anything as well. Why would you want to go into a bank and talk to the broker and actually fill the paperwork yourself?

You just want to get a broker to do it. It’s so much easier. Access to so many more different products and banks, like it’s just such a headache. Sometimes because they’ve been banking with a long time, they have all their documents. They don’t have to resupply the documents. So they don’t have to give up the period between when they last supplied their documents to now.

Whereas with a broker, you will have to start from scratch and give them all of it. But like, if you’re going to get a percent or two or 3 percent better in terms of interest rate, and it’s going to give you 20, a year in savings, it’s silly not to speak with a professional. So I even get people that like, Some investors, especially the really keen ones want to do everything themselves.

They want to know everything inside and out. And they’ll even investigate their own banks. They go, Oh, I found this bank that does this. And they go, Oh, my broker didn’t even find this. And I go, well, one, you’re probably doing something wrong or two, your broker isn’t a good broker. You’ve got a bad one. So a good broker will look at like 80 different lenders.

So you’re more than welcome to look yourself, but if you’re not paying the broker anyway, why would you do it yourself? If you go into a bank and you You speak to the lending person there, you’re just someone off the street, doesn’t have any credibility or no, like you’re just speaking to the first person you see.

Where a broker has contacts, they’ve been in the industry for a long time, they can usually get a lot better loan products than you can over the counter. Sometimes it’s actually not to do with just interest rate as well. Like a lot of people that do investigate on their own or go to the bank, they just try to negotiate the rate but Some loan products are actually better at a higher interest rate like ones that have a a regional facility or he knows is they’re going to give better valuations or in your personal circumstances, they’re going to be able to lend you more.

I’d much rather have a bigger borrowing capacity and a slightly higher interest rate than a lower borrowing capacity and a slightly lower interest rate. Yep, definitely. So Matt, why is it important to use a commercial broker and not just a broker who occasionally does a few commercial loans? Yep. So commercial lending is a completely different space.

There’s different types of loans and it’s a lot more complicated with the leases and types of properties in that. Like most of the time the residential brokers and most people have a residential broker if they’ve got a residential portfolio will say they can do it. But to be honest, most of the time they just go to one of the big lenders and try to get a deal done there.

But by having a commercial broker who understands the nuances of the commercial property, they’re going to give you a much better outcome. They’re also going to have lenders on their panel that the residential brokers are not. Like there’s, there’s some commercial only lenders out there as well. So you want to explore those as well, especially the second and the third tier ones.

So the difference between a good broker and a bad broker, a bad broker can still might get you a loan, but a good broker will get you the better loan. So mate, what are some of the questions that you can ask your broker to basically interview them to see if they’re a good broker or not? I’ll give you a list of questions.

So what are their qualifications? Firstly, how long have they been a broker? This is an important one. How many commercial loans have they actually done? So that’ll give you a gauge on the experience and this is where most residential brokers will kind of fall over that because they say they can do it.

And then you ask this question, they say, Oh, I’ve done 10, whereas a commercial broker should have done hundreds. So. Find out they’ve got experience there. Ask them what lenders they’ve got access to and what panels they’ve got access to. And then try to work out why they choose certain lenders over other ones.

So ask them, why would they choose a certain lender for me over another one? And then if you want, you can actually get some recent client referrals. Try to ask for referrals where the client is in the similar situation to where you want to be. So don’t, because otherwise it is going to send you a mom and dad client who’s bought one and they think they’re great.

Find someone who’s in the position where you want to be in 10 years time. And then ask to speak with them so they can see how they help them out to get to where they wanted to be. Yeah, that’s a good tip there. So mate, what are the different types of lenders? Alright, so main types are you got major banks, mutuals, and private funders.

So major banks, they’re the ones we all know about. The big banks that most people go. They’re owned by shareholders and they’re listed on the stock exchange. That’s the one that most people use in the residential realm. Another one is mutuals. So they’re like building societies and credit unions and things like that.

They work the same as a bank. However, the shareholders are the actual clients of the bank. So you mutually benefit from their service because they’re making money for you on both regards. That can be things like teachers unions, military banks, police banks, and things like that, which you might’ve heard from before.

They’re still authorized by APRA, which is the Australian Prudential Regulation Authority. So they’re under the same scrutiny as banks. So they’re another option to look at. And then in the commercial realm, you’ll sometimes hear about private funders as well. So they’re normally just a glommer of wealthy people who pull their money together and then basically lend it out to people for buying properties and things like that.

They’ll generally charge a higher interest rate on it because they are looking at for the return on investment. However, they’ll be able to give you more money and basically have less red tape than a bank say might because they’re not governed by any kind of governing body. Very, very complicated and very interesting.

So mate, how do the loan types actually differ? There’s a few different types of loans, obviously with commercial and they are like you can get the same for residential, like a 20 to 30 year mortgage. And then you can have different options as well. So you can have like the fixed versus variable, principal interest versus interest only.

And split loans and things like that. So like a fixed and variable is obviously just the interest rate that we’re talking about. So you can fix it for a certain period of time, or you can have it variable. And the other term I just mentioned as well, split terms is where you might have say 50 percent of your loan fixed and 50 percent is a variable interest.

And then you’ve got the options of going like principal plus interest or interest only repayments. Then with those, then you’ve got different types of loans that you can get as well. So you can get like full documentation loans, no documentation, loans, lease documentation, loans, lines of credit and commercial bill facilities.

So this is the main difference. Residential, not just got the full dock that you do a residential. You’ve got some other options there as well, which we can go through some now if you want. Yeah, sure. Sounds good. So what’s a full doc loan that’s similar to the residential one and it’s called Full doc is another kind of way of saying it.

That’s where you have to provide. All your information. So that’s going to come down to your personal serviceability, your outgoings, your debts, what income you earn and things like that. So that’s the most similar to residential. And then you’ve got no doc loans, which is sort of the opposite. You don’t have to provide that much information and a lot of like self employed contractors and things like that will use them.

They’ll have a slightly higher interest rate. You’ll also have a high deposit for no doc loans. So that’s how the banks and lenders mitigate the risk of kind of giving you a loan without having as much, whereas. They might have say a 30 to 50 percent deposit requirement knowing full well, if you stop paying the loan, they can offload that money to get their money back.

So what about leased stock loans? This is the most common one I get asked about. So leased stock loans are really good if you’re running into serviceability issues with the traditional lending. So a leased stock loan is basically where they’ll give you a loan based on the strength of the lease. So, if you buy a five year leased property, you’ll get a five year loan with that lender for that property.

When they’ll, they’ll look at the strength of the tenant, what type of property is, how long the lease is, and give you a loan based on the property itself. Lease stocks can actually get you into the market where you can actually keep buying properties, which is great. So, they’re so powerful with commercial because there’s no glass ceiling in terms of your lending anymore.

You can keep buying if you keep buying quality assets. There are some risks, obviously, as well. So. If the tenant does leave at the end of the lease period, you will then have to pay a slightly higher interest rate until you get a new tenant in. Then you’ll actually have to apply for another lease loan once they sign the next kind of lease.

And that does have some costs involved because valuations do cost money with commercial property. I remember when I first… started researching about commercial property, the lending wasn’t as strict. So I mean, when you get a lease stock loan, I wouldn’t even look at you and look at the actual purchases situation.

But now, I mean, depending on the cost of the property, the value of the property and the rent coming in, if it’s a low budget property, even you’re trying to get a lease stock loan, they still look at you as the purchaser though, right? Different lenders have different criteria though. So there are some like commercial only lenders where they.

They’re going to do a high level check of you, obviously, but they’re not going to go through, like, your full assets and outgoings, like, like a traditional lender will. The actual property itself is the bulk of it. So, like, a leased stock loan will more come into play when it’s a really high value property, when, you know, say it’s a 10 million property, when it has a 600, 000 rental income.

Like, obviously, someone who’s purchasing that property, you’re not going to be usually be able to cover a 600, 000 interest payment or whatever it could be. So I think a leased stock loan is more apparent and a lot easier to get on a really high value property. But if you’re talking about like a 500, 000 warehouse, it’s a little bit more difficult.

Would that be right, Steve? Not necessarily. So like a lot of my like investors, they still get leased stock loans when they hit their glass ceiling in terms of lending because I’ve had people where they’ve got zero borrowing capacity for residential. So they might have say, I don’t know, 350, 000. sitting in a bank account, but they can’t leverage that with residential because they don’t have the serviceability.

But then they can actually go buy a commercial property on a lease stock loan for a million dollars. So it means they actually increase their portfolio by a million dollars where traditional residential investment, they can’t. Alright mate, so what about a line of credit? A line of credit is just effectively where you pull equity from like a principal place of residence or an investment property.

It’s just pulling out the equity. So it’s, it’s an ongoing agreement between you and your bank that basically gives you access. To that amount of credit when you need it, think of it kind of like a credit card. So if you pull out the money on the actual property on your principal place of residence, you have to pay interest on that money that you’ve pulled out.

So it’s just a predetermined amount that the bank’s willing to and agreed to lend to you should you need to use it to buy another property. And you need to take into account the interest repayments on the actual lending of that money, like to pay the deposit as well, don’t you? Yeah, exactly. But however, most of the time, if you’re doing it from a residential property, the interest rates are slightly lower as well.

So it actually kind of can bring into there. The other point to note is obviously if you’re using that as your deposit, you’re no longer like a 70 percent LVR You might be say 105 percent LVR cause you’ve got the whole loan secured. Plus used it for your purchasing costs. So when you’re calculating your cashflow, take that into account.

Yep, definitely. So mate, can you talk about how we can refinance a property and why you would actually want to do that? I’m actually surprised people come to me and they say, Oh no, you can’t refinance a commercial property. That’s completely false. It’s the same as residential. You go to your lender and you ask to get a valuation on the property and then if that valuation does come in higher and you’ve got the serviceability for that property or if it’s a leased off, for instance, you will then refinance that property.

So approach your broker or your lender if you think you’ve got some equity there. But with commercial, as I mentioned before, valuations do cost quite a lot of money. They’re generally in the 800 to 3, 000 price point for most kind of everyday investors. So you don’t want to be paying that every single year.

For instance, you want to make sure that cool. There’s been some really good capital growth or the tenants just on a new leasing. You know, you’re going to get a strong valuation, then go get the valuation. Nice idea to do this when you’re trying to recycle the same capital. I mean, get your money out of the deal and when you’re actually pulling the money out of the deal that you’ve put into the deal, it lowers your risk because basically you’re holding that you have an infinite return because you’ve got no more money in that deal.

It’s a really great way to piggyback off each property that you’re buying. A lot of professional investors, this is their whole strategy. That’s why I love commercial as well because you do have such good serviceability with it because the tenant is effectively paying the mortgage and more. You can keep buying whereas traditional residential methods, you always hit your glass ceiling.

Whether it be one property, two property, three property, five property, that depends on your income and outgoings. But with commercial, you can just keep buying effectively. So what are some more non traditional ways of financing a deal? One less publicized but quite common avenue for obtaining finance for a commercial property is actually vendor finance.

That’s also known as like seller finance or installment sale. It’s less common in a hot market. However, in a cooler market actually is quite common. It’s basically where the seller will help you with the deposit. So because there are such large costs to get into commercial, like sometimes you need 30 percent deposit.

Not everyone has that cash to get it, but if the property isn’t actually a strong property, cashflow anyway, because they’ve got a good tenant. So. They’ll actually lend you the money at an interest rate typically where otherwise where you’d have to save, they’ll somehow extract that money elsewhere. It’s a really clever way to kind of buy properties at a higher price than you can afford.

Yeah. Vendor finance is a really interesting way of getting a deal done. I have tried to do this quite a bit in the past and have been unsuccessful. All the stars have to align for you to be able to get a vendor finance deal over the line, but it does happen. You have to go in with a strategy as well. So you can’t just like be an artist, buy the property and hold it forever.

It is for a set period of time. So you have to figure out how you’re going to add value to that property potentially, or how you’re going to have some other source of income to be able to pay them out. And a lot of the times a vendor, they might just Be sick of dealing with all the problems of the property or they might be, they’re running their business to the property and they don’t really want to muck around with it anymore.

And they’re happy just to take an income for a five year period or a 10 year period. But when does a vendor finance a good option for a buyer? So basically if you’ve got minimal savings So unless you’ve got that kind of 35 percent deposit, you can get into a deal that you normally wouldn’t be able to get into.

If you’ve got like short or poor credit history as well, so then you might not actually be able to get a loan. If you’re going for a full documentation loan, you might not be able to get it there. Whereas them giving you the money to actually can get into it. The other one is if you’ve got like a self employed, so sometimes the lenders don’t like is self employed.

So, you know, you’ve got the money, you’ve got the guarantee on it as well. But as you kind of mentioned before, they’re hard to get done. And you normally have to sort of speak with the actual owner of the property. Trying to do it through the real estate agent is near impossible. But if you can actually talk to the owner of the property and explain your circumstances.

Sometimes they’re willing to lend to you because there are benefits for them as well. So they’ll sometimes command a higher price for the property. You might be willing to pay an extra 5 percent for the property because it means you can actually like a bigger 50 percent borrowing capacity. So just with the cashflow, you’ll pay that back anyway.

Another reason why they might do it is It means they can disperse their profits over multiple years. So they’re not paying kind of that tax on the property about having it all in one hit. So there are benefits. One of the other ones I’ve noticed is sometimes when this attached to the property, like it’s an older owner, they’ve had it for 20 years.

They like the tenant. It’s a good tenant and they don’t just quite want to give it up. They just want to give part of it up and have a kind of a phase out period. What you can also do as well as you can set up an agreement or a clause in the vendor finance contract, if you default on this loan, then they get to take the property back.

So it’s a low risk way for them because they already know the property and they’re just going to take it back off you if you default on that loan. Some of the actual good places for vendor finance. States that don’t incur stamp duty. So like Adelaide and Canberra, especially if you don’t have a large deposit, it can make it a lot easier to be able to get these done.

And I know in Queensland, in more regional parts of Queensland, this was very common many, many, many years ago. Not so common now, but it does happen. So, mate, what are some of the cons of vendor finance? Yeah, well, you just touched on one there, Andrew, about like, don’t actually own the property a lot of the time until you’ve actually paid out that vendor finance.

So. You’re at the risk of the actual seller because if they say they go bankrupt and that property is collateral for something else, you could actually lose the property and lose your deposit for instance there. So be very mindful of kind of that legality. The other one is actually if it depreciates in value.

So say you buy this property and there’s a market slump and the property price drops 20 percent and then you can’t get finance for that property. Due to that drop, you’re effectively going to lose out on that property. The banks are going to sell it and you’re actually going to have a huge liability over your head for the difference in price.

The laws regulating this, by the way, are extremely cloudy. So most of the time you’re at the mercy of the seller. And for instance, like a seller can be a lot more painful than dealing with the bank in some instances, because if you don’t make their payment, say just once, They could then theoretically sue you or keep the deposit.

So there are some risks involved, but it’s worth looking into if you’re in that realm or you think you’re in a market where you might be able to talk to an owner and get a deal done. It can almost be like an option agreement on a property as well, where you don’t actually own it. Like Steve mentioned, you do want to own the property when you’re making payments on it, but it’s not always the case.

Moving on to the loan process. How does that actually work? So similar to residential, you still approach your lender or your broker and you start the wheels in motion as early as you can because commercial finance is really difficult. So it’s best to kind of get all your information up to date. It’s not the same as residential though, where they can give you approval, like a pre approval where the documents saying, yep, you can go bid at auction.

You’ve got this much amount of money. It’s because the banks and lenders don’t know with commercial. What they’re actually buying going to lend you like so you’ll get what’s called a pre approval in principle and based on some assumptions, but they don’t know if you’re buying a 3 percent net yielding office space in Sydney or a 7 percent yielding industrial space in Townsville, for instance.

I don’t know what the lease terms are, who the tenant is or anything like that. So they’ll give you a pre approval in principle before you buy any property, though, make sure that you have approved finance. So make sure the contracts are subject to a finance clause. Or if you are buying an auction, make sure you’ve actually done the whole finance process.

So you’ve got the approval, you’ve done the valuations and it all stacks up. So lending always takes a long time in commercial. It’s literally the longest and most stressful part of the process. And it’s because there’s so much documentation and banks are so slow with it at the moment. And it’s very deal specific, isn’t it?

You touched on, you know, they don’t know what they’re buying, like the deal has to stack up, otherwise, they’re not going to want to lend on it. So, what information will your lender require? So, it’s a similar residential, you’re going to need to give them some personal information about your like your financial situation.

So, that’s your assets, proof of your savings, your bank account. You touched on before as well, they even look at the types of spending that you do in your bank account as well, living expenses, outgoings, any credit cards, and history of default or arrears. Proof of your employment, how long you’ve been there, proof of your income, bank statements, group certificates, tax returns, tax assessment notice.

There’s quite a lot to supply. And then if you own other properties, you’ve got to give all the information on the other properties and their loans and their incomes and things like that. So like I mentioned before, if you are struggling for finance, cause it is always an absolute headache and it takes longer than expected If you are under contract on a property and it’s the one of the conditions of the contract is subject to finance, you can request extensions and most of the time the sellers and the agents will understand because it is a harsh lending environment and they’ll normally agree to give you an extension based on that you’ve got a valid reason.

So always protect yourself and never go unconditional on property until you’ve got unconditional finance as well. Yeah, it’s a good tip. It does make sense, doesn’t it? Because at the end of the day, it’s a lot better for them to actually just give you that extension because they’ve gone through a whole sales campaign and they don’t really want to go back to market and actually have to find a new buyer.

It’s going to cost them money and time. So it makes sense that they’re happy to give you a two to, you know, four week extension to try and get you to settle that deal because that’s the best option for everyone. So mate, in your book, you actually talk about the five C’s of credit. Can you just share those with us now?

This is just a little kind of rule of thumb that most lenders will look at when they’re actually going to give you finance on a property. And normally, this is with the full documentation loans. The five C’s of credit are character, capacity, capital, collateral, and conditions. So I’ll go through those quickly.

So character is basically the lenders want to know who you are. If you’ve got integrity, kind of what your history is and willingness to pay back the mortgage. So they, they want to be as confident of your background, education, and stability. And this sounds a bit weird, but banks will actually sometimes give better rates and higher LVRs to certain professions.

So like a lot of times it’s like white collar or government jobs, for instance, that there might be low risk. So you could be like a doctor or a nurse or a police officer. If You can actually get some better rates and better LVRs based on your actual profession. So that’s one point there. So like what loan amount you’re going for versus your age versus what your other commitments and expenses are.

Please note like lenders will only consider a portion until income that you actually get. So it’s not taking all of it. It’s called shading. They’ll take say 80 percent of the rent that’s coming in. So that’ll affect your serviceability. But the good thing about commercial, even with that shading criteria, they’re still very high cashflow positive.

So you can keep moving forward with your serviceability there. Another one’s the capital. So that’s basically just your wealth. So how much wealth does the actual buyer have in things? So it’s effectively their assets minus their liabilities. And they’ll look at all your things like your savings, your real estate, your shares, the value of your car.

And you’ll see that sometimes when you actually fill out a loan doc form, you actually have to put in the year of your car, what model it is and how much you actually think it’s worth as well, because they actually will take that into account. The other one’s collateral. So that’s got to do with represents the properties that you’re using to secure the loan and what you’re putting up against it.

So you might be cross collateralizing your principal place of residence with a new one and that might give you a better borrowing capacity. And the banks will accept this because obviously if it does turn bad, they’ve got another property that. Can actually use to get their money back. That’s going to come into account like the interest rate conditions are, for instance.

That’s where we talk about the shading as well. So with the rent, how they take 80%. Generally, the actual interest rate is they’ll apply a factor to it. Normally somewhere between 1. percent extra interest. Right on the current market, right? And another good thing about commercial is even with that shading criteria, it still remains cashflow positive.

So that’s why you can keep moving forward with the commercial property. All right, mate. So if you can actually tick off all of these five C’s, then is it the valuation? That’s actually the only thing stopping you getting to the property is what’s in that valuation report that can stop me. With commercial, they actually go into quite a lot of detail.

And it’s, it’s actually similar to the amount of due diligence you need to perform yourself. So that’s basically going to give you an outline as. There’s sometimes 50, 60 pages as well. So they’re going to give you a synopsis of the property, any assumptions that they made on the property, the investment profile.

So like where and what to get into a SWOT analysis, which is like strengths, weaknesses, opportunities. They’re going to look at the title. They’re going to look at the town planning information. They’re going to give you a description of actual self. They’re going to record any improvements that are being made to the building.

Also of the actual business and the property itself, as well as they’re going to look at any other forms of incomes and outgoings you’re getting from the property. They’ll even look at rental evidence. So they’ll check rental ledges from the tenant to make sure they’re actually paying on time. Then they’ll do the actual sales comparison, which is pretty much the only thing they do with the residential property.

And that’s looking at comparable sales. in the area, square meter rates, rental periods, the occupancy levels are versus what the vacancy periods are. And then they’re actually going to have a valuation rationale. And this is the, what method they’re actually using. Most of the time they’re going to do too, they’ll do the cap rate approach.

So the capitalization, the property, which is effectively looking at the net yielding apparent with other ones. Then they’re also going to do a direct comparison method, which is where they just try to find similar properties in buildings and then. Kind of go from there. It’s important to note though, get this valuation, as I mentioned before, prior to going to auction if you are, because you don’t want to buy something at auction and then not being able to obtain finance for it.

And so man, how does actually buying an auction change the valuation? So it’s just because theoretically you could be paying fair market rate at the auction, but. If you’ve missed something, so say you’re buying it, there could be a red flag. So you could be buying a property where it looks good in the bank size and you think normally at a fair market, you’re going to get the auction price.

But if they find something where it doesn’t quite stack up, they might still not give you finance. Do you actually ever buy anything at auction? I have. I generally don’t recommend it. Mainly the lead time on properties. Like I spend 40 to 80 hours on each property doing due diligence. Then you obviously get to get the valuation.

Then you’ve got the costs of doing searches and inspections and doing all what you can, you can be up for 5, 000, 10, 000 before you commit. So most of the time, I’m not willing to sacrifice that money to go to auction just to miss out on a deal. So I’ll always try to buy something prior to auction or after auction, if it gets called in.

Yeah, that’s a good tip. Well, that pretty much wraps up episode five, Steve, where can listeners go to contact you to get any free giveaways and also a free copy of your book? Yep. So any of the social media forms, but the first one’s probably just my website. So go to www. policeyproperty. com. There you can get a free copy of my book.

Just go to checkout and use the code word podcast. I’ve also got lots of resources on there for free. So you can download. Property plans, free spreadsheets, calculators, all that type of stuff. But feel free if you just type in my name or go on any of the social media forms, send me a message and we can have a chat.

Excellent. Well, stay tuned for episode six, where we explain how you can actually prepare yourself to buy a commercial property and what you actually need to do to sell a property as well. So this has been author Steve Polisi and Andrew Bean. on the Commercial Property Investing Explained Series. Cheers, everyone.

Thanks, guys. Thanks for listening to the Commercial Property Investing Explained Series. This show has been produced by the Commercial Property Show Network.