EPISODE 8: Due Diligence Part 2 - 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. is Steve Polisi. I’m your host Andrew Bean and I’m here with author of Commercial Property Investing Explained Simply and founder of buyers agency Polisi Property. Steve Polisi. How are you mate? I’m really well Andrew. How about you? I’m fantastic buddy.

Just getting over a bout of COVID but pretty good now. That’s good man. We actually had to delay one of these episodes because of us. I’m glad you’re feeling better now. Yeah. All right, mate. So in the last episode, we actually started the due diligence train. And the reason that we actually had to split it up into two parts, because due diligence is such a big beast.

If you can actually get someone else to do this for you, I highly recommend it. It is a painstaking kind of part of the process, but it’s vitally important that you do do it correctly. Isn’t that right, Steve? Yeah, exactly. And we’re barely scraping the surface. Like I know we’re talking for a couple of hours on it.

Like it is a long process. Like we mentioned on the last episode, it can take days to weeks to months, for instance. So it is a lot, but if you do get it right, commercial, as we’ve discussed is, it’s just a fantastic performer. You get awesome capital growth, the same as residential, if not more. And you get really high cashflow if you know what you’re doing.

Yeah, 100%. So this is episode 8DD part 2 where we’re going to be talking about the tenant analysis, lease review, and the building and pest process. 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 discount code podcast on his website.

So go to www. policeyproperty. com. Use discount code podcast to get the book free. All you have to pay for is shipping. What a great deal. So mate, just before we get started, you also have a hundred point due diligence checklist www. policeyproperty. com. That’s free on your website. Do you want to just let us know about that one?

Yeah. So just, just visit my website, www. policeyproperty. com and I’ve got a really extensive due diligence checklist that our listeners can print out and have a look at when they’re analyzing commercial properties or whilst they’re listening to this episode as well, you can kind of follow along a little bit easier.

Plenty of other free resources on there as well in terms of cash flow spreadsheets and return on investment calculators and things like that. All right. So flowing on from last episode, next on the actual list of due diligence is the tenant and the business. So why is this important, Steve, to analyze both of those components?

So like a commercial property’s tenant and business is obviously going to be critical to the investment’s profitability. So analyzing the tenant and the business that’s going to help you to determine the longevity of the business and the industry that they’re in as well as it’s going to increase the likelihood that they’re going to take up lease options as well when it’s time to renew and then obviously if it isn’t suited to that type of business as well you reduce vacancy rates in the future if they actually do leave.

Yeah, that’s right. I mean, the business, them being successful means that you’re successful, isn’t it? And you want to be finding property that has the type of business that has longevity in it. All right, mate. So when we’re actually doing due diligence on commercial property for the tenant part of the due diligence, do you talk to the tenant and what do you ask them?

Yep. So, so this is a difference, obviously, with commercial and residential. Residential, you don’t call up the tenant and ask them how they’re doing. Commercial, you definitely do. So. Highly encourage you to speak with the property’s tenant and then find out whatever you can from them. So please don’t go out and just reach out to every tenant of every property you look at straight away.

Like speak with the tenant once you’re under contract subject to due diligence because then like you’re not going to contact and annoy every single tenant if you’re looking online. Sometimes agents will actually ask you, especially in a hot market, not to contact the tenant just for information like the agent cannot tell you to do that.

So Be wary if any agent tries to like get you to sign like a non disclosure agreement, which prevents you speaking to the tenant. This could actually just be because like the owner doesn’t want the tenant to know. However, it’s normally due to unethical reasons and they’re trying to hide something. So just be mindful of that.

But I always encourage you to speak with a tenant and they actually find out like so much useful information when you do. Yeah, I mean, one of the things that I actually do, which is a similar thing is I actually secret shop self storage facilities, which is pretty much like talking to the tenant, you know, talking to the operator to get an idea of their business.

And I, I reckon if you do want to talk to the tenant, but you aren’t under contract and you just want to get an idea of their business operation. You could call them as a potential customer as well and talk to them about their services. If they’re really, really crappy on the phone and give you really bad customer service, then you might be able to say, well, these guys really don’t have a long business life ahead of them because they’re not very good at what they do.

So there’s a few different things there. You can kind of get an idea of how the tenant operates without telling them, Hey, I’m buying the property. How have your sales been in the last 12 months? Yeah, I’ll normally just do a bit of an online stalk of them first, especially if they’re like retail and things like that.

There’s enough websites and social media platforms where they’ll actually have reviews and ratings and things like that. So that can give you a best kind of like first impression of the business as well. Yeah. A hundred percent. So mate, when you’re conducting an interview with a tenant, what are some questions you should be asking?

Um, Yeah. Yep, so I’ve got compiled here a few kind of the questions I will ask as part of my due diligence report. There’s actually quite a lot here and like a lot to understand, but you’re basically just trying to understand from a business perspective and like, is it going to be there long term? So you’re effectively a business analyst, economist, et cetera, for instance.

So quite a lot of questions, but the typical questions I’ll go through is. Have you been told that the property is for sale? Is your business doing well? Have you considered buying the building yourself? That’s a quite important one because it’ll actually give you an indication of profitability and what their plans are in the future versus where their kind of attention lies with the property as well.

Who owns the business? How long have they been there? How much staff do they have? Have they been given any rental abatements such as like discounts during like slow periods of trade or COVID and things like that? How many locations do the business operate out of? And then you can ask them questions about like the future as well.

So like, where do they want their business to be or what do they think they’re going to be looking like in 10 years time? Then you can ask them more specific questions like about the lease, for instance, like, do they want to sign a longer lease? Are they happy with the terms of the lease and things like that?

I always ask things like, What times of the day do they do the most business or what areas are they servicing? Ask them about the building as well because they’re going to tell you about all the complaints in the building about leaks and things like that or if there’s any major problems. What are the things they like about the complex or don’t like about the complex?

What’s their relationship like with the Strata management? What’s their relationship like with the nearby tenants? Who are their main competitors? What are the future issues they see with the industry? What demographic of people typically visit their premise? How many customers actually go into their premise?

What’s the parking like? What are available on the properties in the area that are similar to this? How long have other tenants have been there? Or how long have other properties been vacant for? Who owns the fit out? Do they have the appropriate licenses and permits for operation? So like you can see, I know I’m rambling on a little bit, but Like this conversation can sometimes go for hours and like some businesses will give you time a day.

Other ones who only want a quick 10 minute check, but try to get as much information as you can. Cause they’re, they’re going to give you the inside gossip outside of the agent. And I imagine all of these questions are listed in your book, Steve. Is that right? Correct. So it’s all in the book. Um, it’s even on the due diligence checklist as well.

So you can go through all this and then kind of cross check it off and basically read a script if you like. It’s a pretty extensive, you know, list of questions that you definitely need to be ticking off when you’re not going to be able to just… Remember them from a podcast. So a lot of the times it’d be organic conversation as well.

Like some business owners are really chatty. Like sometimes I’ll just ask one question and then I’ll ramble on for 20, 30 minutes about all the things they like and don’t like and things like that. A lot of the time it’s negative. Most of the time tenants don’t like their owner. And it’s because they’re a tenant’s never going to come up to you, Andrew, and be like, Oh, our business is super profitable.

Please charge us more rent. Like we can afford it. They’re always going to cry poor and they’re never going to kind of give you too much information. But Yeah, if you show you’re a genuine person, they’ll, they’ll give you some good information. Have you ever had any pushback of, from the tenant actually wanting to talk to you?

Do they say, no, I don’t want to talk to you at all? Yeah, quite often, probably about one in 10 times or they just give you two minutes and that’s kind of it. They’ll say, Oh, I’m busy. I’ve got to get out of here, which is fine. Like you’ve got to remember a lot of business owners aren’t investors, especially if you’re buying things like industrial or a lot of like blue collar type stuff.

They don’t understand this game. They just want to kind of do their, do their business deal with that. So sometimes it will be short, but then you just make a call based on the property that you’re buying, if it’s, it’s critical or not. And just so the listeners know, are you just ringing up randomly or are you actually booking in a time and say, Hey, can I have a half an hour, an hour to sit down, chat with you about your business?

So I used to just do that. However, now, because I’m obviously a buyer’s agent, I’m buying quite a lot of properties, I have good relationships with the agents, so I let them know and then they’ll normally give me the point of contact and then tell the tenant that I’m going to be reaching out just as a, just as a nicety.

Yeah. So at least they like put aside time to actually talk to you to be in the right frame of mind to actually give you the information you need rather than just calling them at the busiest time of the day when they got customers piling up. Quite often Andrew, they don’t even know the property is for sale.

So you can imagine if you’re calling them up and then like that’s going to put them on spot thinking they’re going to get kicked out at the end of their lease. So reassure them that you’re an investor as well and that you want them to have a good long term kind of relationship with the property like so.

I always give the agent a heads up and then they normally give me the point of contact. They give me the details of the business owner. Awesome. Awesome. So what are the types of tenants that need a license, Steve? Yeah. So this was one of the ones I didn’t realize when I first started investing in commercials.

You actually, you actually need licenses for certain types of kind of properties and types of activities. So some common ones are like for the food and beverage industry. So if you get like a cafe or a restaurant. You’re gonna have things like dig fries, grease traps, exhaust fans like they, they come up quite regularly as well.

And you basically need to have the CERTIFIC certification for that. The local council must approve their use and it needs to be cross-checked. So like our lease will usually outline the permitted use of the premises, but you should ensure that the tenants allowed to do the activities required for their business.

Including providing all the types of goods and services that they offer as well. So, in a lease though, never guarantee the permitted use of the property. Like, make sure that the tenant’s responsible for getting the right approvals. Never put that on yourself because that’s another risk there. Another point to note, that in the lease, never guarantee the permitted use of the property.

So, make sure the tenant’s responsible for that and make sure that they’re responsible for the approvals as well. So, I guess, Steve, you’re saying that you do not want to guarantee the permitted use of that land, and I’m sure in the 100 point checklist, there’s a point saying get permissions or get approvals from council for the permitted use there, or the actual use that’s on the premises.

Yep, exactly right. And then the tenant and the agent can provide that information as well. And quite often or not, you’ll actually find they don’t have approval, which is not, it’s not a showstopper always. Like they can apply, like if it’s just a warehouse, for instance, and they’ve got like one type of good that they’re operating out of there, they can get the approval.

And a lot of tenants just don’t know as well. They rent the space and then the owner that they have doesn’t know as well. And that is kind of, they’re doing something, but cross check all their approvals for the types of businesses that they’re doing. Yep. A hundred percent. All right. So moving on from just analyzing the tenant, how do we analyze the business?

What should we do? So with commercial Andrew, you’re like, you’re effectively buying into the business as well. So like you’re buying into the business’s future and its longevity. So you need to understand that type of business that they’re operating in. So look at things like how busy the business is, what type of competition they have in the area.

And like, is the competition growing or is it getting smaller? The type of industry it is as well. So like, obviously if you’re looking at like a petrol station, you need to analyze, okay, is this going to be around in 10 years? Is, is there longevity in this type of business? And then you can look at more specific items, such as like, how long has the business been operating?

For me, ideally, I like businesses have been operating more than five years because they’re typically past that kind of three year failure point where most businesses fail. So no good long, the long established business on a long lease is always attractive. Then look at things like, like who runs the business and how much staff they have.

I’m always weary of businesses that are only like kind of operate off one or two people because That for me is high risk. Like if you’re going to a small hairdressers and there’s only one or two people and then someone gets sick or the business owner decides to leave and things like that, that business is effectively going to fail.

So just be mindful of that. Another one is like, is the business, the owner, the occupier as well. So like sometimes like franchisees and things like that, the business owner won’t actually be there, but you’ll find if the actual owner is working in the business, they’ll generally show more care because they’re like their personal wealth success depends on it.

And I’ll also look after the property in terms of maintenance as well because they’re going to be there for long term. Another one where you’re kind of looking at the types of business moving there and it’s like, look at big national tenants if they’re moving to the area because they’re, they’re a good solid indicator for growth or that region.

Like those big companies, Andrew, they spend literally like hundreds of millions of dollars each year, like researching their location because like a found location for them, if they’ve spent hundreds of millions kind of building a warehouse or a Bunnings or whatever it may be. That’s detrimental then hugely.

So a national tenant moving to the area is obviously really good. However, look at is a national tenant moving to the area kind of detrimental. Like if you’re buying a little convenience store and they’re building a Woolworths next door, probably not the best thing for your convenience store, because people are going to go to the cheaper option.

So. Just look at the type of business and what’s kind of moving in there, as well as the current businesses status, you need to look at like future possible industries in the area as well. So like, like I mentioned, petrol stations, for instance, and there’s some other ones like service based businesses, such as like electronic repair and computer shops.

Like they’ve, they’ve always shut in the past and they’re going to keep shutting because the price of electronics is too cheap. So it’s no longer economical to repair things. And another one’s like things like the coronavirus pandemic, like that’s changed the way we businesses operate and things like office space sector is going to change dramatically in the future as well.

Yeah, just analyzing a business, the longevity of that business is a really, really big part of this. I mean, things like a travel agent. I don’t even know why travel agents exist anymore. They have to be going out of business, surely. I mean, things like news agencies, definitely going out of business soon.

Just really got to think about is this, this business and the industry it’s in, is it going to be around in the next five, 10 years due to what’s happening online? That’s the real main thing that you need to be thinking about. Yeah, spot on mate. So another good thing to think about with business as well, Steve.

Is how profitable is that business, different types of businesses and industries run off different profit margins, like your, your actual takeaway restaurant, like a burger joint typically run off a very, very low margin. So things like when COVID happened, if they didn’t have a takeaway portion of the actual.

Premises and they will all sit down. They’re going to be like decimated, you know, things, different businesses have different margins. And if you can find a business that typically has high margin of their services, you’re going to be better off because they have more disposable cash to basically take on extra rent increases or anything else in future that could be thrown at you.

Yeah, and you can actually request profit and loss statements from the business as well. They won’t always give them to you, but they sometimes actually will show you how profitable they are. Similarly for like, if you’re buying like a, a retail and a holiday destination, their profitability over summer or winter, depending on kind of what holiday decision it is, is going to be completely different for the rest of the year where it kind of goes into quiet mode.

So you need to amortize that over the whole year. Yeah, a hundred percent. I mean, and part of why I like self storage facilities so much is I believe that that business is around forever. You know, we’re always going to be having more stuff through what’s going on online, Amazon. It’s just easier to buy things, easier to get credit.

We’ve got a lot of junk and we’re always going to need somewhere to put the junk. So that type of business. It’s easy to understand that business. And I think it’s Warren Buffett who says, you know, he never invested in a business. He doesn’t understand needs to be easy enough for him to understand how it runs and how it can actually make money.

So that’s why that I personally like self storage. I’ve actually started looking at and trying to understand businesses a lot better, just actually analyzing buying businesses as well. Purely on just buying the business, nothing to do with the freehold. So I’ve just been educating myself on the different types of business and the margins they have, because there are so many, like, I don’t know what the statistic is, but it’s like a really, really high percentage of great businesses never get sold.

So there’s heaps of opportunity in actually just buying a business that has really good cashflow. But that’s just what I’ve been doing in the background, just for fun. Yeah, it sort of does have to do with commercial property as well because they obviously are branching out commercial premise, so there are some flow on effects there.

All right, next item on the DD checklist is the lease. So who is responsible for reviewing this and what are they looking out for Steve? Yep. All right. So you should review the lease from as high level and as best as you can as an investor. And like this is mainly just to cross check the figures and just to see if there’s anything unusual that jumps out.

As a formal part of the due diligence into the tenant’s business, I always advise to have conveyancer review the lease from like a legal standpoint. Like this, this will give you like an indication if there’s anything like outside the norm that you’re not going to understand from a legal sense. So be aware that even if you have a copy of the lease, Andrew, like informal arrangements happen all the time between owners and tenants in commercial space.

It’s a good idea to inspect at least like 12 to 24 months worth of rental history. And you do this basically by obtaining a rental ledger from the property manager or the selling agent. And this is actually going to show you the income that they actually provide to the owner. So like when they pay the rent and what it was, if there was any late payments or rental concessions.

So a concession is basically like a rent free period or rental reduction or something like that. So These necessarily aren’t stipulated in the lease and they can be hidden. So cross checking that rental edge is quite important. Concessions are usually provided when the tenant’s struggling financially.

So like, that is like if they need COVID payments or it’s a quiet period of year or you’re trying to keep them on for a longer term. Uh, or alternatively, they might’ve carried out like renovations or something like that, which actually benefit the owner. So they might like do a new internal fit out or renovate the outside of the building.

And you’ll give them a concession there because it’s actually adding value to your property as well. Yeah, well, they might actually be getting a rental concession for starting a new tenancy there. So a lot of the time, you know, they could have a two or three month free period just to get them started in the property.

Cause a lot of, a lot of businesses can’t afford to actually do like a fit out and pay rent before they have income. So it’s just a nice way to get in. And that’s, that’s very kind of normal, especially in like the retail space where expensive fit outs normally happen. Another thing you need to do though, is actually check that the lease is registered with council, like we mentioned before.

Yep. A hundred percent. So how did the listeners do that, Steve? So, basically, you’re asked to request the documents that they actually have the lease registered. So, you can get that from the selling agent most of the time or you can actually go to the council and get it. But most of the time, it’ll be part of the due diligence pack that the agent will give you.

Awesome. And just so the listeners know, as Steve said, having a rental free period is quite normal in commercial property at the start of your lease. And the reason they give you a free period and not just a lower amount of lease, like reducing the actual rent is because the rent is directly. Tied to the value of the property.

So if they give you a couple of months free, but keep you on the same market rent, then the property is still worth the same, but if they reduce the rent, then the actual property, they’re losing value of the property. So it’s detrimental to the investor. And that’s why they actually do that. Yeah. And it’s, it’s a little bit of a double edged sword as well.

Cause like one, you’re getting a tenant who’s basically doing an expensive fit out and adding value to your property. And it’s quite a lot of money. And like on the negative year, you are giving them a rental concession. However, but once they’ve got that fit out and they’ve put a lot of money into the property, they’re a bit more of a sticky tenant as well, because they’ve got, they can’t just pack up and leave.

If I fit out like a commercial kitchen, they can’t just move next door, even if that property becomes vacant. So they’re locked into the location. However, you’re balancing that with having a new tenant, like the new tenants are higher risk than the established tenants. So it’s just about balancing that between those two.

Yep. A hundred percent. So man, what are the key areas in a lease that we need to look out for? So, so when I’m doing due diligence on a lease, I’ll generally look through like the lessee details. So like. Look at who’s actually on the lease, like whether it’s a personal name or it’s a name of a trust or a company, because then you can basically then look into their history and find out if there’s anything untoward going on with that person or the negative.

You can even do a credit check on them as well. So you can actually get your, you can balance it and do a credit check on the person. Then I’ll look at things like rent review stipulations. What securities on the lease are things like the bonds and guarantees. So like, for instance, like a personal guarantee is actually preferable because the guarantee has assets, preferably a property that can’t be easily solved.

So it gives you some level of security as well as things like the bond as well as another level of security. Really look carefully of like we mentioned before, of who owns the fit out and then what the make good clauses are. So like a make good clause is basically the condition that they need to return the property to if they leave.

And this is an area of contention always, especially in the retail space and like. Like we mentioned before, like say you’re doing a commercial kitchen that’s not normally worth the business as well just to rip it out and kind of move it to the next location. So sometimes you need to stipulate who’s going to own it and if it’s going to remain there and if you can buy them out for it as well, because your next tenant may want to use that kitchen for instance as well.

So, so just be mindful of that and then just check things like repairs and maintenance clauses. If there’s any subleases, so the business might have sold onto someone else and subleasing it to someone else. The tax information, the car parking arrangement and schedules. And then if there’s any other special conditions based on it, there’s a lot more we can go through on the due diligence checklist, but they’re the kind of high level ones I’ll look at first.

Yeah, 100%. And I really like the ones checking out the rent review stipulation. Before we were in an inflationary environment, everyone wanted a high percentage fixed increase, but now everyone’s looking for CPI because it’s definitely going to be higher. Yeah, the thing is, so it’s going to depend on the length of your lease as well.

I find a lot of investors, they get really caught up on like, Oh no, I need this rental increase. But if you’ve only got a two or three year lease, you’re going to bring it to market rent at the end of that person. And I see a lot of people walk away from deals because it doesn’t have fixed rental increases or whatever it may be.

Just look at the bare bones of the property and if it’s actually going to be a good performer long term because if the lease is coming up for a renewal in say two years time, you are talking like 1, 000 here and there should not be the basis for your financial decision. So for me, Andrew, like the lease is effectively the rule book between the owner and tenant.

With commercial leases, they can all be so different. So you do need to go through over the leases with a fine tooth comb. 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 Policy Property on Facebook.

Go to Policy Property, hit that follow button, and never miss a beat with Policy Property. Yep. So mate, what are some of the common issues that can Come up in a lease. So the common ones I normally say is the agent’s not calculating the outgoings correctly as one. Basically what I mean by that is you’ll have like your council rates and your water rates and things like that or any other kind of rates, they’ll give it a reduced number.

So they’ll say that it’s actually lower than it is. And the tenant will actually be paying that low number. But if the rates are actually higher and that the current owner has just been making up the difference and not really paying attention, you could be in trouble when you buy the property and then the tenant says, Oh no, I’m only paying 4, 000 per year, but the outgoing is actually 10, 000.

That 6, 000 is actually going to erode your thing because the lease will actually stipulate what the outgoings typically are and how much they are or what portion they pay. So for me, it’s always the outgoings of the lease that’s an area of contention, as well as like things like the rental increases and that.

But you need to verify all these outgoings and make sure that the tenant’s been paying them. through the rental ledgers and their bank statements and what the amount actually is as well. One of the things I actually find as well is when I’m actually doing a lease review is actually find that the property is a lease back.

You’ll actually find that the owner of the property is also the business owner as well. So you need to look into what the reason for the lease back is. Leasebacks, it’s always a bit of a red flag, isn’t it? Why are they a little bit more risky? Yeah, so when the owners is a tenant, they’re always going to be looking out for themselves.

So that’s why it’s risky and they’re always going to put it in their favor. But like just to tell the listeners, so like a leaseback is basically like a financial arrangement, which the owner of the property like is selling it to the investor. However, they’re leasing the property back from the seller. A lot of the time it’s just to free up capital while still allowing them to use the property.

But you need to investigate their reason for selling. Like more often than not, they simply want to sell the property with a lease in place and basically give themselves a high sale price, but have plans to move on in the future. So that’s one of the reasons why it’s really risky is they’re going to stipulate a lease that they’re going to leave at the end of it.

But there are some legitimate reasons as well, Andrew. So, like, sometimes they’re actually trying to expand the business, so they need some injection of funds to be able to expand the business. Or they’ve incurred some, like, unexpected personal costs. Another one I commonly find is actually, they’ve sold the business to someone else.

So, like, the current owner who’s got the property, they’re selling the business. Which is fine if it’s going to get a good price for it and the new person is going to take it over. However, they don’t want to hold the property. They want to get completely out of that asset class and that business. So it’s not always negative.

And I have personally bought leasebacks and I’ve bought some leasebacks for clients, but you do need to check everything carefully. The lease is always going to be in their favor. Like the, so just really double check on like the rental increases. The guarantees is another one. And then the other one is actually just check the comparable rents.

Sometimes they’ll actually put themselves on a really high rent, which sounds counterintuitive, but that’s because they’re going to try to get the best sale price. Yeah, 100%. I mean, I actually found this quite a bit in just a really, really hot market that we’ve just basically gone through, you know, the last 12, 24 months, where there are really big industrial sites and the business in it, they’d had the property for a long time, and they just wanted to take advantage of the hot market while it was hot.

And they wanted to free up capital, as you said, just to expand the business. They still had a 10, um, They wanted to put a five to 10 year lease on the property, but they just wanted to take advantage of the, they’ve held the property long enough and they just wanted to take advantage of the good market.

Yeah. So this is a lot of times when you actually are doing that tenant interview, they can tell you these types of things, but then like I said, try to cross check everything, try to get documents that kind of back it up and do as much research behind closed doors as you can. Yeah, definitely. So Steve, we’ve talked a lot about your freehold properties.

When do, you know, your strata, body corporate properties come into play? Can you explain the difference there? So, so basically like you’ve got the freestanding sites, but then body corporate ones are, they’re basically like a legal entity which is created when like the land’s subdivided and registered on the land title acts, so.

It’s basically when you’re sharing a site and like with the other owners, but you’ve got your own individual section. So similar to like an apartment or a townhouse or things like that. So the body corporate is basically in charge of like maintaining, managing and controlling the common property on behalf of the owners.

Deciding the amounts to be paid to the owners like in terms of this that can be functioning properly, enforcing the community’s rules and bylaws, organizing insurance is a big one as well. So they organize like the public liability insurance and the building insurance. They control the body corporate assets as well as keep all the records of these kind of assets as well.

So things like owners details, financial accounts, registers of assets, improvements to the company properties, renovations to the properties, for instance. So one of the things I actually noticed is Especially if you’re buying like a brand new body corporate property, check that actually a body corporate is being set up.

I’ve actually seen quite of late, like so many brand new properties don’t even have a body corporate set up. And that’s because they’re still under like builders warranties and things like that. And they just haven’t got around to it, but highly encourage that you make sure that the kind of body corporate set up.

So if you are buying a body corporate property, make sure you get a body corporate report. Basically a body corporate report is like a physical inspection of these body corporate documents I just spoke about. It’s just going to point out any kind of special or unusual items such as levies or potential future expenditure, how much money they’ve got sitting in the funds and things like that.

They’re reasonably cheap. They’re normally 300 to a thousand dollars. And I’ll go through the last three years of records and they’ll just identify any kind of items specific to that property. And then that way you can cross check these figures with the ones that the age gave you on the information memorandum.

Yeah, that’s right. I mean, so some of these items in a body corporate report, mate, what should we be looking for in the actual report? Yeah. So there’s actually surprisingly quite a lot that you’ll actually get out of the body corporate report. The key things I typically look at is like one, it’s financial positions, basically how much money is in like the admin and sinking fund.

That’s a figure that’s basically sitting there for, for like renovations of the property and just to kind of manage the day to day kind of operation of the body corporate. It’s also going to tell you things about like building defects or like future kind of renovations that they need to do the property.

Like all buildings have some form of defects and maintenance, whether they be like minor or cosmetic and things like that. And this is actually one benefit of having a body corporate as well is if sometimes if they’ve got a healthy admin and sinking fund. Is they got the money there to do renovations where if you own, say, like a freestanding building and you don’t have a tenant, you might be up for kind of 20, 30, 000 to maintain that property.

There are some value opportunities there as well, but a bit more kind of risk, whereas with a body corporate, it just takes some of the risk and kind of issues away with insurance and things like that. The other thing I’ll actually look at is disputes. So, like, just looking between, like, the fellow owners and the strata committee, what are the common issues that have come up in the, the, the complex?

And this can be lots of things. It can be, like, certain trucks going through certain times of day or, like, blockages and easements and things like that. The other one is I look at, like, compliance with legislation and the management issues. So, how the management actually works with other companies and service providers.

And then the big one for me is actually the certificate of currency. So if you haven’t heard of what a certificate of currency is, basically the document that actually outlines the insurance that they have on the property. So whether like the public indemnity and the building insurance, and it specifies the conditions of the insurance.

So like the type of policy held, the premium paid, the date the policy expires. So basically, you need to make sure that the property is insured for the correct amount to avoid like penalties, for instance, if they’ve underinsured the property, for instance. One of the points to note, so I did mention, like I work with a lot of like insurance brokers and things like that is you need to ensure the property is insured for more than the actual property itself.

I see a lot of people that actually insure the property for, say, 80 percent of the actual replacement value. However, if you do have a catastrophic event, the insurance company will actually only give you 80 percent of the actual build cost back because they’re assessing their risk. They don’t just give you, you can’t insure a property for a million dollars.

Even though it’s 1. 2 million to rebuild it, they’ll actually only give you 80 percent of a million dollars because you’ve effectively committed fraud with them. And that’s just a nice little interesting thing. So, always ensure you have more value insured than the actual property itself. Yeah, one of the good things about this report, Steve, the Body Corporate Report.

Or is it you can basically understand the maintenance and repairs that have been done on the property. So it gives you a really good insight of, is this a problem building? And then you can also say, as you said, like, it was a lot of money in the sinking fund. Well, that’s great. If there’s no money in the sinking fund, that’s a red flag.

There needs to be money there for, you know, potential repairs because roof repairs can be really, really expensive. If you do have some kind of a hail event or something like that, where there’s leakage. Yeah, it’s worth checking as well like what they’re actually insured the property for so as we mentioned before about like when we’re checking area research and have things things like bushfire and flood zones, the property could actually be in a flood zone and the body corporate not insure it for floods.

So that’s something you need to cross check as well. Yeah, there’s so many things that need to be cross checked. It’s ridiculous. Okay, right. All right, mate. So, we’ve done the body corporate report, the lease, the business and the tenant. Now, the main physical things is the actual building and pest inspection.

Can you explain what the building and pest inspection is? So, like, after you’ve done your initial inspection of the property, the next step is to get, like, a formal qualified building and pest inspector to inspect the building. So, these inspections can be forwarded, like, once the property is under contract, if there’s a building and pest clause or due diligence clause.

But just make sure your building and pest inspector is experienced in commercial, because it is different to residential, so… They’re a little bit more expensive sometimes as well, but just make sure you’ve got an experienced inspector and that way they can also give you some estimates of like how much things might cost to be fixed.

Just note though, they don’t guarantee the quality of the property. They just kind of report on their findings, but they will check things like sometimes they’ve got like thermal image cameras and fluid meters. One of my guys I use actually has a high def camera on a drone that he flies over the roof looking for the quality of the roof as well.

So paying a little bit more for a good quality up build and past inspector will kind of pay dividends in the future. So when you’re inspecting, take time to discover if there’s any like potential issues that could arise, especially ones that we seasonal. I find this quite a lot as well. Like if we, like during heavy rains.

That’s when you can like experience like some flooding of certain parts of the building and things like that. So just look for things like poor drainage, um, the common areas during heavy rain periods, like mold issues or poor lighting as well, ventilation, inadequate heating or cooling, things like that.

So you basically need to go through the whole property and check, cool, is this going to be a high maintenance property or what condition it currently is, or can I add any value to it as well? Because obviously we might see some opportunities for renovations and things like that. Just make sure you take lots of photos and videos and that way you’ve got a reference for the tenant in the future as well because if they come back and claim that the issue was there prior, but you’ve got footage that it actually isn’t, you can protect yourself that way.

Just make sure you look at the whole property as well, like the whole building, no matter how much it inconveniences the tenant or their business and things like that, because you are buying into it. And this, this includes like the storage rooms and the parking. Make sure you look at all, all the whole property cause they, they can hide some things.

So what are some of the key things to look for in the building and pest report? Yep, it’s a great question. So, like, basically just look at the quality of the build. So, like, what type of exterior does the building have? How do you think it’s going to look in 10 years time when the lease expires and you may want to sell or release the property?

For office space, for instance, like, what are the proportion of lifts to floor area? Like, a general rule is, you have one lift per 3, 000 square meters. The speeds of the lift can also be important as well, because that can put off potential tenants from waiting for if it’s an industrial property, for instance, like what’s the ratio of floor space to mezzanine area compared to the office space?

Is this suitable for like the area, the tenant, things like that. Another one is just to inspect like the amenities, like what amenities is a building that like, does it have like a fitness center or a cafe or conference center or the toilets and things like that. Does the building have disabled access?

That’s another big one to kind of look at as well. If you’re buying kind of like a body corporate type property, is the lobby or entrance area like modern looking or is it outdated? Is that going to potentially put off future tenants? Are there signs of poor maintenance, such as like poor landscaping, dirty surfaces, things like that, that’ll give you indication of kind of how well looked after the property is.

And then the other big one, we mentioned this before, is actually cross checking the selling agent’s description of the floor space with what’s actually there. So actually get a survey or have your inspector measure things up because like you said, Andrew, you can actually potentially have some value add opportunity if you find that the area is actually larger than what’s advertised.

When you get to lease review, you can bump up the rent there. And then just check things like the mezzanine areas are kind of like a trade standard and approved. Whereas like with retail, it’s common to include like the outdoor seating area. So just check, see what actual size that is and what type of licenses you have for it as well.

In your travels, Steve, what do you reckon the range of the building in Pest could cost? It’s going to depend on the type of building, but anywhere from kind of 500 for like a standard commercial. If you’re buying something like a whole shopping center, you’re up for like five, 10, 000. But for most everyday investor, you’re looking at 500 to a thousand dollars.

Yeah. I was talking to a building and pest inspector a little while ago. I actually interviewed him on the podcast and he was saying the more wet areas in the building, the longer it takes. And so the more it costs. So I thought that was quite interesting. It just depends on the type of building as well.

Like if you’re buying a small little retail shop, for instance, and they can just kind of go in, they look at the internals and then they do a quick walk around the outside of the building. That’s a lot simpler. Same as like an industrial one. But if you’re buying a freestanding building, there’s a lot of like timber or asbestos or things like that.

You need to be mindful of that. Yeah, definitely. All right, mate. So what are some of the most common things that you find come up in the building and pest Actually, so that’s good flow on so like I just mentioned asbestos that that’s the biggest one I kind of find so if you see that there’s asbestos there like go get an asbestos report, and then that way you can kind of basically look at and get some quotes to how much it would be to remove, you don’t always have to remove it like quite a lot of buildings from the 70s and 80s will have asbestos but it is dangerous when it gets disturbed so you do need to kind of budget for that.

With that asbestos report, a lot of the time, the actual owner is responsible for supplying that to you in different locations. I know in South Australia, they have to supply that as part of the sale. Yep, no, exactly right. Whereas things like Queensland, they don’t always, you actually find it on building pests.

So just depends on what state you’re in, but your qualified building pest inspector should be able to find if there’s any asbestos. And then it’s not a showstopper for me necessarily. But I will budget for, okay, if I do have to get this removed, how much is it going to cost? Yeah. It just really depends on the strategy of the property.

If you’re just buying it for a buy and hold and you don’t plan on renovating or demolishing it, then the asbestos piece isn’t really that big. And even if you were demolishing it, it’s only like another, you know, say 15, 20, 000 extra on that demolishing costs to take care and get rid of and dispose of that asbestos correctly.

It’s not totally a showstopper all the time, depending on your strategy. Yeah, sometimes it’s quite minor. I find with like, say, retail properties, like, sometimes it’s just the signage outside, so there’s no asbestos in the actual building, it’s just the facade on the outside, which is actually quite, quite cheap to remove.

But like I said, if you’re not disturbing it, it might be there for another 20 years before you have to actually worry about it. Yeah. And I guess one last point on the asbestos is if there are different places in Australia where there is known to be asbestos, then they actually have to have an asbestos register and they need to actually go through that and have the register on site as well in the location, just so people know that as well.

Yeah, that’s correct. So another one that’s actually quite common always comes up and we’ve mentioned this a few times on these episodes is unapproved structures. So like the most common one is the mezzanine area not being approved. I’m finding this is happening more and more stiff in certain states.

You actually can like part of negotiations, you can obviously get some money off because of it, or you could actually ask that settlement be subject to getting it approved. And I find a lot of owners are saying yes to this, but. Just be mindful it can actually take months for it to be approved. And then there’s another tip and trick you can actually do is you’d actually send a certifier out, a structural engineer to certify that the mezzanine area is safe.

And then that way there are some insurers that will actually give you insurance for the period while you’re doing that application for approval. Yep, definitely. So mate, when you’re booking in your building in Pest Inspector, you need to actually supply them with the documentation they require to do the building in Pest Report.

Can you just list out some of that documentation that we need to supply them? Yeah, no problem. And you’ll also need it for your own information as well, because you’ll cross check it and you are going to be the owner. But there’s quite a, quite a lot here. So like for the site… You’re going to be looking at things like site plans, floor plans, as built drawings, because sometimes the original design plans are different to what they actually built, parking schedules, land tax assessments, inventory lists, council documents, management agreements.

The certificate of currency, like I mentioned before, for the building insurance certificate, details of the easements, covenants, restrictions on the property, drainage and sewage diagrams showing where the current connections are, and any details of like shared access or right of way arrangements. So they’re the ones for the site.

For the building itself, you’ll actually get things like the builder’s details and the date of construction, because there might be some warranty periods, for instance. Engineering certification for like concrete slabs or like there’s mezzanine areas and things like that. I mentioned council approved plans, specifications, records of any work that’s been undertaken in the last 5 years.

And other ones like occupational health and safety documents. So a lot of commercial, especially industrial space, you’re going to have like a hazardous materials register and reports. So you want any details of these hazardous materials that might be stored on site as well as the approval to have them on site as well.

So you need to look at that. And then you’ve got things like service contracts. So you’ve got like things like for roof maintenance, air conditioning, maintenance plans. If you’re buying like a retail and office spaces, even things like plants. So you’ve got like guys that come in and do the gardening on the plants and watering the plants, outdoor landscaping, maintenance, put schedules, like cleaning schedules, hazardous waste removals, rubbish removals, parking contracts, utilities contracts.

The list is really extensive, Andrew, and like it will get a little bit overwhelming, but just go through it one at a time. And as the word we used before, it is growing, but just cross check and make sure you are happy with the property. Yeah. And all of these items are on that 100 point due diligence checklist Steve has on his website.

So please do go and download that. It’s free. You know, he might, he might as well go grab it. Yeah. So Andrew, like throughout this process, even though it is grueling, keep an eye out for like value add opportunities. And we’ll speak about some of those on the future podcast. Cause one of the episodes are we are doing a value add opportunities, but don’t, don’t tell the agent.

If you find a value add opportunity, keep it to yourself because. They’ll tell the seller and then potentially they’ll look at ways to kind of crash the property if they think there’s more value there. Yeah, definitely don’t be telling the agent how you’re going to add huge value to it after you sell the property.

The last thing that I kind of wanted to talk about Steve is that when I’m actually putting in an offer or you had an offer accepted on a property, I like to send a checklist, the whole checklist to the actual agent so they can start getting the stuff back to me. Is that the same thing you do? Yep, so exactly right.

So the due diligence checklist is basically one you can go through, but it’ll change depending on the type of property. I don’t send them the whole due diligence checklist up front. Like I send them like an item, like the 10 or 20 critical items. And then that way you can get started on that because they won’t have all the information up front.

So it’s best to get the ones where they’re most likely going to be like the, the red flag items and get through those first. And then even schedule the things that cost money after you’ve done those. So do all the things that you can for free. Then book your, your valuation and you’re building a pest inspector and your body corporate report and things like that.

Just in case you are not proceeding with the deal. All right. Well, I think that pretty much wraps up episode eight. Been a very, very big two episodes, seven and eight. The due diligence process is an almighty beast. Where can the listeners go to get the a hundred point due diligence checklist? And then also find out more about you and your business, Steve.

Yep. So, so just go to my website, www. policeyproperty. com. There’s a resource section where you can download the a hundred point due diligence checklist. And I’ve also got quite a lot of free resources on there, such as like cashflow spreadsheets and things like that. And the listeners of the podcast can get a free copy of my book as well.

So just on the website, just go to checkout and use the code word podcast, and I’ll send you a free hard copy of the book. And then to get in touch with me, just do an inquiry on the website or stalk me on social media and send me a message and I’ll get back to you shortly. Awesome, mate. Good deal. All right.

Well, stay tuned for episode nine, where we explain what happens post purchase and how to add value to your property. This is going to be really, really good. So this has been author Steve Polisi and Andrew Bean on the Commercial Property Investing Explained series. Cheers, everyone. Thanks, everyone. Thanks for listening to the Commercial Property Investing Explained Series.

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