Commercial property still offers the best returns

Posted On Friday, 12 September 2014 12:30 Published by
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Commercial property still offers the best returns

Rawson Commercial

The rising cost of maintenance services, municipal property rates and electricity costs is believed to be making this type of real estate even more challenging. But Leon Breytenbach, Commercial Manager at the Rawson Property Group, believes that commercial property is still one of the most advantageous types of investments.

What type of risks do you face?

Generally there are two types of investors - those who enjoy the low risk associated with a "fixed-deposit-type-investment" and its lower more guaranteed financial return and the ones who are willing to take on a more challenging investment in pursuit of higher returns.

For those willing to take the plunge and get more in return, commercial property is still a viable path to follow. And though it may seem like a gamble, there are ways to protect your purchase. Breytenbach says getting advice from an experienced property broker is the first step to offsetting the risks linked to commercial property.

"You face some of the same challenges as residential property investors. In both cases there is the chance that a tenant could vacate without notifying the landlord. Key differences would be the higher costs when it comes to electricity and levy rates.

But unlike the physical involvement required by the landlord to maintain a residential property; with commercial property most of the onus is on the tenant. This means that fixing a broken toilet or door would be part and parcel of what the tenant would have to pay for during his/her lease.
Commercial property is usually rented for retail, offices and industrial purposes and according to Breytenbach the highest demand is for retail buildings.

Last year the Rode report stated that large shopping centres still displayed a good capital return performance despite the poor growth in retail sales volumes. Many smaller businesses prefer the option of being situated in a big complex because it gets them more exposure.

Is commercial property still a good investment?

Breytenbach believes the higher interest rate will not make a huge dent in the commercial property market because the ripple effect of the hike will be marginal and South Africa's economy can absorb it.

A big financial advantage of this type of property investment is the bigger returns you can expect compared to a fixed deposit or a residential building. Breytenbach says that where you can earn approximately 6% on a fixed cash deposit or owning a residential property, you can nearly treble this return on commercial property.

Similar to unit trusts, where fund managers manage the investment on behalf of busy investors, those investing in commercial property would be best served by appointing a property manager to control the impact of rising costs and help overcome the administrative burden of collecting rentals.

Other experts agree that in the current economic climate, commercial property is still a viable asset to own. Earlier this year risk finance company, Business Partners, said commercial and industrial properties in South Africa will continue to boast yields comparative to most other investment classes in the near future.

This is because the South African property market is less exposed to shocks in the global economy as, for example, the stock markets.

Capital banks' assessment depends on: The type of asset being financed 

Breytenbach says banks are generally more supportive of retail and office asset classes as opposed to Industrial.

"This does not mean industrial is a negative asset class. On the contrary – this asset class can have some wonderful returns. It just requires a more prudent assessment from the banks' and the investor's side of things."

The strength of the tenant

According to Breytenbach, if the tenant is a third party , the banks will look at who the tenant is, how long they have occupied the property, how much time remains on the lease, whether the rentals charged are market related, etc.

If the tenant will also be the owner of the property (or one of his / her own businesses) – this is generally referred to as an "owner-occupied" property. Here, banks generally look at whether the business will be able to afford the property without placing too much strain on the businesses' cash flow.

"Where the required bond repayments are close to the current rent the business pays (still leaving sufficient profits and cash flow in the business), this type of transaction is looked upon more favorably by the banks."

Will the rental income pay the bond instalment?

Naturally, the required bond installment is dependent on the term of finance, the interest rate secured and the loan amount the bank is prepared to offer. Every transaction is therefore different.
But in general the monthly gross rental generated by the property will only match the required monthly bond repayment, if you are able to put at least a +-35% deposit down. This can be quite a large capital outlay.

What other income sources can cover contingencies?

Breytenbach says this provides the bank with the assurance that there is at least a "plan B" in the background if anything goes wrong.

"If the client has surplus income in their personal capacity or through links to their other business interests or other investment interests, this goes a long way to support the transaction," says Breytenbach.

Commercial property

There are some financial institutions offering loans which are a higher percentage of the purchase price indicated above. But this is by default a more risky transaction for the financial institution involved because the net rental income does not service the required bond instalment.

If considered, such an approval is generally coupled with a much higher interest rate to compensate for the additional risk taken.

If a financial institution is prepared to adopt such an approach, this is generally indicative of their attempts to "buy market share" and enhance their general perception in the market. Breytenbach says it is normally only a temporary measure, and some investors may benefit from approaching these financial institutions during such an opportune time.

However an aggressive lending approach is not in the long term interests of the South African property market in general nor in the long term interests of the financial institution concerned.

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