Investment in rental property - understand investment basics for commercial property before your commitment

Thanks to most central banks for the crazy interest rate cut in 2008, investing in commercial properties, offices and retail stores, are becoming a viable option for investment in rental property. There are however several investment basics to note for incorporating rental property investment into our investment portfolio:

• Commercial property and residential property are entirely different things. There are different rules of game to follow.
• Most people think commercial property need huge sums of money to start. In most cases, banker will look at the property yield more than the borrower. So long as the banker can substantiate the rental income to cover more than mortgage payment, they will consider loaning you the money.
• For residential properties, the owner needs to take care of all the repairs and maintenances are down to you. With commercial properties, all these expenses are often paid by tenants. In fact, tenants will oversee and maintain the conditions of your property. The reason is trivial. The tenants will look after their own offices or stores to preserve their business images.
• Tenants for residential property are normally very short-term. One year to two years terms are typical. With commercial property, the tenants are usually long-term, anything from five to ten years! Most business tenants are not in their interest to move considering the impacts on customer contact, image, renovation costs, administrative burden...
• The liquidity can be determined by the number of transactions per year divided by total properties in a particular area. In Hong Kong, 5% - 10% turnover is already high for most residential real estates in strong years. The commercial properties can be even much lower...
• We however suggest that you NEVER buy a vacant commercial property. Unlike residential property which you should buy with a tenant in place. You should buy existing tenants who have a proven record of paying. You should however note that some tenants are not genuine but conspire with the landlord to “create a yield” to the property. If you do not want to go for a valuation report, one way to assess the fair value of the property is to do some calculations based on some assumptions if the tenant can sustain the rent.
• Rental income is important for structuring bank loans. Banks are interested in the property yield generated from the property, to support the mortgage payment. Due to the current financial turmoil, the financial strength of the borrower is also important to have better terms of structuring bank loans. Yet the key is still whether the property can generate income to cover mortgage payment. In the eyes of banks, the rental yield is important to determine property value. Also the commercial property itself is to offer as a collateral. The risks is much lower than credit cards, clean personal loans or even credit lines to small / medium enterprises...
• The biggest problem for commercial properties is that they are relatively illiquid even compared to residential properties. The transactions are very thin as these are not necessities for most people. It is very difficult to realize into cash in case of emergency.
• The best scenario is that you have your own business such as a chain store / retail / business center operator. In case the tenant is out, you can still take up the space to generate income.
• Another thing to note is that you should research into town planning document before any commitment. A flyover to be built in front can divert all your customer traffic and hence deflate your rental value a lot!
• The final comment is that the general economic condition should be positive to support the “derived demand” of rental property. This means that you should not expect your tenants to pay you good rents if the consumer demand is shrinking, regional office / foreign investment is fleeing and unemployment rate is increasing…

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