Advice and Opinion

If you are successful in residential property investments just be cautious when you dip your toe into commercial property

An enthusiast foray into the commercial office space by someone who has done well in buying and renting residential property can met with unexpected challenges, and this is something that people are sometimes prone to overlook.

However, while investing in commercial property is more complex than the residential market, small-time investors who do their homework properly and acquire an understanding of the market- and invest in sectional title office or free standing units – can significantly build their property wealth.

So said Org Geldenhuys, managing director of property development and management company, Abacus DIVISIONS.

“Location remains the golden thread but there are a host of other more complicated issues that make investing in commercial property completely different.”

Geldenhuys said that one of the major differences is that the lease agreements vary considerably – a tenant of an office will often sign a three to five year contract with certain built-in escalation clauses, while a tenant of a house will generally sign a one year lease contract with a lease amount that increases by a negotiated percentage each year when the contract is renewed. It is a far simpler arrangement.

“Then there are considerations such as a tenant allowance, which are typically upgrades to the building to make it habitable for the tenant’s business. These need to be carefully arranged and considered as the amount typically comes from the landlord. This could be as high as the equivalent of two or three months of rental income. A landlord, especially in a tough market, wants to lure his tenant with a good allowance – but he must not give away the family farm in the process.

“Tenants often want to add fixtures and make improvements and it does take some experience to ensure that there is an equitable give and take.”

Commenting further, Geldenhuys said when it comes to renting in the residential market space the broker takes a certain monthly fee for administering the lease agreement, while in the commercial sector an upfront payment of commission is usually required for finding and securing a tenant – and thereafter a monthly fee to manage the tenant and administer the lease agreement. This needs to be factored into the overall costs.

“Buying an office, or offices, to rent out also requires more of a deposit compared to when buying a residential property. Banks will want 30 – 40% upfront, partly dependant on the credentials of the landlord and the tenant. Even if you have the required 30% deposit, a bank won’t just give you a loan without a financially sound and secure tenant. The threshold of entry to the commercial property market is certainly a lot tougher.

“Another thing that has been making things far tougher for landlords is that council rates have gone up considerably in the last while, sometimes by as much as 300%. This extra overhead typically cannot be recouped from the tenant due to the signing of a longer term lease, which generally precludes the tenant from these hikes – or at least the bulk of them.

“This has been a worrying trend in the commercial office space and is affecting many landlords who are not adequately covered.”

This risk can be mitigated by ensuring a lease agreement makes provision for out of the norm increases in operating costs.

Commenting further, Geldenhuys said that another important factor – which is similar, in many ways, to investing to rent in the residential space, is to buy where there is “good tenant churn”.

He suggested that prospective landlords seek the “sweet spots” in the market, such as small sectional title offices in the region of 100 m2 to 150 m2 – the equivalent of a two-bedroomed townhouse unit in residential terms.

“It would be wise to look at sectional title office space which is generally more in demand. This is less risky and, additionally, sectional title offices will, in most cases, have a body corporate. Having a body corporate can take a lot of stress and strain away from landlords, and also give more assurances that the office complex will be well run and well maintained.”

Geldenhuys also said it “could be wiser” to initially use the services of a good broker, until experience has been gained and a workable and successful property portfolio has been built up.

Leave a Comment