Buying commercial property with 6% yield

I never owned a 'buy to let' property so checking from those who already have experience in this area.

Is it a good deal to buy a commercial property at 6% yield ? Existing rent agreement with reputed company for another 15 years linked with CPI. I am planning to pay half upfront and loan from bank rest....

Have you seen the actual lease from the owner to the tenant?

It seems odd to link the rent to the CPI. It is more common to have rent reviews every 5 years.

And does the tenant have a break clause?

On the face of it a 6% yield linked to inflation from a very good tenant for at least 15 years seems good value. But if there is a break clause, it's only a good yield until the date of the break clause.

6% is a good yield, but if you are borrowing half the money at very high mortgage rates, it might not be that good.

Brendan

commercial leases linked to CPI would not be uncommon...
6% is a gross yield I presume - so you'll be taxed at marginal rate - which will reduce net yield closer to 3% (you will benefit from interest offset...)
you indicate there's 15 years left to run on lease - make sure there are no break clauses before then....
get a solicitor to vet the lease for you - they'll advise you on anything out of the ordinary - e.g. FRL or not - who's responsible for various costs/insurance/maintenance etc...
the other thing to bear in mind is location of property - fast forward 15 years (difficult I know) - is the property in a location that will be attractive to other tenants (assuming current tenant vacates at that stage)...
do your due diligence on the current tenant - satisfy yourself (as best you can) that they are and likely to remain able to pay the agreed rental...

Bank Manager said:

6% is a gross yield I presume - so you'll be taxed at marginal rate - which will reduce net yield closer to 3% (you will benefit from interest offset...)

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Might there be management expenses that cannot be offset that potentially reduce the net yield further?

Deposit class net returns for the risk involved in part leveraged commercial property investment and management doesn't seem that attractive?

ClubMan said:

Might there be management expenses that cannot be offset that potentially reduce the net yield further?

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If costs relate to the property they should be offsettable - but perhaps you have something specific in mind?

ClubMan said:

Deposit class net returns for the risk involved in part leveraged commercial property investment and management doesn't seem that attractive?

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I'd tend to agree - net return marginally above deposit rates with significantly more risk - borrowing - tenant & property... others may disagree with us in terms of diversification of assets and potential upside in property values in to the future...

Bank Manager said:

but perhaps you have something specific in mind?

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No, nothing specific. But I just thought that some expenses might not be allowable.

Either way, I wouldn't go into such a venture without doing clear and thorough due diligence, a business plan that shows that it's sustainable and the best investment option of all available alternatives, and that it's appropriate for my overall savings/investment portfolio.

6% is a decent return but as has been pointed out, it is gross.

How strong is the tenant? Will they still be there in 15 years? The world of commercial property has changed a lot over the last number of years.

Then there is the debt. How much is it? What is the interest rate and how long is the term? Will the rent cover it or will you have to add to it to meet the costs. Assuming you have to add money each year either in the form of mortgage payments and or tax, how much extra will this be and are you prepared to make this commitment for the next 15 years?

Also, what is the state of the property and will any work be required on it? Who is responsible for this cost?

Properties aren't set and forget investments, they require ongoing work and ongoing cost.


Steven
http://www.bluewaterfp.ie (www.bluewaterfp.ie)

6% before tax, if this was residential, I wouldnt find it remotely attractive, can't see the win here at this yield and risk.

I'd stick the money in an index fund and forget about it.

Bank Manager said:

commercial leases linked to CPI would not be uncommon...

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Interesting. I had not seen them but then I have not seen many commercial leases.

So is the rent revised every quarter or every year instead of every 5 years which I had thought was normal.

Brendan Burgess said:

So is the rent revised every quarter or every year instead of every 5 years which I had thought was normal.

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the ones I've seen were done on an annual or bi-annual basis...

The 7,5% stamp duty on commercial property can make it less appealing.

The VAT status of the property and any potential VAT liability transferred by the sale of a property with a sitting tenant will also need to determined.

Commercial property purchases can be complicated from a tax perspective so you would really need to get advise on the specific transaction in order to understand if the 6% yield is a good deal.

Hello,

Despite some good questions raised above, I'm amazed that several people are saying that 6% gross yield is good - it may be, but quite possibly isn't !

A few important questions that I don't see raised:

What type of property is this - retail, office, warehouse, multi-let pre'63 ?

What condition is the property in?

What's the BER rating on the property?

Where is it located, a city, a town, a rural location?

What alternative tenants might want to rent it, if the current tenant goes bust, or vacates?

What industry sector is this current tenant in?

Just how good is the tenant, really ?

- Have you seen evidence of a perfect rent payment record?
- Have you seen their recent financial statements?
- Are there any judgements registered against the tenant and if so, for how much, are they satisfied etc. ?
- Will the tenant provide a letter of comfort from their bank or accountants, indicating that they believe that the tenant "should" be able to meet future rent obligations, based on their current knowledge of the tenant?

In addition to asking if the lease is a FRI lease, and checking for any break clauses etc. are there any guarantors to the lease and if so, how strong are they?

Who is selling the property? Do you know how long they've owned it?

How is the property being sold - through a large known commercial property agent (ie CBRE, Savills, Cushmans etc.) via auction (i.e. BidX1), perhaps ?

MrEarl said:

Despite some good questions raised above, I'm amazed that several people are saying that 6% gross yield is good - it may be, but quite possibly isn't!

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There's no ifs buts or maybes, as I stated earlier, it's a dreadful proposition. 6% yield before tax?

Someone explain to me how a 3% net is a win when the investor is inexperienced in commercial real estate?

I'm obviously missing something and would like to understand better what this is.

@Persia

We've seen commercial yields dropping for most of the last 7-8 years, that doesn't mean that 6% gross yield is good, but it puts a belief in some peoples minds.

Until we learn a lot more about the potential investment, no real view can be formed on the Yield being good or bad.

Thanks for clarification @MrEarl on the commercial environment.

My point remains, I would not commit any monies to a venture with a 6% gross yield (3% net) with no experience or understanding of risk.

There are other opportunities that would yield better returns with less risk.

@Bank Manager, what is "interest offset"?

@T McGibney - OP has indicated s/he intends to part fund the acquisition of the commercial property by way of borrowing - the point I was making relates to the fact that the interest charge on the borrowing would be an allowable expense in calculating profit from the rental income and thus would reduce the actual tax charge.. I also indicated that the net yield would reduce to c. 3% based on marginal rate tax, but this is a crude measure without the exact figures as the interest and other allowable costs would reduce the profit and the associated tax charge. Hope that clarifies.

Fair enough, it's still worth qualifying that the tax deduction on interest that you mention is far from an offset.

Many people don't know the difference and are blasé about incurring interest charges on the misapprehension that it doesn't matter once their tax bill is going down correspondingly. In reality, it isn't.

@bish123 - (why) do you think that this is the most appropriate investment option for your circumstances especially given that, by your own admission, it's something that you have no experience of? Maybe a Money Makeover would be in order here?