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By Andrew Sheed, General Manager Property Finance, ANZ
Most New Zealanders target residential property for their first foray into property investment. This market is seen as easy to enter and relatively low maintenance. However, with property prices having increased significantly in some regions, the amount of equity required to invest has increased and rental yields have decreased in many cases. The commercial property market offers another investment option with a number of attractive features.
To begin with, investing in commercial property does not necessarily require a lot of capital. There are a number of listed property trusts on the New Zealand Stock Exchange, which offer an easy investment option. The trusts are generally large and own a significant number of properties, giving investors an element of diversification. Current gross dividend yields range from around five per cent to six and a half per cent, depending on the trust, and investors who do their research can allocate their dollars to certain property subsectors depending on what trusts they choose. For example, Precinct is weighted towards the commercial-office sector, Kiwi Income Property Trust and DNZ towards the retail sector, Goodman and Argosy towards industrial property and Vital Healthcare needs no explanation.
Investing in a property syndicate is another relatively low-cost way of entering the market and these syndicates are better regulated now than in the past. Syndications offered to the general public usually require a minimum investment of NZ$50,000. There are a number of well-established syndicators in the market. As an example, Augusta is currently raising investor subscriptions on the Southgate Shopping Centre in Takanini, South Auckland. Their headline gross rate of return for investors is eight per cent. Each investor effectively purchases beneficial shares in the property. With most syndications targeting single assets
(and often single tenants), investors should consider the long-term quality of the asset and the quality of the tenants. These are major drivers of value. Investors should also be aware that units in syndications are not necessarily liquid. If an investor decides to sell it may not be easy.
Investors with more equity can look to acquire and own commercial properties themselves. In fact private individuals hold much of New Zealand’s commercial property. Investor returns can vary widely, with the main variables being the quality and location of the property, value of the property, growth prospects for the sector it services, quality of tenant and lease terms. For example, prime retail space on Wellington’s Lambton Quay can sell at yields as low as 4-5 per cent, service stations with 15-to 20-year leases to oil companies tend to sell currently at 5.5-6.5 per cent yields and it is still possible to achieve 9-10 per cent yields on some non-prime commercial/industrial property.
However, commercial property investment is not without risk and there are a number of things to consider when evaluating an investment. A valuation report is a useful starting point, giving the buyer good insight into what similar properties are selling for, the attractiveness of the property to tenants and what rental rates are being achieved for similar offerings in the area.
This report will not cover the quality of tenants and whether they are happy in the building. The buyer has to ascertain that themselves. That job is easier if the tenant is a long-standing well-known company. However, a bit of educated guesswork is often required. A potential buyer should meet the tenant if possible. They will often say whether they are happy with the building and may even give an indication of how they are trading.
Legal due diligence is also important, not just on the sale and purchase agreement and title but on any key contracts, including lease agreements. Key lease terms include the tenor of the lease, any rights to terminate early and rights of renewal. Also important is the mechanism for determining rental increases, such as whether it is tied to the consumer price index or subject to market review. This is important as lease terms can have a real impact on cash flow and value. For example, a property rented at greater than market rates and subject to a market rent review in 12 months, could see a significant decrease in rent paid.
Other considerations include seismic rating, which can in turn affect attractiveness to tenants, insurability and the ability to get bank financing. In the worst case, earthquake-prone buildings can receive strengthening demands from council and, if not remediated, buildings can be locked up.
Investors should also talk to their banker before going unconditional. Unlike residential lending, banks do tailor commercial property lending to individual investment risk profiles. An investor should not assume they could borrow a specific portion of value without engaging their bank.
In conclusion, commercial property offers a number of relatively high-yielding options to investors. However, it is not without risk and investing time in due diligence is highly recommended.
Capital: the amount of their own cash that an investor has available to use for a property purchase.
Consumers price index (CPI): a measure of inflation, this is an index calculated by the New Zealand Government that provides information about changes to the prices of consumer items households buy.
Due diligence: the process of research undertaken by investors on a property before deciding whether to buy it.
Equity: the market value of a property minus the value of any outstanding loans used to finance its purchase.
Gross dividend yield: the investment’s distribution before tax as a per cent of its current value.
Gross rate of return: the return on a property before tax, expenses and interest are deducted.
Investment risk profiles: the level of risk an individual investor is comfortable with, balanced against potential investment returns.
Liquid: easily saleable and converted to cash.
Property syndicate: a group of smaller investors who pool their money to buy a commercial property that would otherwise be beyond their individual means.
Rental yields: the annual rate of return a property owner generates through rental income.
The commercial property market offers attractive features and can be invested in directly or accessed through a trust or syndicate.
There are a number of property trusts listed on the New Zealand Stock Exchange, which offer an easy investment option. Investors can allocate their dollars to certain property subsectors (eg commercial office, retail, industrial or healthcare) depending on what trusts they choose.
Investing in a property syndicate is another way of entering the market and there are a number of well-established ones to choose from. Investors should be aware that units in syndications are not necessarily liquid.
Investors with more equity can look to acquire and own commercial properties themselves. Investor returns can differ widely, with the main variables being the quality and location of the property, value of the property, growth prospects for the sector it services, quality of tenant and lease terms.
Commercial property investment is not without risk and there are a number of things to consider when evaluating an investment. A valuation report is a useful starting point.
Legal due diligence is also important, not just on the sale and purchase agreement and title, but on any key contracts, including lease agreements.
Other considerations include seismic rating, which can affect attractiveness to tenants, insurability and the ability to get bank financing.
This article is intended to be of a general nature, does not take into account your financial situation or goals, and is not personalised advice under the Financial Advisers Act 2008.
The investments described in this article are not suitable for all investors. Before making any investment decision, recipients should seek independent financial, legal, tax and other relevant advice having regard to their particular circumstances. The author, ANZ and its affiliated companies will not be liable for any loss arising directly or indirectly out of or in connection with this article.