There is no simple answer, but there is some golden industry advice we can share with you. There are several routes and approaches you can take to make money through commercial property. We will touch on a few of the most common ways to profit and benefit from commercial property ownership, including advice on development opportunities. This guidance is inspired directly from our professional dealings and situations we’ve encountered in the property market.
NOTE: Of course, the following advice / information is general in nature and cannot take anyone’s specific circumstances into consideration. If you are considering a property transaction, please make sure you contact and take advice from the relevant experts who understand your circumstances and objectives.
1. Cash Flow – Rental Income
This is the surplus cash you can generate from your investment property. It will depend on your gearing. i.e. What rental income the investment property generates compared to your loan repayments for your finance on the property. If your income outweighs your loan repayments and other costs – you will have surplus cash:
e.g. Income of $2,000 per month – less costs of $1,500 per month = $500 surplus
With surplus cash, you can either pay down your debt faster (creating an even larger cash surplus as the debt and repayments reduce), or divert the excess funds elsewhere.Your decision will depend on your circumstances and your investment strategy.
Generate surplus cash flow from your investments through:
- Finance: Getting the right finance is a big part of this equation, as is getting favourable terms with a financier (interest rates, fees, loan term, lending ratio, etc.). This will make a huge difference to what income you have leftover after your repayments (if any).
- Lease: Lease terms are also very important – learn more about dealing with tenants. Securing a longer-term with a tenant should correlate with improved finance options available. Striking the best finance deal will have a huge effect on your cash flow. A longer lease will clearly also lower your average vacancy period.
- Rent Rises: In any lease you agree for your property, you should ensure there is a provision for annual rental increases. Ideally, your increase method will be better than simply CPI (Consumer Price Index), as property costs (insurance, rates etc.) have outpaced inflation rates in recent times. Just consider what the bushfire crisis is doing to the insurance premiums we all pay…
- Review: It may seem obvious, but don’t be too passive with your investment property. Whether you look after your property personally, or a professional assists you – engage with what’s happening on your property. The ‘investment property’ is your business after all, so why wouldn’t you want to review it regularly to ensure it’s performing well?
2. Capital Growth
With this method, you are buying and holding property and waiting for the market to grow, or appreciate, over time. A huge range of factors affect growth in the property market, making it difficult to predict with accuracy. There is also a lot of noise from media and market commentators with competing views or opinions about what the market will do. It can often seem difficult to make sound decisions when buying property!
There will always be anecdotes of people who have bought a property only to sell it just months later for a huge profit. These are generally exceptions and those stories never highlight the true risk involved. As with most things in life, if you’re looking for a ‘get rich quick’ approach to property investment, this comes with a huge amount of risk. Especially true if you’re relying on external, out-of-your-control factors to dramatically increase the value of your property. A story about huge profit is sexier than huge risk – so what are we more likely to hear at a dinner party?
Buying and holding is generally a sound strategy for building long term wealth through property. You may have to ride through some tougher markets, but you will also benefit from the growth experienced during boom periods. As an average, this may amount to slow and steady growth, but long term that adds up! Slow and steady may not be as attractive as quick wins, but it’s more glamorous than living on someone’s couch if your risky investment strategy doesn’t pay off.
Strategic tips to consider when seeking property investment opportunities:
- Look for growth corridors: If you’ve found an area you like, look at the population growth and how it is trending. Is the region stagnant, shrinking or growing? At what rate? Are there any significant infrastructure projects planned or supporting the area? This is often a sign of expected growth in a region.
- Look for underperforming assets: Be very cautious of this approach. There may be underlying reasons why an asset is underperforming. If you’re satisfied with your due diligence, this is a good way to improve the capital value of a property. For example, if the property is under-rented (again, be cautious why?), the sale price may be lower (devalued) from its theoretical full market value, simply based on the low rental return. If you have a strategy for remedying that underperformance (lower rent), and can return the property to achieving a proper market rent, you can increase the property’s capital value. Opportunities like this may not be abundant, but with patience they can be found. Clearly this strategy comes with increased risk, so tread carefully. Leave it to the fools to rush in.
There are multiple avenues to consider when trying to make money through development of property. Some of the most popular development options include:
- developing vacant land
- redeveloping a dilapidated site
- redeveloping an underperforming site
- improving an existing structure
- expanding an underdeveloped site or a land sub-division.
Rather than venture into every possible avenue of property development, we have highlighted two of the most important elements to consider below.
Developments: Cost Analysis
The most common core development costs to consider are:
- Entry Costs: This includes essentials like purchase price or cost of the land (or property), stamp duty, valuation fees, insurance, legal fees (or fees from any other professional advisor), deposit monies, and finance on the purchase (remember how crucial finance is in any deal).
- Development Costs: Depending on the nature of your development, this can include items like design fees (graphic designers, architects etc.), consultant fees (engineers, surveyors, Geotech reports, environment impact reports as required), consent fees, construction costs, holding costs (finance, rates, land tax, insurance etc.), and marketing.
- Exit Costs: Legal fees, agents fees or commissions, capital gains tax and finance exit fees.
NB: This is not an exhaustive list, just a quick guide. Make sure you engage the relevant professionals for a full analysis and guidance on any developments you are considering.
Developments: On-Sale Analysis
Do you have a good grip on the market, relative to the development you’re considering? For example, the Central Coast has experienced a recent boom in commercial property development.
Good market awareness is a crucial component of any successful development. You don’t want to build a great product if there is no demand for it! Engage with your local property experts.
Pursue independent research, review key market factors, and answer:
- Are there specific market trends you are targeting with your development?
- What is the current competition in your specific market?
- What is the predicted competition when you complete your development?
- What is the timeline for your project? Is the market likely to change? (dependent on the scope and duration of your development)
- Is there a current demand for your product?
- Can you forecast the demand for your product on completion?
- How much can you sell your end product for?
- What alternate exit strategies do you have if there’s a dramatic change in the market?
Once you have a firm handle on what your overall development costs will be, plus an idea of the realistic sales results once the project is completed – determine if the relative risk is justified by the potential reward.
As any decent builder would say: measure twice, cut once.
In that respect, completing solid due diligence ahead of any development will help you build the right product for the market. It will improve your odds for success!