Home' API Magazine : October 2014 Contents For example, even a hairdresser who paid
$60,000 for a hairdressing business, plus
the cost of hairdressing equipment, will be
very likely to exercise an option to extend
their lease because they need to get back the
$60,000 paid for goodwill.
Therefore a tenant who has bought the
goodwill of a business plus the cost of the fit
out is a much stronger tenant. For example,
motel leases are nearly always renewed
for this reason as the owner of the motel
business not only paid for the cost of the
fit out of the motel and the gear that went
with it, but often paid three to four times the
annual net profit of that business as a capital
cost of acquiring it.
Tony Lenan, principal of Firestar
Developments Pty Ltd and a seasoned
commercial investor, has strong views about
this issue. He says that the value and position
of a commercial property depends on how
re-lettable it is once the existing lease expires.
“A five-year lease in a retail area, say in
Cavill Avenue in Surfers Paradise, is a lot
more re-lettable than a five-year lease over a
service station in Chinchilla, Queensland.”
So generic uses such as offices are far more
re-lettable at the end of the term than special
purpose leases such as car dealerships, car
washes, fast food outlets and service stations.
You need to ask yourself the question, “What
will I do with this site at the end of the
lease?” And you also need to ask, “Who is
John Potter from The Potter Group and
author of A Property Investor’s Guide to
Negotiating says another question to ask is
about the length of the term.
“ The very first question therefore about
any lease should be how long is the term?”
“You should understand that options in
leases are only there for the comfort of the
lessee. It’s a critical point to understand that
options aren’t in the lessor’s favour.”
The rent – gross rental vs net rental
About 70 per cent of leases are gross
rental. That is, the landlord pays all
of the outgoings with the other 30 per cent
net rentals, where the tenant pays outgoings.
From a commercial investor’s perspective,
net leases are the best. Then no matter what
new outgoings, taxes or expenses come along
you just pass them onto the tenant. Over
recent years, we’ve seen a blowout in such
things as water charges, body corporate levy
increases and insurance costs. With a net
lease, none of these will worry you because
the tenant will pay at the end of the day.
Carefully check a lease that’s a gross rental
and make sure you’re fully informed about
what the outgoings actually are, and whether
there will be any increases such as water
usage, insurance etc.
Air conditioning costs and maintenance
are classic examples. When reviewing a gross
rental that you’re carrying out a due diligence
on you might say, “Oh well. I have to pay the
air conditioning costs as a landlord but it’s
only $1000 a year.” You should know that this
$1000 goes to the bottom line i.e. if you’re
buying the property on a 10 per cent yield,
the capital cost of you absorbing that $1000
outgoing is $10,000.
“ There’s a big difference between a gross
lease and a net lease because the outgoings
under a lease are often about 20 per cent of
the rental,” Potter says.
“So, if for example, you’d normally buy
commercial premises at a yield of 10 per cent
but the lease was a gross lease and not a net
rent lease, the yield you’d want to pay as a
buyer and commercial landlord would be 12
per cent, not 10 per cent.”
Therefore you must read the provisions of
the lease very carefully. In the commercial
property world, far more than in residential
property, you must become the best
generalist you possibly can. Don’t flick-pass
the problems to your lawyer, town planner
or accountant. A big part of becoming a
successful commercial investor is in knowing
as much as you possibly can about leases.
And that translates into the doing. It’s in
the doing that the prize exists, not in the
espousing or the philosophising of it. So roll
up your sleeves and get in and learn about it
if you want to own commercial property.
According to Lenan, the best type
of rental increase is the one that
includes some actual real growth.
“Like a fixed rental increase (over the next
five years) of five per cent a year,” he says.
“CPI by itself just isn’t good enough. It
should at least be CPI plus a minimum of
one or two per cent a year. You need growth
and ideally you need a market review of the
rental every three, or at least every five years.
This can be a bit of a hard sell with a tenant,
but it’s worth pushing for as you must have a
lease that has growth.”
Fixed rental increases vs
Some leases provide that the rent
increases by a fixed percentage each year and
others provide that the rent will increase by
a percentage of the tenant’s gross takings.
Leases which provide for an increase in line
with the tenant’s increase in gross turnover
(percentage rent) are far less attractive to
a commercial investor than a lease that
provides for a fixed rental increase each
year, or even CPI (cost of living) increases.
Percentage rent increases negatively impact
on the yield the property is sold for.
Investors will want to know not what they
might get out of the rental, but what they do
About 70 per cent of leases are gross rental. That is, the landlord pays all of the
outgoings with the other 30 per cent net rentals, where the tenant pays outgoings.
FEATURE n Advanced Investor
68 n APIMAGAZINE.COM.AU n OCTOBER 2014
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