By Frank Newman on 5th May 2018
Politicians have been giving residential landlords a hard time. It’s no surprise that some are switching to more benign investments, like commercial property.
The April issue of New Zealand Property Investor magazine interviewed three property investors that had made the switch from residential to commercial property investment. They spoke candidly about their reasons for doing so.
One switched half of his residential portfolio into commercial because, “I got fed up with all the regulations that were hammering landlords. Residential costs are going up and then there is all the ‘anti-landlord’ stuff”.
He said there was limited government interference in commercial property: No insulation requirements, no five year bright-line test which taxes gains on the resale regardless of intention or circumstance, and no ring-fencing of losses.
Then there is also the problem of having to deal with difficult tenants. One switcher said, “I had multiple occasions where tenants did thousands of dollars worth of damage to property then complained about the bond being taken off them. I became sick of a system which is poorly designed with protections only in one direction”.
Of commercial tenants he says, “The risks may be greater, but the cash flow is better, the margins are improved, management is easier and the tenants are the biggest difference. I’ve never had anyone do wilful damage, and if they don’t pay they have to go”.
Residential landlords overcome this problem by engaging someone else to deal with tenant issues. Property managers come at a cost, as was explained in a Property Plus column recently, which makes the paltry rental yield even more paltry . In Auckland, residential yields are down to about 3%, which is simply unsustainable in a market with little capital growth. It’s not a lot better in the provinces where a 5% yield is typical. Commercial tenancies have better rental yields.
Commercial tenants are a lot easier to deal with. As people in business, they tend to be business like in their approach to their tenancy and they are much less likely to damage the property or do a runner. If they do cause damage most commercial tenants fix it themselves, instead of calling their landlord and demanding immediate attention. And there is also the advantage that commercial landlords do not get phone calls at 2am from neighbours complaining about the boozy party taking place in their rental.
And then there is the problem of meth’. The use of meth’ appears to be increasing, and the testing regime is far from perfect, not only in the detection but also in the threshold levels deemed to be safe. This is putting residential landlords at a greater risk of having to “decontaminate” a property at great cost when the actual risk to health is debatable. Drug-taking is very unlikely in long-term commercial tenancies.
Commercial property investment is not without risk, but it is more to do with the location and suitability of a property, as well as the gap that can occur between tenancies. One investor says, “If the tenant stops paying the rent and has to be removed, it’s much harder to fill the vacancy again. In residential you just drop the rent a bit and get a tenant. But in commercial, you might have to drop the rent a lot to get another tenant, if times are difficult, or you might have to wait it out and carry the vacancy.”
There is also an issue of finance. “The deposits required are higher, around 35% to 40%. But interest rates are higher too. And when going to the bank, you need to provide them with information about the lease, the value of the building, the tenants, and so on”.
Commercial rentals require a good understanding of lease agreements, but there is a good body of case law in this area so when legal issues arise they are usually well defined. The standard commercial lease agreement is also more favourable for landlords than residential tenancies. “There are longer-term leases and tenants pay 100% of outgoings. The combination of better, less demanding tenants and improved costs was the biggest attraction for me. But on top of all that, the returns are great”.
His advice to those starting out in commercial property is, “Buy in the right area, be sure it’s a good building with decent tenants and it will be hard to go wrong”.
Residential property investment is not without its attractions: Tenant demand is strong and is likely to remain so, and house prices have shown very steady growth in the long-run. But as a result of the political onslaught against residential property investors, some are waking up to the fact that there are alternatives. If this trend continues – as is likely – there will be fewer private sector landlords. The rental housing gap they leave will need to be filled by state housing or the rise of social sector housing – which will come at a very significant capital cost to taxpayers.