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How to buy into commercial property

07 Feb 2007
Many investors watch late night infomercials and dream about buying properties with no money down. They want to make big returns in just 30 days! But is it really as simple as that? Kara Michaels investigates.

What do I need to know before I buy a commercial property?
Yes, it is possible to get creative with financing, but the truth remains that investors should have enough discretionary money set aside specifically for investing.

And even if 100% financing was a possibility, payments would still be due for some pre-closing and closing fees. Some of these fees include appraisals, environmental reports, credit reports, document preparation, loan origination, etc. Money in reserve is also needed to take care of any maintenance or legal issues etc.

How much money should be in hand?
According to Bernard Gordon, owner of Brightridge Properties, the rule of thumb is that one requires a 25% down payment of the value of the property. "The cash reserve thereafter, in case the property sits empty for a certain period of time, should include a multiple of the monthly bond repayments – ideally for a six-month period," he says. "For pre-closing and closing costs, 2% – 3% of the loan amount should be budgeted for.

"It might well be that all that has been budgeted for is not needed as a lot depends on the lender and his requirements. But it is wise to have the money set aside just in case."

The money needed for reserves once the property has been purchased also depends on the condition of the property. Questions that need to be asked include whether the property will need any big ticket items in the near future, like a roof? Will the parking lot need to be re-paved? This is information that will be obtained during the due diligence phase of buying the commercial property. As a rule of thumb, budget at least 1% of the property value as reserves. Also, some lenders will require that a portion of the monthly income from the property be maintained in an account for these types of maintenance issues.

Where can the money be obtained?
According to Gordon, banks will lend investors approximately 70-75% of the purchase price of a commercial property, provided certain criteria are met.

"An external valuer, appointed by the bank, will be required to verify that the purchase price is market related. If the valuer deems the purchase price to be non market related, the bank will adjust the loan according to the value accorded by the valuer to the property," he says.

Secondly, Gordon stresses that of great import to the bank is whether the property is income producing, whether it has a lease in place for a reasonable period of time, ie three to five years, whether it has strong tenants, and whether the net income generated from the property is sufficient to cover bond repayments on a monthly basis. "If an investor wants to buy a commercial property for R1 million, he is likely to get a 75% loan from the bank and have to raise the other 25% on his own. The bank will make provision for monthly operating and maintenance costs, and will ensure that the net rental generated thereafter from the property is adequate to cover bond repayment on a R750 000 loan," he says.

"As a last condition, the bank will look at the borrower and his financial standing, and will require surety for monies borrowed.

"And let it be emphasised that being wealthy does not mean a loan will be forthcoming. A bank's philosophy for assessing whether to finance commercial property hinges on whether the property can stand on its own two feet. So if a wealthy investor wants to buy a vacant property, he might well have to sign for collateral and cede other assets.

"Overall, one of the reasons why it is so difficult for many would be investors to get bank loans to purchase commercial property hinges on the fact that very few people have say R2,5 million, ie 25% of the cost of a commercial building worth R10 million, to hand over to a bank as a cash down payment."

Protect yourself!
We live in a litigious society, where anybody can get sued over anything. It is therefore wise not to own an investment in commercial property in one's own name. Gordon advises putting it into an entity where it can be ring fenced. "This would serve two purposes, the one being protecting the asset from other creditors and secondly protecting assets outside the entity from any liabilities pertaining to the commercial property," he says. "Putting it into a (Pty) Limited is advisable or setting up a trust which then owns shares in the company which owns the asset is another option." – Kara Michaels

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