Episode 165 | Investing in commercial property| Steve Palise, Suburbanite

Commercial property, is it worth investing or avoid risking?
Steve Palise is a commercial property buyers agent, who started his career as an engineer but found his passion in commercial property. He has helped thousands of clients secure and purchase properties across every state and has achieved amazing outcomes whilst reducing their risk. In this episode Veronica and Steve discuss the intricate differences between commercial property and residential property; how it grows, why people invest into it and how it can add to your portfolio.
Here’s what we covered:

• How does commercial property investment differ from residential

• What type of investor buys commercial property?

• What are the options to getting into commercial real estate?

• How do you minimise your risk with commercial property?

• What due diligence needs to be done when commercial property?

• How is commercial property valued?

• Is capital gains a big part of the value proposition of commercial property?

• How is interacting with the tenant different from residential property?

RELEVANT EPISODES:
Episode 160 | Soren Trampedach
Suburb Trends November 2020 | University Towns

GUEST LINKS:
Buy Steve Palise’s book: https://www.paliseproperty.com/ 

HOST LINKS:
Looking for a Sydney Buyers Agent? www.gooddeeds.com.au
Work with Veronica: https://linktr.ee/veronicamorgan

Looking for a Mortgage Broker? www.wealthful.com.au
Work with Chris: hello@wealthful.com.au 

Send in your questions to: questions@theelephantintheroom.com.au

EPISODE TRANSCRIPT:
Please note that this has been transcribed by half-human-half-robot, so brace yourself for typos and the odd bit of weirdness…
This episode was recorded in February, 2020.

Veronica Morgan: This episode is all about commercial property. It's known to be riskier than residential property, but why is that? And given the sector spans retail industrial office space from small shops to office blocks, how does the average investor even know where to start

Veronica Morgan: Welcome to the elephant in the room? This is the podcast where we love to talk about the big things in property that never usually get talked about. I'm Veronica Morgan, real estate agent buyer's agent co-host of Foxtel's location, location, location, Australia, and author of auction ready.

Chris Bates: And I'm Chris Bates mortgage broker. Before we get started, I need to let you know that nothing we say on here can be taken as personal advice. We always recommend you engage the services of a professional.

Veronica Morgan: Don't forget that you can access the transcript for this episode on the website, as well as download our free fall or forecast report, which experts can you trust to get it right? The elephant in the room.com did I, you We're joined today by Steve Polisi, author of commercial property. Investing explained simply and buyer's agent as well. Steve's been buying commercial property of all shapes and sizes all across Australia for some years now. And we figured it's time we delved into this topic. So thank you for joining us, Steve. And I will say very quickly, Chris isn't with us, unfortunately, he's been called away. So it's just you and I, Steve, and thanks for coming along. No problem.

Steve Palise: Thanks for having me on.

Veronica Morgan: So look, my business is all residential. We except for owner occupied commercial, we don't look at commercial property for investors, and I'm often asked questions about on our Chris and I have talked about doing an episode on this. So I guess, give us a quick snapshot that how does commercial property investment differ from residential? What are the sort of the key point is here?

Steve Palise: Okay. So the main difference is obviously residential that someone's home, where they're going to live. Whereas a commercial property is any property where a business operates out of. So you can obviously have a mixed juice. You could have a residential property and a commercial under the one roof, but it's generally any property that.

Veronica Morgan: And so from an investors point of view, there's some reasons why an investor would look at commercial, but there's also some challenges that they would have that they won't have when they're looking at residential. Can we sort of tap into that and understand a bit about what that is and what those challenges are and why they come about? Okay. So one

Steve Palise: Of the main reasons people go to commercial property is obviously the cashflow. So you get a much, much higher cash flow. Like we're generally talking five to 7% net yields. And I use the word net because with residential, you typically refer to a grocery orders, you know, whereas with the commercial space, normally the tenant will pay a hundred percent of the outgoings. So basically the rent you're getting minus whatever loan you have on the property, that's the return that you're going to get. The reason why everyone doesn't just flock to it is it does a much more of an online space. There's, there's a lot more moving parts in residential. Yes, you need to look at all the usual fundamental. So like infrastructure spending, population growth migration to the areas, things like that, but then you also need to understand businesses. So you need to look at because when you buy the commercial space, you're also somewhat investing in the business. That's going to be there. And then just analyzing that type of area is going to be completely different for depending on what commercial space you buy. Like a retail is going to be more dependent on foot traffic and flow. Whereas industrial space is going to be versatility and exactly where it is in what area servicing and then office space is obviously it's got to be near the people that actually need to work there.

Veronica Morgan: You sort of answered one question really, which is one of the reasons that people invest in residential properties because they think they understand it because they live in it. And probably one of the hurdles is that lack of understanding, which is actually very interesting. And it's a good point because I would argue most people don't understand residence property either, but, but commercial is a lot more complicated. And you've just said that you've got to actually understand the nature of the business and the activities that go into that. Now, there, there there's a lot of change. Obviously 20, 20 last year was, was full of change. And it's accelerated a lot of change, a lot of in a lot of aspects of our lives and certainly in business. But before that, even there's been change in terms of retail, moving a lot of businesses online, warehousing, you know, drone deliveries, all sorts of movements. How do you see, I guess, where, you know, and let's look at small investors for a minute, right? Because you know, high net worth investors can go and spend multi-million dollars on, you know, shopping centers and office blocks and that sort of stuff. But the indivi, you know, most individual investors aren't spending that sort of money on an, on a commercial investment. Right. Would that be fair to say?

Steve Palise: Yeah, exactly. And then that's one of the misconceptions as well, because we hear the statistics about like our retail spending down. But like you said, it's only the millionaires and billionaires buying that the mum and dad investors, they're not going to go out and buy a Westfield shopping center. So that statistic doesn't really apply to them. They need to be looking at the suburban stats. So what, how are cafes doing and hairdressers and barber shops and now salons and things like that because they're the ones who are probably the most likely going to buy. And so how, I mean, where do you start? You just got to educate yourself much like residential you'll, you'll naturally gravitate towards one type and then you'll kind of dive deeper in that field. I generally recommend if you were going to start out go industrial. The reason I like industrial is you can get a little bit of comfort in the numbers.

Steve Palise: So like if you're going to buy a small industrial warehouse, you can look at all the other warehouses in that complex and they're joining complex, what they rent for, what they sold per four per square meter, find the ones that went vacant, how long they'll vacant for. So you can get some confidence in those types of numbers, whereas going out and buying, I don't know, like a freestanding medical building, for instance, that one's a bit harder. It sounds, sounds like a really good tenant, but you're not going to have 30 comparables. Like you're going to with the industrial,

Veronica Morgan: Actually, that's a really good point. And I want to unpack this in a number of different elements to this, right? First of all, you know, you're talking about an industrial unit, which is effectively in a strata building, correct? Correct. where they're built and you, you see them around and there's, there might be 20 say industrial warehouses, fairly small ish in the total scheme of things where the central driveway and car parking lots sort of stuff. And you're absolutely right. A lot easier to price that, but not very scarce, correct diskette. And because he in residential scarcity matters to scarcity matter in industrial as well.

Steve Palise: It definitely does, but it depends where you bind. So funnily enough, vacancy rates for industrial amendment are actually quite taut. So like Sydney is 2.2 Melbourne's 2.8% and Brisbane is 3.2%. So you'd actually can get that but much like residential's, it's all about checking and doing the due diligence because if you buy an industrial complex and it's completely surrounded by residential properties and there's nothing on the cards for them to be building any more warehouses, you know, that's a fairly secure investment. As long as population growth, increasing demand for that industrial space is going to be increasing as well. And a lot of the times it's only three to six months vacancy, which I know is going to scare off a lot of residential investors. They're going to think, Oh, three, six months vacancy. That's ridiculous. But on average, you're going to have the tenants seven to 15 years.

Steve Palise: So it's actually not that much different to having a residential property where you lose your tenant every two or three years for a few weeks. So that's also one of the reasons why I recommend industrial spaces. It's a really versatile asset and they normally get filled a bit quicker because anyone can move into our commercial space, like an industrial warehouse. Like it can be a car mechanic, a wholesaler fabricator, distributor storage, things like that. Whereas buying something like the medical center, I said before, that's generally going to be stuck as a medical center. So if you ever lose that tenant, there's not a thousand doctors putting up their hand to take over a failing medical center. So it's about versatility and getting that kind of, that, this reducing the risk, getting the cash flow, but trying to reduce the risk.

Veronica Morgan: Now it's, you know, back in my early days in real estate, you know, I was told certain things. And one of the things I talk about with a lot of our clients as well, is that, you know, there are, there's all these rules of thumb in property, certainly in residential, then there's exceptions to the rules. And I suspect it's probably similar in in the commercial space as well. For instance, we were always told that you know, there's, there's offices, there's retail and then there's industrial. And so there's, if you're going to have retail and commercial industrial, I think as basically, and whenever there's a property, boom, you know, industrial's the last one to take off. It's always the first one to slow down. That was what we were told. Is that true? Is, does it, is there anything in that

Steve Palise: Generally not, it's going to be case by case maybe 50 to kind of 30 years ago. Yes. But with e-commerce and things like that, now it's a different world. So even like the next five years is going to look completely different in the office space, for instance, because of COVID and people are working from home. So I try not to make any blanket comments because it's, depending on what asset you're buying, where you're buying and the longevity of that asset. So it's always going to be case by case.

Veronica Morgan: So what options or we talked about getting into for that, for someone to start off looking at industrial is a safe way because of the, basically, because of the, the information you have at hand to be able to compare one property against another. And I guess in a way that's the versatility of tenants. So you've got like nice spread spread there, but you also got the ability to be confident with whatever price you pay beyond. Yeah, because I mean, and that's another thing that I learned early on in property is like, if you're trying to price it, residential property based on yield, well, you're going to be wrong. But if you, you, you need to have yield in, in mind when you price a commercial property. In fact, to value a very early on said to me, that is the only way to value a commercial property. Now I suspect that's not exactly the truth or, or exactly the full story. How do you go through the process? Not just of industrial, that sort of easy, because as I said, you've got comparables, but how do you go through the process of working out what's the right price to pay?

Steve Palise: Yeah. So what do you alluded to before the commercials are generally priced off the yield that they're returning, but it's going to be still case by case because having a really strong tenant is going to reduce the yield. So you can actually going to pay more for that type of asset than say something that's on a one year lease and then something with a really expensive fit-out you might pay a little bit more as well. So it's always going to be case by case, but you're actually right. They, they are priced on the return and the rules of thumb do apply. So like something like a warehouse, and that's why industrial. I said, it's good for the beginner. Is there that rule of thumb is going to be pretty generic and work 99% of the time, because it is just floor space and some concrete tilt up panels. So you can kind of compare 200 square meter warehouse with another 200 square meters, but then you just kind of lick your thumb and say, Oh, well, this one's got a five-year lease versus a three-year lease to strong business versus a weak business. Things like that. Much, much like residential, you can generally kind of value a house, but one with a nicer fit out for instance is going to go for a bit more.

Veronica Morgan: Yeah. And so with residential, right. And it's another bit of a mess, but you know, it's a truth, but it's a myth at the same time, it's got exceptions to the rule that, you know, the value is in the land. Right. But in residential, the land's got to be in an area where land is valuable for that to really matter. So with industrial or commercial, if you're basing the value on what you pay on the yield and also the offsetting, the risk of finding a new, you know, so if you've got a good tenant in places, there's a level of risk that you don't have there. Right. And so that's worth something, these all sort of external measures, aren't they? I mean, like if, if something major happens in terms of the business you know, if, if that, if that becomes an obsolete business or a whole whole industry is obsolete or that tenant sort of vacates after nine years and, and the, the actual estate is not invoked or, you know what I mean? You've seen some that are a little bit like ghost towns. How does that impact on the actual value of the property? Yeah.

Steve Palise: So it's a similar to residential. It's like buying a residential property in a mining town and the mine closes that becomes a ghost town. You lose a price there. The, the difference with commercial is yes, you can get burnt if you don't know what you're doing. Whereas with residential, if you're buying a good fundamental capital city property, worst case is you might have some big maintenance bills and things like that, whereas commercial. So you buy a retail shop and it's extreme back from the main street. You can't compare the mainstream properties with that straight back because they've got completely different foot traffic. So the chance of vacancy is much, much higher if you don't know what you're doing. But like you said, with different industries, I try to buy things that are really versatile and going to be there. Long-Term like, I stay well away from petrol stations. Cause I don't know how that Outlook's going to be over the next five, 10 years with electric cars, much. Like I see lots of banks going on online and they're on really, really strong eight, nine, 10% yields, but I won't touch them because I don't think there's going to be a bank where you actually walk into in the next five years. I, I personally, haven't walked into a bank in five years.

Veronica Morgan: It's actually funny, isn't it? Because the banks have actually been offloading their investment portfolios over quite a few years now. Is that in there? I mean, they know what they about to do, don't they? Yeah.

Steve Palise: [Inaudible], I've heard from some people in industry that reducing It by two thirds. So it's going to be a third of what it was and there's no need, you're walking into a bank now and it's, it's 99% like space. Like there's no one, there there's one person at a desk and maybe someone like behind the counter and that's it. So yeah, that's a shift in industry as well, but that's why I kind of recommend buying like industrial because there's always a need for floor space, especially if you're in a scarcity.

Veronica Morgan: But it's, it's interesting because, you know, I talked to a lot of people in a lot of different industries and the offshoring for instance, has also reduced pressure on office space in recent years. And yet there's a lot of businesses, large businesses bringing our shoring back into this country. So they need desk space. And so there's sort of a bit of a moving feast here, but what do you see in, in that space happening?

Steve Palise: So I generally avoided office space even prior to COVID. One of the, one of the reasons for that is for me, it's, it's similar to like a high density apartment. You're not actually getting the land component, you're buying something for airspace and purely demand. And for me it's risky because if you're buying an office space and say a 20 story skyscraper, and then next door is a three-story one and they knocked that down and build another 20 story one, all of a sudden, there's going to be pressure on your rent to stop your tenants from leaving if you're at the end of a lease. So I've never really bought them, but just generally, it's going to be a bit of a shifting space. Obviously the big companies in the city going to downsize the people I speak to they're calling it the hub and spoke model. So they're going to downsize in the CBD has been then open up little kind of satellite ones around the fringes of the city. And that way they can actually get more talent as well because they can get people that live three hours away or so that they're happy to drive in an extra hour, two or three times a week to their job. So it actually increases their data pool there.

Veronica Morgan: Yeah. We in interviews are on from, Oh, work club, a couple of episodes back. And we did talk about that exact exact change that's on the horizon. It's sort of interesting. It's a bit of a moveable feast as well, because let's face it, you know, the whole hybrid model of working in the office, not working in the office, working from home, all that sort of stuff. It's still, it's still sort of settling, isn't it still sort of really taking shape. So what about, so, okay, so that's, we've talked about office, you don't love it. What about those? And we'll get to regional in a minute. I mean, you talk about industrial being, you know, lesser risk for a new or first time commercial investors. What about the retail what's happening there?

Steve Palise: Yep. So retail actually still quite like, so I buy a lot of regional retail or what I call like suburban retail. So like I call it essential retail. So that's the ones where you need to go face to face. So like a physio or a Baba or hair salon or nail salon or takeaway or cafe or something like that, where you're generally gonna go face to face. But again, I'm not going to buy like the ones in the big shopping center. I'm talking about the little strips in the suburban town where there's might be 12 in a row kind of thing. And they service that area. I don't mind those funnily enough, a lot of those like cafes and things like that in those suburban areas have actually increased their business since COVID. So it's all about just analyzing the market, what they're servicing, what the foot traffic's like, where people are working from. And yeah, that, that one you can be safe because you can, you can look at what future developments are on the cards and if they're the only retail and that population is grown in, they're not going to build anything that's going to compete with it. You know, you're going to have five, 10, 15 years of kindness.

Veronica Morgan: It is sort of interesting that you know, cafes has seen increased traffic. And a large amount of that I would imagine is from people working from home. So that it's distributed that from, from the CBDs. But you know, you drive down Oxford street for instance, in Paddington, in Sydney and there's Felice signs. It looks like on every third shop. I mean, clearly the idea of small suburb, you know, strip shops being a good investment isn't necessarily the case everywhere. What, what's the difference between say something like they're there and a regional town

Steve Palise: It's just going to mean on the amount of stock that's on the market. So funnily enough, regional most regional retail is quite secure if you buy in a good regional area because the vacancies are really low because there's only Spire stock, they've got their main street and that's it. So if there's only one vacancy in 30 shops, for instance you know, you're probably only gonna be looking at as a six to 24 month as a worst case vacancy. But then something like a CBD, the stock can just be supplied and it depends where it is as well. So I used to work in Bondai junction and the main streets near the Westfields were fine. You literally go 20 meters away from those streets and there's vacancy signs everywhere. So I, I prefer the kind of suburban retail just because, you know, what's there, that's it, they're not building anything in the future. You can get some comfort in those numbers. But again, you need to do your due diligence. It's going to depend on what you're buying and where you buy.

Veronica Morgan: Now, you said, you know, you might have a six to 24 month vacancy. No, that would strike absolute fear into the heart of most property investors. And obviously, you know, banks deemed commercial property to be riskier than residential because, you know, obviously you need a higher higher equity to be able to get it, to borrow the money, to get into it. And obviously you got to have pretty good cash reserves to be able to fund a period of time up to two years without a tenant. You know, how do people stay the course? You know what I mean? That you'd have to have an enormous amount of faith that you've actually got a decent asset. If you're potentially going to be sitting without a tenant for two years,

Steve Palise: It is. And that's why you need to know what you're doing with commercial. Like with residential, like I said before, you can buy a mediocre property in a okay suburb and you're going to be okay. Like you might be 50, a hundred bucks a week out of pocket with interest rates way they are, but commercial, you need to be prepared for those kinds of longer holes. Generally, any times in my personal commercial properties are coming up for lease renewal, I'll make sure I have minimum 12 months worth of cash for the interest repayments on that debt. So I can handle that vacancy, but then it just going to depend on the individual, like if I've got a mum and dad investor and they don't own any investment properties, I'm not going to throw them into a commercial, but if I've got a high income earner or a low risk client, then you can look at that. Or if they've got a large residential portfolio ready and they're trying to beef up their cashflow.

Veronica Morgan: Yeah. But okay. So what due diligence needs to be done? I mean, you talk about doing your research and doing your due diligence, but how do people sort of get some certainty that they are actually buying without taking enormous risks?

Steve Palise: Right? So there is no certainty of this game, but generally you just want to tick as many boxes that you can. So obviously the first one you're going to check is the area. So I just find out much like residential, find out what the area is doing, what the population growth is, where the infrastructure's going, where people are commuting to and working from what areas that that region serve services. And then once you find the property, whether it be industrial or retail or office then you need to look at the, for big one for me is the vacancy rate. So try to do as much due diligence as you can, to find out what the demand for that type of property is. And that's equivalent to effectively the vacancy rate, because if it's in high demand, you're going to have a low vacancy rate.

Steve Palise: If it's in low demand, you're gonna have a high vacancy rate. So I talk to property on the ground as the first way. That's probably the quickest way for them so they can find out cool. When stock comes on the market, how long has it sitting there for? And then what demand it is, then you can start actually going through all the comparables. So find the leasing rates per square meter, what people purchase them for per square meter, and then just start ticking off those boxes. Then you're also going to have to look at the business. So how long has it been business operating? Do they have multiple stores or locations? What's the length of the lease? Then you're gonna have to do a full lease review as well. So you're going to have to check things like there's, there's bonds and guarantees on commercial basis.

Steve Palise: They need to understand leases. So you'll go through all that. Then you'll look at things like the versatility of the space you're buying. So if the tenant ever leaves, what can you do with it to get a tenant in quickly? Then there's also value add opportunities. So making sure they're paying like fair market rent, can you add any extra streams of income on top of it? Can you renovate it? Things like that. So there's a lot more moving parts in the rods, residential, and that's why you need to be well-informed before you just go and buy one.

Veronica Morgan: Yeah. There's, you know, I think that's preaching to the humble to the choir here in terms of being well-informed. But one of the thing that I find, you know, whenever I, as I said, we on occasion, we don't do a lot of it. We do help owner-occupiers by commercial. That is when an owner of a business actually wants to buy a commercial space. And certainly what we know is that the access to information on commercial properties is a lot less ready than it is for residential. Now. Do, do you agree with that? Do you find, or was it just because you do it day in day if on it,

Steve Palise: No. No, it's, it's very tedious. So it's not like residential where you just type in, Oh, what's the vacancy rate of this suburb and it kind of pops up on Google. You, you actually need to go on something like core logic and actually click through every single comparable. See if they had a sales campaign, how long it took, what rate they ended up getting speak with agents, speak with property managers, every property you do, the due diligence is very tedious. It's not as easy as clicking send like you can with residential.

Veronica Morgan: Yeah, it's totally murky. I have to say it. The other thing I thought was really interesting as well is because and I actually went and I didn't actually buy it, but I was looking at a commercial building for my own business some years back. And I marveled at the fact that I didn't actually need to register to be that, that auction now in in new South Wales and in, in many States you do need to register to bid at auction. And I think from what my understanding is that the assumption is that, or the premise is that, you know, if you're buying a residential home, you're not necessarily a savvy or educated buyer, but if you're buying a commercial property, you're assumed to be an educated buyer. And so you don't need to actually go through the registration process. It, I think that's a bit of an interesting, have you ever sort of pointed?

Steve Palise: Yeah, but the commercials also a little bit of an unregulated space as well. It's like, besides the retail leasing act like industrial things like that, you can actually have whatever criteria you want on a lease. Like you can literally negotiate everything. So it's basically just like a personal transaction between the two parties. So it's a different space. There's no governing body or anything like that. It's yeah. It's a little bit wild West.

Veronica Morgan: Yeah, it is. And you obviously need to get a lawyer involved in the negotiating of that lease if you're, you know, if you're renting a space or if you're actually owning a commercial property and leasing it to someone else, there's no standard residential tenancy agreement that you can, you can try it out. So obviously your costs and your advisor costs are going to be higher as well, right?

Steve Palise: Yeah, it is. But not, not greatly. Like you might pay an extra couple of grand for a few legal fees and things like that. But when you're spending hundreds of thousands of dollars, I wouldn't put that to put people off.

Veronica Morgan: If you like, what you're hearing here, please share this episode with others, you feel would benefit. And while you're at it, why not leave us an iTunes review five stars, please. Every review helps make it easier for other people to find us and hear what our amazing guests have to say. We love hearing your questions and we're planning more listener Q and a episodes. Please send your questions in. You can send them via the website, which is the elephant in the room.com today. You or directly via email to questions@theelephantintheroom.com did I, you, we did talk earlier about, you know, the type of investor that can buy a property and you did sort of allude to different types of investors might buy different types of properties. Can you give us a bit of an overview as to who might be right to invest in commercial and who might not?

Steve Palise: So they're the first people that would buy commercial, obviously slightly high net worth people that can handle the longer vacancy periods. But if you know what you're doing and you're trying to build a passive income quickly, commercial is going to get you there a lot quicker. Like if you go out and generally buy a, say a $500,000 commercial property on a 7% net yield with interest rates, the way they are now in a 70% loan, you're talking about 25 grand a year, passive income. So when I, when I pose it like that to people and say, look, you could buy two, $500,000 properties, and you've got to have a small passive income of $50,000. They start kind of scratching their head going. There might be something in this like early retirement might actually be possible. And the other four kind of point out the fact I'll point out is a commercial property on a six and a half to 7%. Net yield actually pays itself off in less than 10 years. So having a debt-free property in 10 years and a large passive income, it can give you a cashflow quickly compared to residential property. So anyone who's just looking to diversify or build a passive income or can take on a little bit more risk, I'd say commercials, right? For them.

Veronica Morgan: I want to talk about the risk because the, you know, I'm, I'm sitting here, Whoa, Oh my God, what am I doing? You know, what have I been doing? Focusing on residential and my ears are perking. And the problem is that, you know, I'm not disputing what you're saying, but I am, I am mindful that a lot of property spruikers come out with similar claims. Right. And you know, and I'm talking about property, spruikers, spruiking, you know, residential crap. So it's compelling, but there's never that sort of opportunity without risk. Correct. So can we talk about the risks?

Steve Palise: Yeah. So the main one with commercial is obviously the vacancy period, like cars buying the mediocre residential property and having a tenant is fine. Buying a mediocre commercial that sits vacant for two, three years. That's actually going to put a big halt to your investing as well because banks aren't going to lend to you because you all of a sudden going to have this debt with no income coming in. So that's why I always try to buy the really low risk ones, the ones with the versatility but the, the risks oversee the tenant defaults and can't pay the mortgage. So the only thing you're going to get out of them is either the bond or you can actually get what's called a personal guarantee on some releases. So a lot of the business owners will actually put their like house or something like that up for collateral to pay out their lease.

Steve Palise: So you can actually mitigate that, that way if you're getting a personal guarantee. And so if you're on a, say a five-year lease, you at least know, call I'm most likely going to be good for those five years after that, that's the unknown because if the market shifts and COVID hits or world war three, kind of erupts like that, that's, you're not going to know about people are still going to need a roof over their heads. Whereas businesses shift with time goes on. But for me, it's, it's just similar to residential, just do the due diligence, tick all the boxes, be aware of those risks, that longer vacancy period. And you're generally going to be okay. Long-Term like, I'm not saying it's no risk. I'm just saying, there's a way to get really high cash flow if you know what you're doing.

Veronica Morgan: So on that, I mean, certainly when it comes to residential, I would say don't ever buy for yield. You know, you've, you've the yield's not good enough anywhere. And if it is then you, capital growth is going to be in the toilet. So, you know, we're talking and, and yield and risk sort of you know, we'll you as a function of risk, really. So how do you look at the growth side of things or is it just not something you worry about?

Steve Palise: It depends what purpose you're buying for. So a lot of the times I'll actually buy in a much better Bluetooth area for tenant, but they'll actually get less return on the cashflow. So we'll get like say a four or 5% net return, but we're buying a really good Bluetooth asset. That's going to have the capital growth, but just a point of note is commercial properties actually do grow on average. They do, they grow five to 6% per annum long-term and they actually have to otherwise you'd end up with residential properties being $5 million, and then you'd have a warehouse sitting next to that for 500,000. So there has to be some parody that actually has growth. I think a lot of that comes from actually office spaces don't grow. And that's much like the argument that high density apartments don't grow the same as houses, but it's very hard to get a solid stack with commercial because what are they talking about? Are they talking about office spaces? They talking about retail. Are they talking about warehouses or here? Here's the one. So like the example I used before, if you buy a medical center, that's say a converted house, what growth is that going to have? Because it's a residential property has bare bones, but it's got a commercial tenant in it. So that one, theoretically, you could argue, you get the best, both worlds.

Veronica Morgan: Although a lot of them are located on main roads and they, they, they cop it for Capricorn.

Steve Palise: Yeah. But it sounds like residential, you buy something silly and you don't get the capital growth.

Veronica Morgan: Yeah. Yeah. So, and look, I think that also comes back to that lack of clarity in the data and being able to pull it apart and understand on a micro level. I would suspect I'm putting words in your mouth here, but it's much the same with, you know, with investing in residential property. If you, you, you can't use macro data to make decisions on a micro level. And I'm guessing it's a little bit the same, but even harder really because you finding even more difficult to pull out that individual information that actually gives you or points you in the right direction for a specific type of property in a specific area.

Steve Palise: Yeah, that's right. And commercial commercial grows in slightly different cycles is what a residential is not going to precisely follow it. Obviously the economy is going to drive it, but then just demand for that type of tendency. Because if you've got a commercial investment, that's really high demand, that's going to push rental increases up. And as we discussed before, how it's priced off the yield that you're buying, if you get 3% rental increases a year on year, that's going to effectively acquire to 3% capital growth year on year.

Veronica Morgan: There's an element of fashion though. Isn't there. I mean, see, the weird thing is, so in a, you talked about a building, you know, an office building scenario where another one might be built next door and all of a sudden it's, it's newer, shiny. And so building an owner of an, of an office suite, for instance, he's going to have to entice their tenants to stay rather than move to the shiny new building. So there's, it's a little bit like brand new apartments. I think there is probably that similar that that comparison there, but there is an element of fashion right. With these buildings. And so how, how do you avoid that?

Steve Palise: Well, as I kinda mentioned before, I actually stay away from office buildings. I just don't like them as an investment because as we mentioned before as well is a lot of the growth comes from the land as well. So I like to buy industrial or retail that has a land component. So whether or not you own it, you still have that significant land component for the space. Yeah.

Veronica Morgan: Yeah. But even with industrial, like, you know, the old, you know, pebble Creek, industrial warehouses, you know, there's an element of, there's certain types of businesses that are going there wouldn't care, but there's others that, that won't want to go there, you know? And there's, there's gotta be an element of trend around that and, and finishes and all that sort of stuff in that space too.

Steve Palise: Yep. And then that's part of, that's part of the due diligence as well, Veronica. So like funnily enough, some areas the lower cost warehouses are actually in higher demand than the nice ones, because if that area is servicing, like, I don't know, it's an industrial area where they're just like, they're shipping. So say you're next to a port and it's just for storage of stock before they put it on a boat. That one doesn't have to be all fancy. They don't actually see any, any clients. Whereas the industrial ones that might have some, face-to-face like a mechanic or something like that, that obviously needs to be slightly nicer. Then if you've got like a, a new age company, that's got like a lot of honorary robots or something like that in the warehouse, they're going to want something newer. So it's all about assessing where you're buying, what the tenants want in that area. There's going to be rough areas that kind of do well. And then there's going to be really nice areas that do well. And then there's going to be the mix in between.

Veronica Morgan: So you can't judge a book by its cover. What about zoning? Because you know, the biggest uplift anyone's going to get in their property value is really on a one-off zoning change. Right? So, and I was driving through America the other days, driving through Alexandria the other day, it's in Sydney, we're talking in Sydney and these are, these are in an urban areas and there's a lot of this light industrial properties around there. And you can see the, see the signs of some of them are really just getting gearing up to, to be converted, to residential, to be read developed. I should says residential. Is that something that, I mean, that's obviously risky cause you're, you're betting on future developments in areas, but obviously that's a big uplift for someone who's getting investing in in industrial property potentially. Is that something that you get involved in or what's your thoughts on that?

Steve Palise: Yeah, so I, I always buy with today's data, not tomorrow's data, so it might be Susan, that would be for me a value add. So when you've done all your due diligence, you say, I'm happy with this property. What are the value adds? You'd like value add is zoning change in this area, which might give me uplift. Funnily enough, we actually work both ways as well with commercial. Sometimes it changing it to residential zoning can actually increase the price because the houses are in a better cycle than the commercial. And then on the flip side, obviously if you get in a better kind of square meter, right? I mean the industrial space changing a residential to a mixed use where they actually build more. But again, it's going to be case by case. It's can trying to try to do that for retail is going to be completely different to doing it for industrial.

Veronica Morgan: Yeah. Well, it's sort of funny too, because you do see these in certain areas you do see certain buildings that originally was a shop. For instance, it's on a main road and it's been zoned residential and it's like, well, nobody really wants to live in it. So it, yeah. It's, as you say, it's, it's downgraded the value of that.

Steve Palise: You got to analyze the market as well. Like I, I had a client bring to me a property. It was a cafe and it was a little freestanding building and he's like, Oh, this is great. They're building a 20 story apartment block next door to it. It's like, that would be increased the business. And I, so you're showing that we're building a retail underneath it as well, because I'll have a check me, come back. And he's like, yeah, they aren't. I'm like, what happens if it's a cafe? And then he's just like, okay, I might leave that property. Now.

Veronica Morgan: It's all about knowing the questions to ask

Steve Palise: Though, isn't it? Because that grew up there. There's all, there's a lot more questions to ask with commercial and a lot more unknowns as well. We kind of doing a bit of a thumb suck.

Veronica Morgan: So what, what are some of the unknowns that you, you know, that you come across? I mean, it's the same in residential, you know what I often say to our clients? You know, we know the questions we need to ask and we know when we haven't been able to get an answer and we can tell you that, and then you have to make a call. So what are some of those things that you can not find the answers for or you'd like to, and you often can't when it comes, advising your clients and buying investor buying commercial investment. Yeah.

Steve Palise: So there's, there's a lot, like you obviously got to look at the area and the tenant and the lease and things like that. But one of the things that's most different for, for commercial is actually talking to the tenants. Sometimes people aren't aware that you can actually speak to the tenant so you can call them up and I'll ask them, what's the grumbles in the area. Like who's the competition. Are they planning to opening more stores? How many people work in the business? That's a big one for me as well. So I'll really buy into one. That's got a business where there's just kind of one operator who manages everything, because if he, if he gets sick or has a kid or whatever, it may be, that business is really going to struggle. So I always make sure there's kind of two or three staff that can handle the location.

Steve Palise: But I dig deep into the actual business, how long I'd be there. And if you can actually get a good relationship with the tenant, you can actually both make money from it as well. So, so some of the times is they might not have the cash to do. Let's say a renovation on the property. So they want to say, you're buying a retail, like a fish and chip shop or whatever it may be. They, the building might be a little bit run down. They may not actually have the money to actually be able to do that themselves. But you doing it actually increases the value, but you can actually work with them where they pay for say, half of it, or you give them some form of incentive. So thank you. Say, I'll look, I'll, I'll pay for this. It'll cost me 30 grand, but over the next five years, I want 3% rental increases or you're on a two year lease. Can we extend it to five years? If I do this renovation and then a five-year lease property obviously sells more for the two year lease one. So you've actually increased capital wealth then by any phone, 20, 30 grand.

Veronica Morgan: So it's about being creative and a whole new level with Ann on that too. I mean, obviously when you say, when you lease a commercial property, you say you're leasing an officer or a retail store, you do the fit out, right. You basically get the shell. How does that work when you're buying?

Steve Palise: So the tenant would normally do the fit out, so they'll come in and fill it out. So that's, that's part of the due diligence is where you need to understand when you're buying it, who exactly owns a fitter and what the make good causes are as well. Because if they leave, are they leaving it? And it's, it's very important for things like like I own a cafe up in Brisbane, that's like $150,000 worth of equipment sitting there. So I need to know who understands that the banks also need to know who owns that. And the make good causes that are there.

Veronica Morgan: And what's some of the, what, what's the typical, what, what, what will be usual to expect?

Steve Palise: It's just make good back to where it was. But that's assuming that it's a simple property. So like if, if it was an empty shell or a warehouse or something like that, they'd go back to normal. So just the usual, like paint the walls and make it look clean and tidy. If there's a fit out though, there's always going to be discussion because if they've got kitchens and counters and stuff like that, and you think your next tenant is actually going to want that you may actually negotiate for them to leave it there as well, because there's no benefit then ripping it up and just putting it in a skip in. But but that's, that's the main thing with commercial. There's this, there's so many kinds of negotiations and unknowns. And because it is that unregulated space, you can literally negotiate everything. And on that,

Veronica Morgan: Certainly with COVID commercial tenants have had a different experience, I guess, negotiating rental changes or whatever, with their landlords than a residential tenant, it's been a completely different arrangement, right. So, you know, have you come across any stories in terms of, you know, good teamwork or bad teamwork, bad examples what's been going on out there.

Steve Palise: It's just, most of the time it's just working with the tenant. So like the common one I see with say industrial is they might have bought a bigger warehouse because I thought they were going to expand. And then in five years time, they're still the same size, but they've got a 30% over supply. So you can actually have a chat with them and say, look, how about we rent out the space and I'll give you a rental concession. So you get two rents that way. You've got two tenants and you're increasing the cashflow and effectively reducing this. So there are happy tenant because they've still got the capacity to actually expand. Should they need in the future? So the new tenant, you may put on like a 12 or 24 month lease only. So you, when we're there I've seen ones where just people go crazy with value, add, like they, they buy a retail shop and then they put an ATM machine in and they put telecommunications on top and then they've got solar panels and then there's residential built on top and things like that. You can go as far down the rabbit hole as you want.

Veronica Morgan: Actually, I heard recently the ATM's losing favor because people aren't using cash.

Steve Palise: Yeah. I don't touch ATM's anymore. I think they're their thing of the past. What else is a thing of the past? So the what'd we talk about for banks petrol stations I stay away from obviously like post offices and things like that, which sounds weird because obviously people are sending stuff a lot more, but I think the old conventional post office is going to need a shift into a, more of a kind of industrial type one where you're going and it's purpose built for sending things out and then taking all the patient center. Yeah, exactly. Right. And technology is going to take it out. There'll be, there'll be less people. You don't have to go fill out a form. It will be go walk up to a computer, press buttons, put it in a box and then the machine will take it away kind of thing. So the, the technology sector is going to change quite a lot of things. What else would they be?

Veronica Morgan: It's it's, you know, it's funny cause I've, I've sort of been observing and I may have got this wrong, but certainly there's been a bit of a market for investors buying post offices. I think that they're franchise aren't they? And then obviously then the actual building they're housed in, it's been pitched as being a bit of a safe investment, a little bit like defense housing to investors it's like on the surface. Oh yeah. How could that go wrong? But actually when you dig, you think, Oh, it's actually really shocking.

Steve Palise: It's actually quite hard for them to make money as well. Like when you actually do the sums and they're kind of turning over a few dollars every few minutes. It's not actually that lucrative.

Veronica Morgan: If you had gone into a postal shop, Steph full of junk, mind you, I think your books actually,

Steve Palise: It's next to property investing for dummies,

Veronica Morgan: Except for that, except for your book of course, and a few other books. But you know, it's interesting how it's like every time I go into the post office, isn't very often as I think your is, it's like, how the hell does this? You want to go there to buy a gift for their kid or something. Anyway, that's just a bit of a bit of a, a diversion. Now look, I do want to just sort of check in on the, on the regional side of things as well, because of course, you know, you've been borrowing all over the country. And so you'd be doing that for some years and, and residential property right at the minute is, and I'm talking about houses more so than apartments is going gangbusters in every CA in every city and regional center, it appears that throughout this wide country, it appears that it doesn't matter where you are. If you have a house it's going up in value, right. This buyers for it, right. The minute now that's take that with a grain of salt. I mean, it's it's but it is it's, it's unusual that it's, it's widespread now what's happening on the commercial side of things. Is there a knock on effect?

Steve Palise: Yeah, it seems similar. Like I mentioned before, there's going to be a parody between the commercial prices and the residential growth prices, but I won't buy in a regional town unless I'm happy with it as a fundamental investment. And that means, funnily enough, I actually need to be happy with the residential market there, cause that that's going to be the driver, like a driver for commercials, obviously, population using that service. So you need the population growth, so you need to be in a good growing area, but then you also need to look at all that periphery areas of where's that industrial space or retail space servicing. And how's it going to look long-term versus what the risks are. But I actually really liked regional it's it's, it's a nice kind of little bubble that you can actually buy into and have some,

Veronica Morgan: And they do go hand in hand you're right. Because I mean, certainly when we're looking at, at, at locations to invest in in terms of a home, a house you're looking at the infrastructure around, you're looking at the cafes, you're looking at the retail, you're looking at all that sort of that lifestyle element to it as well. And a whole area can start to gentrify off the back of a really cool cafe.

Steve Palise: Yeah, exactly. I've been, if you talking something like industrial infrastructure spending is you actually get increased demand for it because they need somewhere to store their machines and fabricate and have like bulk goods and things like that. So if they haven't built the industrial space and they're doing some major roads or hospitals or whatever, it may be that industrial space has actually become more in demand during those projects. But it's

Veronica Morgan: Quite short term though, isn't it, it depends,

Steve Palise: Depends how long the project is, but again, odd bite on today's data, not the future data. So if I'm buying it now and at the vacancy rates are really tight and they've got all this kind of backlog of stuff they're going to be doing over the next 10 years, I know it's actually going to be actually lower risk investment by buying into it.

Veronica Morgan: That's yeah. I mean, I think it's interesting what you say about buying in today's data. In that instance, I'd be a little bit worried personally, but in terms of the other side of things, in terms of not sitting there thinking, I look, you know, you're banking on a future zoning or future infrastructure. I think that that's a really good point because you know, it's the same with residential. You hear people go look, I'm going to buy on that area because there's an airport going in or there's a, you know, a road going in or a train line or whatever. And it's like, well, how, how sustainable is that in of property prices for the long-term and also ease it going to go in because,

Steve Palise: Oh, I was going to say most of the time they say that, and then 10 years later, they're still saying the same thing. And I don't know about you, but I try to get a return like in slightly less than 10 years on my residential investments.

Veronica Morgan: Yes. Well, that's, you know, it is very true. I look at Badgerys Creek as a great example. I mean, that's been measured for over three decades, so,

Steve Palise: But there's, there's so much data out there to show that you don't actually need an airport to have growth. Like there's plenty of regions in Australia of growth that don't have an airport like Byron Bay fall enough as being one of the best performers in the last kind of 24 months. Like it's, it's not.

Veronica Morgan: So when, when it is near an airport, you got bell and a half an hour away and you've got the gold coast an hour North. So, so in reality that that's probably, and then there's Lismore, which is much smaller. So in a way you just shoot yourself in the foot with that argument.

Steve Palise: Well, no, so they, they, they're not, they're not new airports though. They're existing ones. So that's the whole point that the growth has come in the last 24 months, there's been nothing of speculation or recent airport that's opened up next.

Veronica Morgan: Well, and this is the thing though, isn't it? Because the reality is, is after it's built and you know, in the longterm as to how it's used and all that and, and who we're brings to the air and the sustainable growth and the sustainable change over time. And so then when someone announces an airport is definitely not time to buy into it just in case it doesn't happen, but you need to be holding a property for decades in order to make, to make those gains.

Steve Palise: Just one of those kinds of flavors of the month. People love that. The other one they love is buying universities as well. And then I asked him so, well, what are the stats to show that universities actually grow? And that it's like, I don't know. Sounds good.

Veronica Morgan: Well, we actually did it at one of our suburbs trends episodes with Kent Lardner. I think it was back in November, if you, anyone wants to go back there. And we did actually do a whole episode on university towns, and we're actually going to interview a buyer's agent from Byron Bay in a couple of weeks. So we're going to be sort of digging deeper into that market as well. So there's, there's lots more coming on these, some of these topics that we've been running.

Steve Palise: Yeah. That's a point to note is also when you're buying my commercial property in those holiday towns, you also need to understand that holiday destination as well. So where are the people coming from? So like Cannes and those ones where you might get a lot of Japanese tourists, for instance, that's obviously hit a lot harder since COVID, whereas some local ones are actually doing so well. So that, that's another kind of thing you need to analyze when you're buying the commercial space is who is actually going to that tourist destination isn't seasonal as well. So some of these areas do really, really well over summer and then they're horrible and winter.

Veronica Morgan: Yup. I think that, you know, and that's talking about Byron Bay, it's probably a very good example as well, that it's a high S local as in Australian demand, you know, all the way up, up the East coast down the East coast loved going to Byron Bay right down in Melbourne. The bell is LA Byron Bay. So that as a, you know, that has that local demand. If you want to call it that rather than focusing on the overseas demand. And I think probably one of the reasons why, and also now with the big sea change and tree change thing, it's, it's highly desirable. And over years and years and years, you meet people, you always meet people that say, I want to retire to Byron Bay. So, you know, all of that stuff comes true. So it's just that general desirability and, and that's really where the money starts flowing when they feel it, that that's the time to do that.

Steve Palise: Exactly. Right. And there's a confidence in the market as well of is this going to be, is this going to be in demand longterm? And that's what we're talking about before much like with the commercial space.

Veronica Morgan: Yeah, absolutely. Save. If you got a property done by for us,

Steve Palise: I don't have one specifically, but the one I always see happens is people will go out and they'll buy something that I think is a really good price. They'll say, Oh, the cap rate of this area cap cap rate is just net yield. So the cap rate is 6% for this area. I bought this property on a 6.7% net yield. I've done really well. They've, haven't checked the comparable rentals and they've bought, got one where they're paying 20% above market rent. So then what happens after the tenant gets to, into the lease and then negotiate it back to market rent is they're actually lose 20% capital value. So that's, that's the most common one. It's just because people don't know how to check the actual comparable. So they'll go off what the real estate agent gave them. But they're going to hand pick some and square meter rates for instance, are going to change depending on the floor size. So like a big warehouse, rent's cheaper than a small one for instance. And they've just looked at the two or three examples and haven't done the dog work of actually sitting there for a day, clicking through all of them and talking to property managers on the ground.

Veronica Morgan: That's such a good example. It's a bit like people are comparing a square meter is rates on a, on a house, on a block of land, you know, exactly the actual dollar rate per square meter does go down the bigger the land is. But yes. Very interesting. So look, thank you so much, Steve, for sharing all this with us, we'll put the link in the show notes to your book, which is, do you want to say it

Steve Palise: Commercial property investing explained simply

Veronica Morgan: I think you do explain these things very simply. So I think that's fantastic and I really appreciate your sharing, sharing with us today.

Steve Palise: No problem. Thanks for your time, Veronica. We want to make you a better elephant rider and this week's elephant rider training is

Veronica Morgan: So in this boot camp, I just want to touch on buying in a hot market. We all know market's gone silly and it's gone silly across the country and it's pretty unprecedented, but he's unprecedented, which is a you a word that we're so sick of hearing, but every city is hot. Pretty much every regional area is hot too. Okay. That's really unusual. So there's a lot of money out there trying to buy a property at the moment. And you know, when I visit my sister in Italy, obviously it's a long time ago now or a long time before I get to do it again. And I always remember, it was funny just when to hear that smart cars couldn't get on the freeway or the outdoor strata. Okay. So the freeway where basically people just Fang it, you know, 140 is not unusual. You can't drive a smart car on a freeway.

Veronica Morgan: And to be honest, most buyers trying to buy in this market is a bit like trying to take a smart car onto a freeway eight. They're just going to get, it's just a whole world of pain and damage and fear and all sorts of palava going on. If you're driving a smart car, don't get on the freeway, you know, get some advice. And a lot of people look at to a buyer's agent. So I want you to be able to work a miracle to get what other people can't get. And the reality is if you've got a buyer's agents basically saying, look, you know, you've just got to pay more in order to achieve a property or I'll get it for less or literally silly sort of promises or I'll find the off market for you. That's not really the true solution to your problem.

Veronica Morgan: A lot of people think these things are the true solution, but it isn't the true solution. The true solution to your problem is making sure you buy the right property and making sure that you have in your head, the right amount of money you need to pay for that property and having a good framework for understanding which property you should push yourself for on price versus another one, not to push yourself. So the fact is in a hot market, you are going to have to pay a premium for anything. So if you're going to pay a premium for anything, make sure it's for the right property. And then really spend the time working out what that property is worth and factor in how good it is, and then work out your premium that you're prepared to pay before you start the negotiation process. But don't just think you have to throw money at it because that, that sort of attitude there's a lot of people hit decision fatigue and they get to a point where they're like, Oh, it doesn't matter.

Veronica Morgan: I just have to pay 50 grand more or whatever, you know, but the reality is if you're doing that without actually discerning which property is worth paying that 50 grand more for you're going to get caught out, you run the risk of buying a data asset. You run the risk of buying the wrong property and you run the risk of paying too much for it. So if you're going to have to pay a premium approach, it calmly work out the price and work out the premium repair. You're prepared to pay, be clear that it's worth paying a premium for that property. Not just because everything's going up. And then do you negotiations or go to war