In our last blog post, we looked at issues around fixtures and fittings.

In this instalment, I will explore issues around three versions of rent – rent under the lease, market rent and potential rent. Where there are material differences between these figures there are large opportunities to make money or lose money on your investment.

To illustrate, let me share a simple case study based on a real-life example:

Sanjay purchased a two-storey commercial property for $500,000.00. This property was subject to a new five-year lease for $30,000 pa – which meant a 6% yield. This met Sanjay’s criteria and he signed the contract and settled the purchase.

Five months later disaster struck. The tenant defaulted, abandoned the premises and there was no chance of recovering against the insolvent tenant.

Worse still, Sanjay was advised that the market rent for the property was $25,000 – meaning that at a 6% yield the property was now worth about $410-420,000.

A more recent example involved a SME vendor who was selling a commercial property with a 10-year lease back to themselves. The lease had a high rent that suggested a value of approximately $1 million on a yield basis – but a neighbouring, similar premises had recently sold for $800,000. This suggests that the vendor was inflating the capital value by inflating the rent. This is an interesting way to raise capital if you find a purchaser prepared to take the risk….

The final example involves exploring potential rent. 

Let’s adopt the figures from the first example ($500,000 purchase price, $30,000 rent, 6% yield). If we knew that the market rent was $5,000.00 higher, we could expect higher than average capital gains as the rent catches up. If there was the potential to earn a further $5,000 higher rent from say signage, sidewalk seating, an ATM or utilizing surplus space then we could also expect to manufacture a higher rent and therefore better capital gains over time.  The extra $10,000 in rent could add $150,000+ to the value of the property.

The above simple examples also illustrate how sensitive capital values are to small changes in rents in a low interest rate environment.

To succeed in commercial property, you need to remain aware of the three rents – lease, market and potential – in order to maximise your gains from commercial property.