Gearing is one of the major contributors to property’s popularity and success as an investment, enabling investors to access the benefits of assets far more valuable than their initial cash outlay. When it comes to commercial property, however, gearing involves some significant additional complexities that have deterred many an investor from leveraging this useful financial tool.
Common deterrents to gearing
“There are three, main factors that tend to hold commercial property
While financing residential property is so commonplace and streamlined that it can be completed within 24 hours, Breytenbach says commercial properties have far more variables to be considered. This makes the application process more complex for the investor and accurate risk assessment more complex for the lender, leading to processing times that can extend to several months.
“To make matters worse, most bond originators don’t handle commercial financing, which means investors need to navigate the application process on their own,” says Breytenbach. “This can be daunting as a first-timer, but does get easier as you learn the system and the banks learn more about your business and you.”
Pro tip: Always apply for financing at the seller’s bank (in addition to a selection of others). They’ll be familiar with the property, eager to hold on to an account with an existing risk profile, and keen to gain a new client – great incentives for them to offer you a favourable deal.
The second major deterrent to commercial property
“With no legislated cap on things like raising fees, things can get expensive,” says Breytenbach. “Investors need to prepare for between 1% and 1.5% of their loan amount plus VAT in financing costs, and interest rates of at least prime plus one – except in extraordinary circumstances.”
According to Breytenbach, 100% loans are extremely rare for commercial properties, and tend to command exorbitant interest rates when they are on offer. As a result, investors typically need access to a sizeable deposit in addition to cash-on-hand for the other transactional costs.
This large upfront investment, together with the expense of financing and the risks of potential interest rate hikes and/or defaulting tenants, can produce the third most common deterrent to commercial property
“Fear is a very real deterrent, particularly for new commercial property
A balancing act
Getting the right balance of financing vs cash investment is also a good way to mitigate risk. Breytenbach suggests aiming for the ‘sweet spot’ of between 55% to 60% financing, which generally enables investors to cover their costs – and any unexpected expenses – with a realistic net rental yield of 10%.
“If you have a lower risk appetite, you can weigh your investment more heavily on the cash side, giving you more room in your rental income to accommodate interest rate hikes or other unforeseen expenses,” he says. “Of course, the less you finance, the fewer benefits you’ll reap as part of a gearing strategy – and those benefits can be significant enough to warrant a riskier posture.”
While making money with someone else’s money is the best-known benefit of gearing, Breytenbach says it’s far from the only one commercial property
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There are also significant tax benefits to gearing a commercial proper
“Commercial investments within Urban Development Zones have their own tax benefits, which you can access regardless of whether you finance your purchase or not,” says Breytenbach. “They can, however, enable you to buy a bigger or better property, thereby maximising both your development and gearing write-offs.”
“Finding the right balance between all these variables is where the art comes into commercial property