How to make above average returns on commercial property

News > Market & Opinion - 02 Jul 2019

For the past few years, most industrial and commercial properties have shown good capital appreciation and income returns, and many investors took to purchasing any available commercial or industrial property.

However, this will not be the case moving forward and property purchasers need to become value investors - ditching the generalist market investor approach - if they want to see above market returns.

This is according to Tony Bales of industrial property broking specialists, Epping Property who says that the market has changed and because of this wise investors need to seek out properties that will grow at an above average rate if they want to make decent returns.

Enter the age of value investing

Epping Property explains that value investing is investing in a property that has been undervalued or where one can purchase the property at a below-market price. “The specific benefits are an above-market appreciation in either the capital value or rental income or both.

“It is important to understand the difference between price and value. Price is what you pay, while value is what you receive. This may sound like a simple statement, but it’s implications run deep,” says Bales. “Buying investment property at too high a price isn't good value and is the surest way to limit future returns. However, commercial property can double or triple in value for an investor who can spot a value purchase.”

How to find value in property?

Finding properties that offer value may involve sifting through a lot of various opportunities. It is basically a three-step process:

  1. Spot hidden growth potential (for example, does the property offer underutilized space that can be developed further?  Is there a parking garage that can be leased out for night parking if close to restaurants and event venues?  Can large empty office spaces be divided into smaller units to meet market demand and reduce vacancies?); 
  2. Develop a strategy to unlock that identified and untapped value;
  3. Execute your plan.

Bales advises that what is value for one investor may not be value for another. “For example, a passive investor may offload a property to someone who has the capacity, time and inclination to develop it and unlock the potential value. Investors all have different profiles, such as knowledge, capacity, skills, etc. thus ensuring constant value arbitrage in the commercial and industrial property market.”

Epping Property provides a list of questions that buyers should ask themselves when looking for a value property:

  • Do I have an excellent understanding of the property I wish to buy?
  • Does the purchase price offer upside potential?
  • What is it about this property that will ensure its value grows faster than other properties?

What do I need to do to ensure this potential value is unlocked as soon as possible?

“The highest returns come from buying commercial investment property at a price that doesn't reflect its inherent attributes. Value investors follow strategies to find, and mine, those features. The key here,” says Bales, “is to understand exactly what is value for oneself. The greatest value investor of all time, Warren Buffett, did not buy any technology shares during the boom in the late 1990’s – a move for which he faced major criticism. However, his actions were well rewarded in the end as today he is one of the wealthiest people in the world. And he has now included tech shares in his investment portfolio.”

Value in listed property versus value in physical property

“It is also important to distinguish between the listed property sector and investing directly in physical property. Unfortunately, the listed property sector has had a torrid last 18 months. Investing in listed shares is different from investing in specific physical properties. It is vitally important to understand what the drivers of the listed property sector are versus the drivers of physical commercial and industrial property. Value investing in the listed property sector is different from valuing investing in specific properties.”

Value has no borders

According to Epping Property, another aspect to understand is that of internationalisation.

“Investors must see the value concept as one that has no borders. What may seem overpriced to South Africans might be value for international players due to the higher yields. Conversely, when the US dollar strengthens, we must expect the SA property market to offer less value than more developed countries, and hence investors will move funds to those countries that offer them more perceived value.”

“It’s simple. We are part of the international economy and can not ignore the fact – it affects our commercial and industrial property market and the concept of value.”

Epping Property concludes by advising that the most successful commercial property investors in the next 24 months are going to be those focused, knowledgeable players who exploit the concept of value investing. “As Warren Buffett says, be a property analyst, not a market analyst.”

 

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