Leveraging your commercial lease

For Scott O’Neill, founder and director of Rethink Investing, a lease is one of the most powerful tools in an investor’s arsenal. Commercial leases contrast considerably with residential leases, O’Neill explains. For instance, occupied commercial properties include the lease as part of the sale, with the tenant generally covering day-to-day costs – unlike a residential tenant.

“A good commercial property will have a net lease – the tenant pays most, if not all, your outgoing expenses,” says O’Neill. “That might include rates, strata, maintenance, insurance and sometimes even rental management or land tax. Maintenance blowouts are one of the biggest expenses for residential property, but for commercial property expense blowouts are much less of a concern since the tenant will be responsible for these costs.”

With so many advantages over a residential lease, there is one more key point of difference: unlike a residential property, which can be purchased without a tenant and quite readily leased out, commercial properties are best secured with a tenant locked in. O’Neill advises buying with a lease already in place because it’s not only immediately more cost-effective but also provides confidence around future rental income.

“A good commercial property will have a net lease – the tenant pays most, if not all, your outgoing expenses”

For example, part of the due diligence might include asking for the last 12 months of rental statements to prove rent and outgoings are paid on time by the tenant. Banks also prefer lending against properties with a secure lease in place.

“When you buy a commercial property with a business in place, it’s viewed as an ongoing concern,” says O’Neill. “But without a tenant in place, you’ll be liable for GST. You’ll also need to find a tenant, which can incur further costs around renovations, advertising and, of course, time with the property empty.”

Commercial leases can be anywhere from three to 10 years long – sometimes more, if it’s a large-scale operation. Residential leases are typically only six to 12 months. This is important, O’Neill notes, as in tandem with other costs being covered by the tenant, it allows owners to have more consistency around rental income. This predictability is further enhanced by the inbuilt rental increases every year, which are usually around 3–4%. Residential properties, by contrast, generally involve a detailed market review before an increase is suggested, which can end up placing the owner at a disadvantage.

This isn’t to say there’s no risk at all involved in commercial investments, O’Neill is quick to note, but purchasing commercial is certainly a way of reducing potential exposure.

“Interest rates can obviously fluctuate, and tenants may decide to leave,” says O’Neill. “But the truth is that if you’ve got a tenant who’s paying a fair rate, has a successful business and is happy overall, they’re unlikely to move.” 

Indeed, most businesses won’t even consider moving unless their rent is going to be at least 10–15% cheaper elsewhere, notes O’Neill. Working with the tenant to resolve any prospective issues can often enable a better outcome for everyone. 

“Businesses aren’t normally keen to chop and change all the time,” he says. “All the other incidental expenses that come with moving can negate the benefits of the cheaper rent.”

Scott O’Neill is the founder and director of Rethink Investing, a BRW Fast 100 property investing company specialising in finding rare positively geared properties all around Australia (commercial and residential).

Scott is an experienced and active investor who was able to retire from his day job at the age of 28. With a current portfolio of 32 properties worth $20m, he is one of the most successful young property investors in Australia. O’Neill has a passion for all aspects of property, especially helping others find great deals.