For those scouting for commercial real estate deals in COVID-19 times, it is best to purchase completed leased assets where leases have a longer lock-in and where tenants have spent on fit-outs, said a commercial real estate expert.
"This makes them sticky and tenants tend to vacate these leases last," advises Kunal Moktan, the chief executive officer and co-founder of PropShare Capital.
If invested in an institutional grade property with a blue-chip tenant, the credit risk of rents not being paid or the tenant vacating can be significantly reduced. An experienced real estate investor will increase "stickiness" by making the tenant take care of the fit-outs or tenant improvement (TIs) and by signing a "lock-in", a term used to bind tenants to a building for a longer term, he explains.
In the present situation, an investor can hope to receive a good discount too depending on how stressed the seller is in terms of cash flows. "If you’re lucky, you may get a property at a discount of 20 percent to 35 percent right now," he says.
Purchase only completed lease assets so that leasing and development risks are fully mitigated. The last thing you want to be doing in these situations is to look for a new tenant or be dealing with a rogue developer, Mokran cautions.
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He also shared some quick tips that will secure you rental income as a landlord:
- Try signing leases with yearly escalation of 5 percent instead of 15 percent every three years so that tenants find the increase more gradual.
- Use little or no leverage in buying assets that do not have long lock-ins so that you match the risks associated with rental cash flows with interest and principal payments.
- Always look for Grade A multinational tenants for whom rental costs are a small proportion of total revenues so that they do not look at your assets as cost centres.
“You should avoid buying any leveraged assets. You should not buy any properties which have a loan against them and neither should you take a loan to buy properties. Especially if the rents are not secure,” he says.
Should one take a loan?
If an investor has zeroed in on a property in a complex where the tenant has signed a three-year lock in, then he could consider taking a loan for it.
"This gives you an assurance that the tenant cannot break it for three years. And if they do, they get to have to pay you the entire rent," the PropShare chief says.
Having said that, take a loan only up to 40-50 percent of the property value, but not more than 70-80 percent.
This is important because if there is no lock in, the tenant can leave at any point of time. You should avoid any kind of leverage because in case a tenant vacates, you have to pay the equated monthly installments (EMI) and the interest that could definitely have an impact on the cap rates, advises Moktan.
Investors should look to purchase assets at below replacement cost, which is the cost of buying land and building the property from the ground-up. This will mean that rents cannot go down much lower as new buildings will require huge amounts to be developed.
Do not buy land
And a parting warning, in a dull market, Moktan adds one final point: No matter how lucrative the deal, avoid buying land."One should never buy land – there are several restrictions one has to comply with and be wary of," he says.