How to Invest in the Industrial Property Market. So, we’ve all heard that the industrial property market is a great sector. How can we take advantage of this and what is the best way to go about it?
Industrial property may be regarded as any property that is zoned for industrial usage;
- Small to medium sized factories – often found in complexes
- Larger warehouses
- Industrialized business parks
- Large distribution centres
- Storage facilities
- Open land
Generally, an industrial zoning has far broader usages than residential, thus affording an owner of industrial property many different types of usages should the need ever be required. Industrially zoned areas are generally found in most cities and towns and, depending on the age of the city, may be in a range of locations within such city or town.
During the last 6 years, interest rates have been low and the Rand has been strong, thus fueling the growth of a range of different types of businesses. Many small businesses have grown out of homes and thus the most cost-effective step thereafter is in a predominantly industrial property. Larger and more established businesses simply needed more space. In searching for new premises most businesses realized it was almost as cost effective to purchase as it was to rent and hence many tenants became owners. At the same time as this growth in demand, building costs rose significantly, thus rewarding those early purchasers and creating an urgency for those still wanting to purchase. Higher building costs, shortage of suitable land, coupled with increased demand led to excellent growth in industrial rentals, with still further growth anticipated.
Industrial Property can be purchased in the following forms;
- Directly held (the most widely used method of ownership and that concentrated on in this article). Property can be purchased vacant or with the tenant(s).
- Listed property funds (although most funds are not industrially orientated, the listed sector on the JSE has grown significantly during the last few years). This is a more liquid form of holding property but also suffers from the fluctuations of the stock market.
- Syndications (while joint ownership is fundamentally a good principle, investors are urged to act with extreme caution as there are good and “not-so-good” syndication companies operating in SA).
How is industrial property different to residential property?.
- Location of industrial properties usually have different criteria to residential properties (for example an industrialist wants to be as close to busy roads as possible – the opposite for residential users)
- Users/ tenants of industrial property generally evaluate premises in a more businesslike, unemotional manner, following market rental and Rand/ Square metre norms.
- Leases of Industrial property are structured differently to residential leases (usually longer than 2 years and have fixed escalations each year. Escalations are usually in the 8% to 10% per annum compounded range.
- Purchasing of industrial property usually involves a lot more research and takes more time than a residential purchase.
- Financing of industrial property is a far more difficult and in-depth procedure than residential property. It also usually requires a larger initial capital commitment than residential property.
- A purchaser of industrial property needs to be well advised on aspects such as legal framework, value-added taxes versus transfer duties, accounting, and taxation.
- Valuation of industrial property is primarily linked to the net income the property can generate (after all expenses).
- Industrial property yields a far higher income return than residential property, but sometimes offers a lower capital return than residential.
Directly owned property can be purchased using the following methods;
- Tender (usually in the case of government/ state-owned property)
- Auction (no longer is industrial property sold on auction a forced sale – auctioning has become a mainstream method of selling although purchasers need to be aware that these sales are cash sales and one does need immediate access to the full purchase price plus agent’s commission plus VAT or transfer duty).
- Private Treaty (still the most popular method of sale – handled mainly by brokers specializing in industrial property).
How does one go about finding suitable industrial properties to purchase?.
- Determine a broad location where one wants to invest.
- Drive around the area(s) and make sure one knows the area and the types of businesses operating from the area.
- Contact property brokers (more than 2) specializing in the area as well as specializing in sales and renting of industrial properties. Have discussions with them on what they think would suit you and what is the type of industrial property in highest demand by tenants. Check on the area statistics.
- Have a look at actual properties for sale – physically and financially. Make sure you get given enough information up front.
- Contact a financier/ bank for advice on one’s personal circumstances with special regard to your investment in industrial property.
- Consult with your accountant/ lawyer to make sure any intended offer to purchase will be correctly structured to suit one’s personal circumstances.
- Evaluate all industrial investment alternatives and select 2 that one is happy with. This provides a basis for comparison.
- A correctly structured offer should be made with a view to negotiating to close the transaction.
- Keep calm and unemotional throughout the whole process and be prepared to walk away from anything one does not feel comfortable with.
Factors and information one should consider when evaluating an industrial purchase
- Property Purchase Checklist for Industrial Property – incorporates the items below –
- The Site. Location – macro and micro.
- Accessibility and road systems.
- Land and Building Inspection. Age and condition of buildings.
- The flexibility of premises. Specialized premises have a smaller chance of getting rented out if a new tenant needs to be found.
- Background on the Seller. Who is selling and why?.
- Title Deeds, formal legal description, and size of land.
- Municipal valuation and resultant monthly charges.
- Availability of public utilities.
- Town Planning conditions and Zoning Certificate.
- A copy of Approved Building plans.
- Soil and surface conditions.
- Rentable areas.
- Tenants?. If so, tenant mix & description.
- Copies of all current leases. Are the rentals market-related?
- Expense analysis;
Repairs and Maintenance estimate
- Month-to-month administration and rent collection
- If property is sectionalized;
Latest financial statements of Body Corporate
Check with managing agents that all is in order and no special levies are due
Copy of Rules of Section Scheme
Monthly levies of the unit being purchased?.
How are the parking bays owned?
Financing of Industrial Property
Newcomers to investing in industrial (and commercial) property should not underestimate the tedious process one will have to go through to arrange finance, should this be required. You have been warned, but please do not let this put you off!. All banks arranging non-residential finance go through different in-depth processes to evaluate non-residential loans. The purchaser will have to submit mounds of documentation relating to both the purchaser as well as the property and its tenants. Allow for at least 14 days (at the very quickest) for a loan approval. Depending on one’s bank, one may be referred to a non-residential lending division. Always go to more than 1 bank, even if it is just to keep one’s own bank honest and competitive.
Standard industrial financing norms
- At least 30% of the pre-VAT purchase price as a capital down-payment on the date of transfer. This may be more or less, depending on the client.
- The lending rate will not be as low as residential loans. Prime less 1% is usually a very good offer from a bank, but this could be as high as prime plus 1%.
- Loans are paid off over 10 years. (Residential is usually 20 years or more). This has the negative cash flow effect of having to pay far more in bond repayments, but the positive effect of one’s bond being paid off far quicker than a residential property.
- Read the small print. There may be hidden clauses like penalties if a property is sold within the first 3 years, or that one needs to give the bank 3 months notice before a bond can be canceled.
Liquidity of holding directly held property
Just as a property purchase takes time to initiate and get transferred into one’s own name, one needs to consider the “non-liquid” nature of industrial (and other forms of) property when selling. One will not be able to initiate a sale and expect to realize funds from the sale in a hurry. Do not purchase property if one may need the funds in the short term. Industrial property must be seen as a 3 year+ investment.
Is the Industrial property market likely to remain positive into the foreseeable future?.
There is no doubt that the current depressed global economy and the strong Rand are having a dampening effect on the industrial sector. Tenants are more likely to seek less expensive premises as the squeeze on growth in the SA economy gathers a grip. However, the industrial sector should merely slow down from its frantic pace during the last 3 years to a reasonable pace. Rental growth should still outpace inflation for at least 3 years. While one needs to keep a close watch on the economy and consequently one’s industrial investments, the outlook for the next 3 years remains solid at this stage.