WHEN IT COMES to in-depth analysis of Commercial properties, it is obviously far more complicated than a simple rating system.
That’s because you actually need a sophisticated piece of software – of which there is a number out in the marketplace.
But you’ll find most of them seem overly complicated … are not very user-friendly … and tend to generate endless pages of output data.
There are about 20 Key Items involved.
So, let’s quickly run through these various items.
You have the purchase price, stamp duty and acquisition costs (things like your due diligence) all of which need to be included.
You also need to choose your loan-to-value ratio (LVR) and include any costs associated with the mortgage. Plus, your appropriate level of tax, which may vary – depending upon whether the “purchase vehicle” is an individual, a company, a unit trust or your super fund.
You must take into account the passing rental, the rental reviews, the un-recouped outgoings, ongoing management fees, and depreciation. Plus, you have to decide on the holding period and estimated selling yield down the track – which I will come back to in a moment.
Finally, you need to allow for the selling costs at that time; and also the capital gains tax – where you need to include things like your initial cost-base.
Without going into the intricacies of the specific software, what’s important is that you undertake your calculations within a fixed timeframe. And I generally tend to view everything over a 4-year period.
A lot of software packages like to stretch their calculations over 8-10 years. However, there are two problems with doing this:
- You can’t make accurate estimates that far out, but more importantly …
- It spreads your acquisition costs (stamp duty, legal fees, etc) and your selling costs (commission, advertising and legals) over a much longer period.
And that tends to distort reality and make everything look unrealistically attractive.
Instead, you should stick to 4 years – because, if the property does not make sense over 4 years … then you are simply kidding yourself to view it over 10 years – in the hope of making a reasonable return.
As such, my yardstick is an after-tax return of 10% per annum (or better) on your equity, over a 4-year period. Otherwise, you simply don’t proceed with that property.
As you will appreciate, many people might well say: “But I am buying it for the long haul”. And that’s okay.
Why the Short Timeframe?
My reason for four years (and there’s no real magic here) … other than over that period, people can have a change of circumstances. They’ll get married, divorced, posted interstate or overseas – even have kids.
Somehow, there will often be a change in personal circumstances. Therefore, whether you plan to, or not … it is a good idea to have a mandatory 4-year review. That’s why I settled on this timeframe.
You may continue to hold the property longer-term, and that’s fine. But you need to know going into the deal that if (for whatever reason) you find yourself having to sell the property in four years’ time … it is still going to make economic sense. And over the longer term, it makes it a very good deal going forward.
To help with this, I developed my Final Judgement software – which is made available to everyone in my Mentor group. And by using this software, you can calculate what (in technical terms) is called the internal rate of return.
In other words, what annual return will the projected after-tax cash flow represent … as an annual percentage on the equity you invest in the property.
Being “after-tax” is important because that takes account of your relative tax position. And if you have negative gearing, that’s taken into account as well.
Bottom Line: If you are getting a 10% pa or better after-tax … this represents anywhere from 14% to 18% per annum pre-tax … depending on your tax level.
And I wouldn’t have thought that was too shabby.
