Q&A: Hydrauliking

BigSheep asks:
Hi Olly,
Would very much appreciate your advice here. Have done some residential investing and have a positive cashflow portfolio with >50% equity and now looking to buy Commercial for the first time – the property is in the retail centre of a provincial NZ city, main street, good position, building divided into 2 with two separate tenancies, both new for 8 years, one with an international retail/optical company and the other a retail shoe store moving in to fill a hole for this in the city. I believe these are good tenants and there is a sound business opportunity for each of them.
1. I understand that rates, insurance and interior fitout and maintenance is provided by the tenant – is this std in a commercial lease agreement? 2. It appears I can get it with 8-9% gross return on purchase price – is that reasonable? 3. Do banks charge different mortgage interest rates for commercial properties compared to residential?

Many thanks

Olly replies:
Dear BigSheep.
I cannot do justice to your question because the details you have supplied are woefully insufficient. Any purchase of any commercial property needs proper analysis of every page of every document and detail.
The purchase of a simple house is complicated enough but a commercial investment is one that only professional advisors should answer.
Typically when one of my clients wishes to purchase a commercial property it takes some time to gather all the information and it is sometimes staggering how an apparently good investment often turns out to be a dud, and vice versa.

Taking your situation in particular I have questions for you.
1. Provincial Town? Not good enough. Some provincial towns are dying and others a doing OK. It varies enormously whether such a property is in Huntly or Hamilton, Taupo or Taihape, or Tokoroa or Thames etc.

2. Good tenants? How do you know? Have you seen their accounts? Statements of Position? Previous history? Any PG’s

3, Divided shop? Has this been done legally? Have you checked with the Council?

4. New 8 year leases? Really? Somewhat unusual. Are there rent reviews and /or rent renewals during the term? Makes all the difference.

5. Rates, maintenance, fit outs? Is the rent based on the bare shell or on the the fit out? Who owns the fit out? Makes an enormous difference to the rent. And there is no such thing as a “standard lease”. The common lease is the ADLS version but which version- there are many? All leases can be re drafted to suit in any event.

6. 8%-9% may be a bargain or a jack up. How do you know if the rents are below market or above market? May be they have been hydraulicked? Take care.

7. Gross return? A gross usually means the landlord pays all expenses including GST . Do you mean net return? Have you allowed for all expenses to get to the net return? That’s the only return that matters.

8. Banks usually charge more for commercial and lend less- but not always. That needs sorting as well.

I could go on and on but I think you get the picture by now. The best advice I can give you is to get hold of an independent and experienced advisor such as myself, be prepared to pay a fee, and do the job properly.

BigSheep asks:
Hi Olly,
Thanks for your comments Just wonder if you can explain what Hydraulicking is? After further research something just doesn’t ring true with this deal – which is in Wanganui – a building 2 doors down is very similar – (similar age and size, divided into 2 and has telecom and a bookshop as tenants BUT the rent is less than half of what is being claimed here) – I agree an 8 yr lease is unusual, there are no renewals or reviews in that time, the rents appear well above market, but tenants have signed such a lease – I don’t know what being hydraulicked means but suspect its when the rents are somehow made to look higher – I believe that is the case here. BUT there is a lease signed with new tenants – the price being asked is $1.2Mill, RV is $450k, rent is $99k/yr, building was bought in 2004 for $250k… The mentuoned building 2 doors down was valued last year at $520k – something fishy here.

Olly replies:
“Hydrauliking” is the expression used to explain rents or asking prices that have been pushed up over the market rate. It has been known for some sellers to get the tenant to pay more than market rents and to refund them the difference in private. That’s why it is so important to check all the details out professionally. I have had many clients sucked in by this method and there is little that can be done without facing a massively expensive court case. One of the most blatant cases I handled was where an investor bought an industrial property which was offered with a rental of $120k p.a net. He paid $1.45M for it (8.3%). The day after he settled for it the tenants closed the doors and vanished. At that point he consulted me and investigations showed that the actual market rental should have been $70K ($850K value approx). The cost to take the vendor to court would have cost a fortune with less than a 50/50 chance of winning. He chose not to pursue it in the end and suffered a $600K loss for his pains. Had he seen me in the first instance he would never have fallen for this old trick.
Cheers, Olly

Posted in Q&A | 2 Replies

2 thoughts on “Q&A: Hydrauliking

  1. Hi Olly,
    Excellent example of danger of buying commercial property. This guy should have asked you for advice (he has actually for free!) or he would have suffered a huge loss if he bought it. I will come to you one day for advice (not for free of cause).

    Regards

  2. Rhett- the story is 100% true, just that the numbers were changed to hide the identities. In fact the numbers were much larger. And there has been a twist since then. The new owner on-sold the property yet again for a further profit. So there is still money to be made despite what some commentators might say otherwise. Cheers Olly

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