Commercial properties especially high-yielding ones in prime locations, add diversity and act as a good hedge in an investment portfolio.
Having so far examined pure residential properties in our deal analysis series, this time we have decided to focus on a commercial property instead.
While Japanese commercial properties are very similar to residentials in most aspects, there are a few differences which are worth considering:
- Commercial properties tend to command higher rents and yields as a general rule, when compared to residential properties of similar profiles.
- Rent fees for commercial are more volatile and sensitive to economic cycles – while residential rent fees remain mostly untouched in Japan throughout a single tenancy. Commercial rents can and often will be increased or decreased based on regional averages whenever a tenancy lease is renewed. An established business with existing clientele which is running at a reasonable profit will always prefer to stay in its established location, and reasonable rent hikes are factored into their balance sheets as a rule.
- Similarly, vacancies are also more volatile as far as commercial properties are concerned. Whereas residential tenants will always need a place to live, businesses can and will re-size, move or stop operating altogether when things take a downturn.
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Commercial properties often suffer more wear and tear when compared with residential properties, as they are used more extensively and by more occupants – if the business leasing the property has walk-in traffic and clientele, (such as a shop, school, etc), these damages will be even more pronounced – with the highest usage and damages reserved for businesses serving food and drinks such as bars and restaurants.
Fukuoka city, which we have written about a year ago in Issue #9, has been the target of a large exodus of Tokyo businessmen and company employees since 2011. Due to its geographical position as Japan’s gateway to Southeast Asia, a vast influx of Chinese investors crossing over from the north-west and purchasing large quantities of investment properties, would seem to also indicate the promise of this area. Monocle magazine has included Fukuoka city, the prefecture capital, in the world’s top 10 most liveable cities in 2014. In Q4-2012, Fukuoka city property prices have begun rising, and haven’t stopped since.
ADVANTAGES
Location – in the heart of Fukuoka’s central business district, and within only 5 minutes’ walking distance to the city’s main transport hub, Hakata station (bus/subway/train/bullet train). Without a doubt, the best spot in the city for a business.
Dual-purpose unit – current tenant is a Chinese trading company – but the property may be used for residential purposes as well if required in the future.
Exceptional yield for this location – 8.4% net pre-tax per annum – unusual for central city properties in Fukuoka, and even rarer for properties of this size (36.5 sqm).
Tenant has rent insurance, covering up to 3 months of delinquency – also obliged by lease to pay a cleaning and restoration fee upon vacating.
Three large renovations performed in 2013-2014 (exterior, water supply & drain pipes, new elevators installed).
DISADVANTAGES
Built in 1980 – one year prior to the introduction of the latest earthquake-resistant standards.
Previous building management company replaced in 2013 due to financial mis-management.
Current accumulated renovation/repair funds quite low, covering less than 5% of the purchase price per unit owner.
DEAL ANALYSIS
Upon its appointment, the new management company has immediately taken action to act on the large renovation items required – the building now seems to be in good hands. The lack of large accumulated funds is slightly disturbing, but with three large renovations already performed, chances of another large item being required in the near future is greatly reduced. Furthermore, the exceptionally high yield for this profile and location provides the investor with a buffer in case of monthly fees being raised or a one-off payment required, as annual yields will still be most likely acceptable.
Coupled with the fact that, in this particular location, prices have more than doubled in the course of the last five years, growth potential, while only a secondary criteria, is also quite likely – and more than compensates for the older build.
The tenant, in place for more than two years upon purchase, seems to be well established and profitable – with no late payments or other issues, and a rent insurance policy and cleaning/restoration fee most likely covering any substantial potential vacancy expenses.
Considering all of the above, our client, a Thailand-based family office, has decided to add this property to their already substantial portfolio – this purchase marked their second commercial/mixed purpose property purchase, and provided them with further diversity and hedging in an already highly profitable investment portfolio.