In our previous article, we looked at the positive aspects of commercial property investments over residential. In case you missed the article, go to:

http://www.iproperty.com.my/news/1147/Residential-versus-Commercial-Properties-The-Positives

I am sure many of you may have been tempted to jump into lucrative commercial property investing after reading it. Before doing so, it is important to be aware of the various negative aspects as well. They are:

When you purchase residential properties from developers, they will have to use the statutory Sale and Purchase Agreements (SPAs) as set out in Schedule G (for landed properties) or Schedule H (for sub-divided buildings such as residential apartments or condominium units).

These agreements are Buyer-friendly and the Act offers buyers ample protection. For example, developers have to open a separate HDA bank account within 14 days after the issuance of the housing developer’s license. All sales proceeds from the purchaser or his financier must be credited into this account. The developer can only withdraw from this account for specific construction expenses only. In the event, the developer goes bust, the Housing Ministry can easily step it and use the remaining funds to complete the project. For more information on the mechanics, visit:

http://www.hba.org.my/articles/lawyers/2002/buyer.htm

When you purchase a commercial property from a developer, there are no statutory SPA requirements. Hence the SPAs drawn up by the developer’s lawyers are usually skewed in their favour. Hence before purchasing, it is important to go through the SPA and be aware of the risks involved as the agreement will not be in your favour. Many times, you will have to weigh the commercial and legal risks versus the potential return of the project you are planning to invest in.

Banks are usually more comfortable lending money for residential properties compared to the commercial ones due to the lower risks involved. Hence they are willing to offer higher margin of financing even up to 90 percent if you are purchasing your own home versus maximum 85 percent for commercial properties. The high margin of financing makes it easier to do ‘Zero or Little Money Down’ deals in the residential property market.

Another important factor that affects the margin of financing is the valuation aspect. As long as you are buying at the market price, it is much easier for get valuation at or very close to your purchase prices due to many previous transactions around the market level.

In commercial properties, there are usually only few transactions previously done. Worse still, they could be several years and several thousands of dollars apart. Also rental rates have a direct bearing on the value of the property in the eyes of both sellers and buyers. However, valuers seldom take the market rental rates into account in coming up with a valuation price. They usually use the replacement cost or comparative method of analysis in determining the official valuation and forced sale prices.

Personally, I have come across many instances where the transaction takes place at RM1 million giving a decent yield of around 7 percent per annum based on the existing rental rates of RM5,800 per month. However when the valuation comes in, it is at RM600,000 or 60 percent of the transacted price! Assuming the margin of financing is 85 percent of the lower of the transacted or valuation price which in this case will be 85 percent x RM600,000 = RM510,000 or 51 percent of the purchase price. Hence the buyer has to be prepared to fork out a lot of hard cash to make up for the shortfall between the transacted price and the bank loan.

As you can see from the example earlier, the down-payment requirements are much higher for commercial properties due to the lower margin of financing as well as the official valuation prices. Hence in the resale market, it is often more challenging to do ‘Zero or Little Money Down’ deals in commercial properties.          

Unlike residential properties, the loan tenor is shorter in commercial properties as the banks feel that the risks are higher. In the event there is an economic downturn, businesses are usually the first to be hit. This could affect their ability to service the monthly rental which could be a big proportion of their monthly expenses. In prime retail shoplots, the rental could be as high as 50 percent of total expenses with material, staff and finance costs making up the other half.

To mitigate risks, banks will charge higher spreads on commercial compared to residential loans. Previously, you could get rates of up to BLR -2.4% for residential properties and BLR -1.85% for commercial properties. At the time of writing this article, the new rates with the recent revision in the spreads are not out yet. The only sure thing is that the spreads for home loans will still be better than commercial loans.

The combined effect of a lower margin of financing, shorter tenor and higher interest rates will mean higher monthly instalments or less cashflow every month.

In residential properties, the advice is to specialise in not more than three different locations, ideally places you go frequently. For example, you should begin by focusing on areas near your home, workplace and other places like your close relatives home, children’s school, tuition place, etc. Within these three places, there are thousands of properties for you to choose from. You must know these places and the prices like the back of your hand. Anytime a good deal comes up, you can confidently purchase without much hesitation.

For commercial properties, due to the limited supply and high demand in each area, it is very difficult to specialise by location. Good deals seldom come up. Hence instead of waiting, you have little choice but to cast your net wider. In commercial properties, the advice is that the deal more important than the location. As long as the numbers make sense and the location is good, you can go-ahead. Hence you have to be on your toes and know what is happening even in places you have never been before. When a good deal comes up in areas you are unfamiliar with, you have to take calculated risks.  

Lastly, an important factor to consider is that in the event of any mistake, which will inevitably happen sooner or later, the impact on your bottom-line can be fatal. A wrong commercial property purchase can tie down your available cash for many years. Hence it is advisable to venture into commercial properties only if you can afford it. Otherwise it is best to stay away until you are on more solid financial ground. Alternatively, instead of venturing on your own, go in as a group to minimise the risks in case something goes wrong. This way, a potential mistake will be bearable but not fatal!

If you have any comments on this article or questions, please email to me at achievers88@yahoo.com. I would highly recommend that you sign up at our moderated getrichbook egroups at:
 
http://finance.groups.yahoo.com/group/getrichbook/

It's free for all my book readers and readers of this article. Only relevant emails pertaining to finance, property and stock investments will be approved for broadcast.

Article Contributed by
Milan Doshi
Financial Trainer and Best Selling Author of
“How You Can Become a Multi-Millionaire Real Estate Investor!”
For more information, visit www.milandoshi.com