I have experienced an alarming trend recently in the way agents are under reporting the outgoings for a commercial shop for sale. I think it is false advertising leading to the deception of the unknowing buyer. Real Estate agents are not disclosing the outgoings beyond the standard statutory charges: strata, council and water. Over 30 years of pursuing property and reviewing several hundred IM Packs the frequency of this deception is increasing!
Unfortunately, I see the problem is most prolific for smaller shops (less than $500,000), where investors are typically less experienced. Let me explain the impact of this “oversight” on the agent’s behalf with an actual example. For a 50m2 shop in a large strata complex, the Information Memorandum declared the Gross Rent to be $32,500 per annum, with the following outgoings:
Outgoing Annual Cost
Council Rates $1,250 pa
Water Rates $1,050 pa
Body Corporate $3,600 pa (Includes the building insurance for a strata shop)
Total Outgoings $5,900 pa
If you make an offer at 7.5% return for this property based on the above information you would considers its value to be $355,000 (Gross Rent-Outgoings/0.075).
In Chapter 7 of Engines of Wealth I share the complete list of outgoings that should be captured in the IM Pack, including management fees, maintenance, fire inspection, gardening, grease trap cleaning and rubbish removal if the shop is on Torrens title (i.e. not strata). One of the key lessons in Engines of Wealth is to establish the true Net Rent position of a building and thus ensure all the outgoings are declared. Do not fall for the agent or owners deception of omitting expenses to artificially inflate the net rent and in turn the building’s value.
When I called the agent and indicated the obvious omissions, he quickly sent the full information and apologised for the “oversight”. In this case, the missing outgoings were:
Management Fee $1,520 pa
Air Conditioner Maintenance $600 (when it occurs, this is part of the landlord obligation)
Land Tax ($80,000 at 1.7%) $1,360 pa (this may not apply to you, but the agent doesn’t need to know that)
New Total Outgoings $9,380 pa
Your 7.5% offer for this shop would now be $308,000. As you can see it makes a HUGE difference.
The practice of routinely omitting outgoings is not as prevalent in the larger transactions, for example neighbourhood centres consisting of 5, 10 or even 15 shops for sale. The reason is because these type of transactions attract buyers that are often experienced investors, hence the agents know that things like administration, cleaning, land tax, fire inspections and repairs and maintenance are costs that must be accounted for.
Again, this is best demonstrated with actual evidence. Below is a recent outgoings audit I commissioned for my neighbourhood centre. This represents the true costs and categories when you own and operate a neighbourhood centre. Note, if you own a single strata shop these are typical of the costs that will appear on the balance sheet of the Body Corporate, which will be allocated based on shop size and appear as a single cost in your quarterly strata invoice.
Outgoing Annual Cost
Bank Charges $200
Cleaning & Gardens $25,500
Common Electricity $5,500
Council Rates $28,500
Property Management Fee $26,000
Repairs and Maintenance $11,000
Waste Removal $9,500
Water Rates $11,200
Land Tax $26,000
To avoid the agents outgoing deceptions always look for the complete list of outgoings. Below is a legend of the typical outgoings that are omitted and what the agent may say to refute there existence.
Administration Fees: if the agent says “the owner manages the property himself so he doesn’t incur those charges.” Your reply is “I’ll be using an agent and have factored in a 3.5% management fee”.
Waste Removal: if the agent say’s “The tenants looks after their own rubbish.” Your reply, “OK I’ll go to the shop and ask the tenant about that”.
Cleaning: when the agent say’s “The tenant keeps the place tidy and does the gardening so there’s not much cleaning required.” Again, you should check with the tenant and understand what cleaning and gardening is required or done on a regular basis.
Fire Inspections: agents will tell you “The owner hasn’t called these out so I’m not sure if there required.” My strong reply is something like “Fire inspections are a mandatory requirement by law, please ask the owner when was the last inspection and tell them that I will add $500 to the annual outgoings”.
Repairs & Maintenance: agents will say “There is no allowance as it is a well-built shop and nothing requires repair.” For a small shop there is always something that needs to be fixed each year, so I would assume $1-2,000 for repairs and maintenance. Tell the agent that is what you have deducted from the Net Rent.
Land Tax: agents will always say “Land Tax does not apply to this property and has therefore been omitted as the land value is below the land tax threshold of $600,000.” The catch here is that this figure is cumulative! If you have 2, 3 or 4 properties within the same state in your name, commercial or residential, you may exceed the threshold, in which case land tax will be payable on this property. When negotiating I always inform the agent “that I own other properties and hence will be paying land tax, therefore I will deduct the land tax off the net rent and base my offer on that.”
Audits: the Retail Lease’s Act requires a landlord to provide the tenant an independent audit of the shops outgoings if they are being passed onto the tenants. The cost of this will be from $300 up to $1,000 for a larger centre. You should ask the agent for a copy of the last audited outgoings statement, if he doesn’t have it ask the tenant if they get one as required by law.