Buying Commercial Property - The Process Explained
The information provided in this guide is of a general nature and should not be considered personal investment advice. Investing in commercial property, as with any investment, carries potential risk. Before investing, please seek advice from a financial advisor who can advise on your best options.
Early on in its operation Mackersy Property identified a number of people who wanted to participate in the commercial property market but weren’t keen to go it alone, be exposed to only one part of the market, or run negotiations with bankers. So, it started putting together groups of potential investors (syndicates) to acquire commercial properties. Investors who qualified contributed their funds (equity) while the bank provided mortgage lending (debt) for the shortfall.
In this way investors could spread risk by
- taking a small part of many of Mackersy Property’s commercial property offerings
- owning a part share in buildings located throughout New Zealand, and
- having tenants from different market sectors.
In broad terms, this is still the way Mackersy Property operates.
Finding commercial properties
Mackersy Property is regularly approached by vendors and agents selling commercial property. The Director, Investment and Transactions Adam Copland and his team interact constantly with sellers and developers, or their agents, and assess all offerings that fit the criteria for a successful investment.
Mackersy Property likes to source its product offerings “off-market” where possible. Its portfolio is now large enough that vendors and agents consider it has sufficient ‘horsepower’ to make a deal work and will approach it with a proposal to consider rather than taking it to the open market. Over time, agencies have become familiar with Mackersy Property’s requirements, and the fundamentals it looks for in a property. These fundamentals are discussed in more detail below.
Off- & On- Market Opportunities
Off-market deals allow Mackersy Property to deal directly with vendors, negotiate or re-negotiate key terms, seek the support of Mackersy Property’s Investment Committee, assess the likelihood of investor support, and refine the terms of the deal before the opportunity is published to the investor group. In this way, the investor group gets access to property that is not on offer to the general public.
Mackersy Property also makes offers for on-market properties, but usually in tightly controlled situations when it can indicate in advance its intention to buy, and the terms on which it will proceed: that is, it can canvass whether the vendor will accept an offer which suits Mackersy Property’s model, and ensure the project will have broad appeal to the investor group.
As its portfolio grew Mackersy Property established relationships with the commercial banking teams of NZ’s major lenders. It now enjoys support from all of them at different times for different syndication projects.
Early in the property buying (acquisition) process, Mackersy Property’s Treasury team liaises with key personnel from ANZ, BNZ, Westpac, ASB, or Kiwibank about financing the purchase of the property. It works to obtain the best possible commercial lending terms available and recommends which lender is best to fund a project. Part of that team’s analysis is to evaluate the types of lending facilities on offer, interest rates, margins, loan-to-value ratios and hedging strategies. This enables Mackersy Property to model the investment and provide initial and predicted returns for investors to evaluate.
Interest rate risk is one of the many risks associated with property ownership and should always be considered when making a purchase or joining a syndicate. However, well-managed debt has traditionally been the friend of commercial property investors, allowing leverage and increasing return.
Determining the potential returns on a given property
In a worst-case scenario, the property should be able to be on-sold for fair value or repurposed and re-let to an equivalent or better tenant. Valuation and leasing advice are important, as are the support of the bank and condition reports confirming there are no deferred maintenance or compliance fishhooks.
After basic hurdles like these are crossed, Mackersy Property undertakes further due diligence by running a model it has developed. Mackersy Property’s model adds the purchase price and the costs of acquisition together to give the full purchase price. Costs to investigate the property’s merits (building, geotechnical, quantity surveying and valuation reports), bank and accountancy fees, legal due diligence costs, facilitation and management fees make up the end figure. That figure is split, with around one-half being ‘sold down’ to investors, and the balance being provided by bank funding. Bank funding or gearing has traditionally worked to maximise return, but the current interest rate environment is challenging that assumption.
The model shows the actual initial return on investment and also extrapolates potential returns on an investment over a three-year period. Anticipated funding costs are factored in, along with annual accountancy costs and those for Mackersy Property’s full investment management service. The assumptions made by the model are conservative. Growth in the leases (increased rent), interest rate risk, and the effect of the loan to value ratio are factored in. Cash flows may be run internally, or by Mackersy Property’s accountants, Moore Markhams Otago.
Mechanic to invest
Investors who decide to commit capital then choose to invest directly in the Limited Partnership (LP) which is completing the purchase, or in a limited liability company which is one of the Limited Partners. Those investing in the LP directly are responsible for their own tax, allowing them to offset losses held in, or by, other entities. Investors in the limited liability company receive their monthly returns after the tax has been paid.
Making an offer on the commercial property
Offering on a property
Offers to purchase commonly use the Auckland District Law Society’s standard form of Agreement for Sale and Purchase, and include such additions, alterations and Further Terms agreed in the negotiation process. Offers may be drafted by the agency responsible for a sale, by one or other of the lawyers acting for purchaser or vendor, or alternatively, by an offeror like Mackersy Property. The offer may go back and forth between parties before being signed in its final form.
Once finalised, the time for the satisfaction of any pre-conditions set out in the Agreement begins to run.
Contract or Agreement
If the outcome of Mackersy Property’s preliminary investigations is positive, a contract is negotiated for the purchase.
In commercial property negotiation vendors and purchasers are involved in a game that revolves around reaching a point at which both parties are satisfied with the outcome. The process may be rapid-fire, quickly completed and recorded, but if the expectations of the vendor and purchaser don’t match, it can be protracted, or even fail.
The respective interests of the parties dictate what’s up for negotiation and what’s not. The matters to be agreed on, price, deposit, and settlement date are often the simplest to establish.
Other commercial terms or pre-conditions usually favour the purchaser and may be more contentious because they rely upon the input and advice of third parties like valuers, quantity surveyors, bankers and lawyers. The advice their professional advisors give Mackersy Property may not necessarily favour the vendor, and re-negotiation may have to occur.
The legal due diligence process, the outcome of a valuation or finance application, and the content of Building or Geotechnical Reports may all alert Mackersy Property to matters not known or disclosed by the vendor which need to be resolved prior to any confirmation.
The terms of a contract or agreement are determined by the nature of the property being purchased. The sale/purchase of an existing building, with established leases and listed fixtures which will pass to the purchaser is the most straightforward.
If the purchase is of a property yet to be built, or being built, then the Agreement will have a different flavour and record key milestones and payment dates, and the terms of the lease to commence on completion.
If the project is a turnkey one, the terms will be different again, with final payment to the developer only being made once the project is complete.
What is common to most Agreements, will be due diligence conditions allowing Mackersy Property the time to investigate the project in depth. After due diligence is complete there will also be a further defined period during which investor support must be obtained.
Conducting due diligence
A contract or agreement will always be conditional upon a satisfactory legal due diligence process being carried out, and that’s done by Mackersy Property’s lawyers, Duncan Cotterill. The due diligence process investigates and reports on the title, LIM, building or geotechnical reports, NBS ratings (the structural strength of the building), offers of finance, the value of the building fixed by a registered valuer, an analysis of the leases, the potential or need for lease renegotiations and any other relevant commercial terms. If the property checks out, practically and legally, then support for the project will be sought from the investor database.
The buildings Mackersy Property considers have to measure up against its ‘fundamentals’:
- Is the property new or near new?
- Does it have a long-term lease?
- Is the tenant covenant strong?
- Is there rental growth built into the lease?
- Do we have valuation/bank support?
- What does the rate of return model up at?
- Will this particular property appeal to investors?
- Then, if one or other of these factors isn’t present: how is the risk around the absence of that minimised?
Mackersy Property’s Facilities Managers and other independently qualified personnel will also visit the site in the due diligence period to check out the claims made for the property in person. For major acquisitions, it is common for many of the team to view the property and discuss the positives and negatives of the project, site or building.
An Investment Committee sits every week to ask these questions. It is made up of past and present owners of the business, team members, and Colliers Otago personnel who discuss current opportunities and debate their merits. Matters like the potential for upside, the property’s location, investor and market sentiment, the property’s back story, its ability to be re-leased, and any other relevant factors are all discussed.
Accepting terms and completing the purchase
When the commercial terms of an Agreement are agreed both vendor and purchaser sign an Agreement for Sale and Purchase. In Mackersy Property’s case the Director of the General Partner signs by and on behalf of an investor group yet to be formed, which will be the end buyer.
In the pre-settlement period, the Director of the General Partner, acting on trust for the Limited Partnership will also sign:
- company incorporation and resolution documents;
- an initial offer of finance from bank;
- the legal documentation necessary to complete settlement (Authority & Instructions forms, loan and mortgage documents, Land Transfer Tax Statements, company resolutions) prepared by General Partner’s lawyers, Duncan Cotterill;
- a Management Agreement between the Partnership and Mackersy Property.
The process of confirmation is likely to be in two stages. This is because an investment opportunity will only be offered to Mackersy Property’s database if the pre-conditions are met satisfactorily. Confirmation of an agreement only happens when sufficient investor support is obtained.
Presenting the offer to Investors
To enlist investor support, once a contract or agreement is signed, an Information Memorandum (IM) is put together summarising the opportunity.
The IM contains information to allow investors to assess their commitment and participation: purchase price and parcel sizes, descriptions of the building and its services, analyses of the location, tenant, lease, and valuation, and the likely terms for the lending required. The direct costs of acquisition are factored into the purchase price, and include allowances for accountancy, bank, valuation and Mackersy Property’s facilitation and management fees.
In the pre-confirmation and pre-settlement periods, investors who have expressed interest are qualified and identified by the Compliance and Investment Teams. Once those steps are complete, investors pay in their equity, and their monies are applied to the purchase. When the property purchase settles, units or shares in the Limited Partnership are issued to the investors. Directors are then appointed from the investor group to take on the governance of the Partnership.
Once the IM has been published and sent to the database and sufficient investor support has been gained, Mackersy Property confirms the Agreement and all parties proceed towards completion, known as settlement or handover.
Settlement day is the date the purchaser pays the balance of the purchase price to the vendor and the vendor transfers the property to the purchaser. The date is usually set for:
- some weeks after the Agreement becomes unconditional, and
- is non-negotiable.
During the weeks leading up to settlement the legal paperwork is prepared and the relevant documents signed. Both parties ready themselves for the settlement day in advance, as both can face penalties if the settlement doesn’t occur on time and on the day stipulated. If a purchaser fails to pay before 4pm on the settlement date, for example, the vendor’s lawyers may charge penalty interest on the unpaid purchase price.
Achieving settlement on the due date is often a tense and last-minute thing, as all parties are reliant on the transactional efficiency of the bankers and lawyers to ensure the time frame is met.
In a residential property purchase, a pre-purchase inspection and handover of keys are usually involved but for commercial property purchases, inspections are usually completed in the due diligence phase, and it is the tenant who holds keys to the premises.
Post settlement, the Director group signs all the documentation related to the investment, including lease reviews and renewals, loan rollover facilities, resolutions and the like.
Change of ownership
Both the vendor and purchaser sign documentation to effect the change of ownership, called the transfer, along with Land Transfer Tax Statements. A purchaser will typically sign bank loan documentation, while a vendor will sign mortgage discharge documents. Their lawyers exchange undertakings promising to carry out the tasks necessary to effect the ownership change, such as signing ‘dealings’ prior to settlement and, once monies are paid, registering the change in the Land Titles Office. Vendor undertakings may include making the documents associated with the property (like original lease documents) available to the purchaser.
Delays in negotiating or confirming an Agreement can be related to communication failures of one kind or another, to the need to raise and resolve issues arising from the due diligence process, or to a sluggish response from the database. Although the Agreement will provide strict time frames for confirmation, it is commonplace for negotiations of time for confirmation to be sought and granted by the vendor.