Therefore, this particular question relates to substantial properties located in Regional areas, having a passing yield of 10% to 11% pa alone. And this generally means … you will most likely receive little (if any) capital growth going forward.
Why is that?
Most of these properties will be large, purpose-built structures – designed to meet the specific needs of the Government department or major corporation.
The initial lease may be for 10 to 15 years. However, upon expiry, local demand will be unable to readily absorb this volume of space – should the tenant vacate.
Plus, the building may require some major renovation or upgrading – after such a long period of occupation.
And furthermore, these purpose-built structures generally have very large floor plates – which often don’t lend themselves to an easy subdivision.
A Case Study
This example is not in a Regional area. However, because it presented a major problem within metropolitan Melbourne, it will serve as a good case study.
A few years ago now, the Australian Tax Office (ATO) planned to decentralise its activities into a number of key locations around Melbourne. And one of those was on Nepean Highway, in the Bayside suburb of Cheltenham.
It was a purpose-built, 7-story building – which was pre-leased for 10 to 15 years.
And after about six years, the ATO decided that Cheltenham was no longer required location.
Being still under lease, it remained responsible for the rent and outgoings. But was unable to find a sub-tenant for much more than 60% of the current rental.
Does this affect the Landlord?
As far as the lease obligations are concerned, nothing changes. And that’s because the ATO was still responsible until the lease expires.
Therefore, any shortfall in the rental from the sub-tenant was borne by the ATO. However, as you can appreciate, the growth potential took a severe hit.
You see, the property’s value had suddenly fallen – because the effective rent level at the end of the lease would now be substantially less than the “face rental” actually being paid by the ATO, under the original lease.
Bottom Line: These sort of properties appear to be ideal for an investor who wants a healthy, set-and-forget cash flow going forward. However, you need to be aware of the potential downside – if the tenant were to vacate at the end of the lease; or earlier, as it was the situation in this example.
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