The Real Cost of Vacant Real Estate

A quick search on realcommercial.com.au reveals that there are 12,781 commercial properties available for lease in NSW right now! Even taking into account duplicate listings, that’s a lot of warehouses, offices and retail spaces just sitting there, gathering dust.

In the meantime, commercial property owners are left to bear the costs. But how much does it actually cost to hold a vacant commercial property?

In this post we will dive into some numbers, as well as a real case study, to illustrate the true cost of ownership of an empty commercial property.

Vacant Property Cost – Hard Costs vs Opportunity Costs

To best visualise the costs associated with owning a vacant property, we can split it up into outgoings, mortgage repayments (both hard costs) and lost rent (an opportunity cost).

First, Outgoings. During a vacancy you will have to cover the following bills:

  • Insurance
  • Council rates
  • Water rates
  • Land tax
  • Utility bills
  • Perhaps even services such as cleaning or garden maintenance.

These hard costs are usually paid for by a tenant. But if you find yourself without a tenant to pay them, it is, unfortunately, down to you to pick up the bill.

Next, we have mortgage repayments. The bank doesn’t care if your property is vacant. Interest rates are at an all-time low which is certainly taking some pressure of commercial property investors; well, at least those who have refinanced. Nonetheless, interest is usually an investor’s single biggest monthly expense, and without a tenant to top up the bank account it can be hard to cover this cost.

Finally, we have the lost rent. Being an opportunity cost, rather than a hard cost, it can be easy to forget exactly how much rent you are missing out on each week, month, or year.

Let’s look at a real life example.

Anthony (not his real name) owned a light industrial building in the heart of a thriving Sydney suburb. The 15-year-old building is a decent 780sqm of lettable area sitting on 680sqm of land. If Anthony’s tenant moves out (which they did) his holding costs would be as follows:

  1. Outgoings: $680 per month
  2. Lost rent: $13,500 per month
  3. Interest. Assuming a market value of $2.2m I’ve estimated the interest repayments with the following calculation:

Property Value × Loan to Value Ratio × interest rate ÷ 12 = monthly interest

$2.2m × 70% × 7% ÷ 12 = $9,000 per month.

Total costs for holding a vacant 780sqm warehouse in Sydney: $23,180 per month.

How a Property Manager Can Help

In the example above, we saw that the true cost of holding a vacant commercial property in Sydney can easily be over $20,000 per month. Employing a property management firm is the 1st and best step you can take to mitigate this huge risk. Through their tried and tested systems, process and technical expertise, a property manager will significantly reduce your vacancy period, saving you $1000s each month.

Effective Rent – What Is It and How to Use It

When your prized investment does become vacant, it can be tempting to hold out for top dollar. “Hey, this is the best warehouse in the area!” you rightfully think to yourself. But with the true cost of vacancy now freshly imprinted in our minds, we should consider a concept called effective rent.

Effective rent is the rent you get when you take into account everything. This includes the time it takes to lease your property, any rent free period, increases, fees, everything!

Calculating effective rent is easy:

  1. Add up all the rent you will receive over the life of the lease (don’t forget those rent increases).
  2. Take away any rent free or the lost rent during the time it took you to find a tenant.
  3. Divide this total by the length of the lease to get it back to an annual figure.

Let’s take a hypothetical scenario this time.

Scenario 1 – Your property leases for $100,000pa. It’s a fantastic property, so you held out for top dollar and it took 4 months to lease. You negotiated 3% annual increases on a 5 year term.

Scenario 2 – The same property leases for $95,000. You thought you might have been able to hold out and get more, but you received an offer just 1 month into the leasing campaign and took it. Because you accepted the tenant’s 1st offer, you were able to negotiate some other terms such as 5% annual increases.

You can probably see where this is going. Despite a seemingly lower rent – $95,000 vs $100,000 – Scenario 2 is actually a better deal! Once you factor in the lost rent and annual increases, scenario 2 will earn you an extra $19,438.05 over the life of the lease. So, A bird in the hand is worth two in the bush.

In this post, we’ve seen how expensive it really is to hold an empty commercial property. Having a property manager you can trust is vital in minimising vacancy, and saving you money. This is especially true for commercial property. And now you understand the idea of effective rent, don’t be too quick to turn away an early offer to lease. Consider the big picture.

To read more about how commercial property owners can minimise vacant periods, download your copy of our free eGuide, ‘How Commercial Property Owners Can Avoid the Vacancy Plague‘ below:



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