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Commercial Property Australia: THE BASICS - YouTube
Channel: Kent Cliffe
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what i would encourage you to be is
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extra diligent when the property is
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vacant or partly vacant
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and this is because what the owner can
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try and do is weight the outgoings to
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the tenants
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which ultimately inflates the net rent
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g'day cliffsters i'm ken cliff making
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property and personal finance videos for
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people with a bit of money and some
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knowledge
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but they want to take the next step to
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direct investing
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as always with all my videos there is no
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thin marketing fluff
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there is no expensive cause and there is
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no service upsell
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just a guy with some maybe some runs on
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the board
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giving you genuine content today's video
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is for cliffsters who
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are considering commercial property
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investment and when they look at real
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estate ad or speak to an agent
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there is a lot of foreign terms which
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are used that can get quite confusing
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so what i thought i'd do is two things
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firstly for the beginner viewers i'll go
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through the common terms and explain
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them
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but for people that are a little bit
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intermediate i'll throw in some tips of
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wisdom at each point
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as i get prompted throughout all the
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definitions so without further ado
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let's get into commercial property
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investment terms the first two terms i
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was going to talk about is
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yield and cap rate which are two
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commonly misused terms
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firstly let's talk about the yield
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effectively the yield is the net rent
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divided by the purchase price of the
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property
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so if for example the rent that you're
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receiving on a property is a hundred
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thousand dollars
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and the property's purchase price is a
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million dollars that yield would
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effectively be
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10 the reason why this term is commonly
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misused is because it's interchangeable
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with cap rate but cap rate
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is not entirely representative of a
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yield
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a cap rate is what's called a
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capitalization rate
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when we refer to the yield on commercial
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property we're referring to the
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individual return
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on a property which you are looking at
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whereas a cap rate
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talks about what the market perceived
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return of a yield is
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the calculation is the same but they are
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very different things
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now remembering the market perceived
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return is based on a range of different
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factors
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this includes what the asset type is is
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it industrial or retail or office
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the age of the asset if it's purpose
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built for that particular tenant
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if it's over rented or market rented the
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term of the lease and the quality of the
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tenant if you're buying the income
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the other thing worth getting your head
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around as an investor in commercial
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property is it's not just
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all yield driven a lot of people that
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are new to commercial property investing
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go into it and think that the biggest
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possible yield that they get is the best
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possible deal
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this is not the case it's the
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risk-adjusted return based on the market
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view of the capitalization rate
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relative to the yield for example if a
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building has a bad tenant and it's over
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rented and it's old and it's hard to
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release
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the actual yield that the market might
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sell it to you on is quite high
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but also the capitalization rate of what
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the market perceives value for that
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building might be high too
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the other thing worth mentioning with
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capitalization rates is there's an
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inverse relationship between the
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capitalization rate and the building's
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value for example when the
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capitalization rate of an area or an
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asset goes down
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the actual building value goes up
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provided the rent stays the same and
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while we're on this topic it's also
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worthwhile mentioning cap rate
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compression what's that well cap rate
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compression is where the capital market
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or the debt market
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has driven up values of assets because
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money is affordably a lot cheaper
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nowadays with commercial debt
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people can get higher returns when they
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take into account gearing than what they
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used to and consequently the value of
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assets get bid up the next term i want
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to touch on is due diligence and this is
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either a contract term
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an option or a period prior to making an
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offer where you
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as the buyer conduct a lot of research
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into the property to determine
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if all the facts and figures provided by
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the agent their property manager or the
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landlord
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is correct and accurate with residential
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property due diligence is often capped
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at building and pest inspections
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but with commercial property it is a
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little bit more involved and it's quite
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common to have anywhere from 20 to 90
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days
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to verify all the information which the
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agent has provided
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if there's anything wrong with this
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information or it has changed
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you can either renegotiate the deal or
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walk away from the contract
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some of the due diligence items which
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you might want to consider include is a
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rent around market
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you know if for example the tenants
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coming up for an option period
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if the rent is over market you're
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actually incentivizing the tenant to go
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out and find
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a different property the other thing is
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the net little bit net lettable area so
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for example
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if the lease says this 300 square meters
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a net level area
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are you actually leasing out 300 square
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meters area then you want to dig into
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the lease and get a good understanding
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around all the rights and obligations of
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being a landlord including rent reviews
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as well as having a look through the
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outgoings budget to confirm
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everything which is represented and all
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expenses which are related to the
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building are included in the budget then
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you want to look at the structural
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component of the building itself and any
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plants and equipment such as fire
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services and air conditioning and
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confirming that they're all up to date
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and compliant
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the other thing that's important is if
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the tenant has a planning approval to
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occupy that premises because unlike
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residential
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different businesses need planning
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approvals to operate in different areas
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and the list for due diligence goes on
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we are not even at the end of the leases
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yet so if you have
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learned something from this video and
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most importantly have a mate that's also
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interested in commercial property share
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this video to them
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they'll then hear this they'll then get
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a warm and fuzzy feeling too that you
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intro them to this channel
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while you're at it hit the subscribe
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button hit the like button turn on the
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notifications give me some love because
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this encourages me
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moving on to the different types of
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leases and the first one i want to talk
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about is a gross
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lease this is basically where the tenant
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pays one amount to the landlord and then
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the landlord deducts all the expense of
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the building out of that
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and what you're left over at the end of
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is the net rent when you're comparing
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buildings against one another
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as a landlord you always want to be
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dialing everything back to the net rent
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because this
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is what ends up in your pocket at the
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end of the day it's also worthwhile
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touching on the difference between gross
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rent and
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a gross lease because i've just realized
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myself
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i've made a mistake in describing it the
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gross lease is the document which says
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that the rent the gross rent is the way
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it's going to be collected
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and the gross rent is the total amount
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of collections
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from the tenant now remember how i said
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before what you want to do as a landlord
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considering a building is dial
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everything back to a net rent
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well that's my next term is net rent and
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basically think of this as what you
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end up at the end of the day as a
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landlord so getting it right this time
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the net rent is
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part of a net lease and this document is
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basically a lease between the landlord
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and the tenant that sets out that the
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rent
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of the building will commonly be a
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square meter rate so a dollar per square
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meter
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times the net level area plus vo's
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variable outgoings
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plus gst so it doesn't matter what the
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variable outgoings is or if the gst
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changes and this gets me onto the next
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thing i want to talk about which is
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outgoings or vo's which is short for
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variable outgoings this includes all the
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expenses are holding the property
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excluding interest which we'll talk
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about later so basically property
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management fees
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land tax rates water rates maintenance
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strata fees any servicing with the
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building such as a fire equipment or the
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air conditioning
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almost anything which you can think of
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insurances
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is generally a part of the outgoings
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budget
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now there are some exceptions under
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retail leases
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where in some states or almost all
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states you can't charge property
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management fees
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now same landlords do this two different
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ways sometimes in an informal agreement
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where basically the landlord passes on
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any invoices that they get to the tenant
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and the tenant just pays it direct
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or the other way is that the landlord
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commonly sets a budget at the start of
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the financial year
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and then they divide that total budget
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by the amount of square metres of the
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building
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they apportion that to the respective
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tenant and they break it up into
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installments over 12 months
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the tenant basically then pays a portion
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of the outgoings which is held by the
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landlord
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the landlord then uses this to pay the
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budgeted expenses
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at the end of the financial year what
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they then do is check that their balance
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of what they budgeted is basically what
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they
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expected or what happened and if there's
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any adjustments which need to be made
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they're made at this time while due
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diligence is still fresh in my head and
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we're talking about outgoings it's
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worthwhile noting that
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if you're considering purchasing a
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building you should be checking
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all of the outgoings costs this includes
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insurances and right
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down to what the building is insured for
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because this changes your insurance
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premium
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and it's also worthwhile mentioning that
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if the building has air conditioning
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call room or fire services it's
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worthwhile getting an inventory of when
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the inspections were conducted
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for example if the inspections weren't
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conducted last year and don't fall
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in the vo budget and then all of a
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sudden they fall within the new year
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when you are in the building
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this might be something which you have
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overlooked to help work out what the
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outgoings are
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what i would do is speak to the
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building's property manager and
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hopefully this is independent of the
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selling agent
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and then i would ask for the income and
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expenditure report for multiple years
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not just the last year but multiple
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years back
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then i'd go through this journal and
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confirm all the different expenses
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how they've been concurred when they've
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been incurred and what i would expect
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would be anticipated in future years
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as a extra pro tip here what i would
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encourage you to be is extra diligent
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when the property is vacant or partly
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vacant and this is because what the
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owner can try and do
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is weight the outgoings to the tenants
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which ultimately
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leads to a reduction in their holding
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costs which when you are looking at your
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own due diligence
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inflates the net rent which you would
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anticipate if you apportioned the
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outgoings
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as per what the lease says a quick rule
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of thumb is looking at the variable
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outgoings paid by each tenant and then
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dividing it by the nla
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and making sure that this number is
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fairly consistent if there's any
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inconsistencies then i'd refer
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back to the lease and see if there's a
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different way of apportioning the vos
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this brings me on to nla which i have
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just mentioned which is short for net
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lettable area effectively this is the
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square meterage which the tenant
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occupies within the lease it's common
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that the lease if it's a net lease
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is based on a dollar per square metre of
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nla
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now it's best speaking to a surveyor
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about how much nla your building has
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because there's all different rules and
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regulations sometimes it's the internal
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walls
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sometimes it's the midpoint of dividing
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walls so just make sure you understand
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where the boundaries are and confirming
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that the net
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lettable area that your tenant occupies
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is correct and accurate
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and if the owner has been slack what
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they often do is use the construction
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drawings
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rather than as constructed surveys to
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dictate the nla
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sometimes this can be a little bit
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smaller and what can happen
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is if the tenant then finds out they can
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then ask you or ask a previous landlord
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for that rent back paid
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this brings me on to whale and not my
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new south wales
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problem i had in my previous video it is
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the weighted average lease expiry
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effectively what that is is if the
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building has multiple tenants
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and the leases are staggered which is
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good as a landlord having staggered
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leases because you're not all vacant at
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the same time
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then you'll portion the income as the
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weight
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to how far in the future the leases
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expire
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for example if you have two tenants and
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one lease expires in two years and one
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lease expires in four years
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and the rent which those tenants are
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paying are identical
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the whale would be effectively three
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years
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remembering if the income from each of
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those tenants is different
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this will impact the weighted average
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lease expiring
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moving from lease terms into more
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financial terms
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the first one i want to talk about is
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free cash flow basically
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free cash flow is your net rent less
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your interest expense
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so when you're going out buying a
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commercial property you'll have some
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equity
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and then you'll have some debt that debt
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component will have an interest cost
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attributed to it at the moment not very
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much but you will still have some
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interest cost
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and then once you pay that interest back
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to the bank whatever's left over and is
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the free
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cash flow is what you're getting based
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on the equity which you have invested
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which gets me on to annualized return on
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equity which i want to discuss now
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investors come to me and say i'm
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investing in this property trust or
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syndicate
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and it's paying out a return of seven
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and a half percent they think that that
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return is a seven and
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a half percent yield it's not exactly a
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seven half percent yield
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if the building had a seven and a half
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percent yield
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and they were gearing it at six percent
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the annualized return on equity which is
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what the figure they're quoting to you
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is
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would probably be over eight percent but
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there's obviously cost of running that
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syndicate so being a smart commercial
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impressed
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it's not only important to compare the
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yield versus the capitalization rate
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it's also important to compare the yield
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versus what the annualized return on
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equity is
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which then brings me onto irr the most
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basic
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kent definition of what an irr is is
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what the expected n sale value is in the
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future it is the purchase price at the
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start
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the time in between and then all of the
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cash flows that you get
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throughout the carry if for example my
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annualized return on equity which only
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takes into account
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rent coming in is say eight eight and a
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half percent
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the irr might be 12 or 11 because the
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capital value of the building
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increases over time so until you learn
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all the terms of commercial property
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investing or my next video
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best of luck and goodbye
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