Cash deposits and banks guarantees are traditionally the most common way of securing rental streams when entering into property leasing transactions. More recently, insurance guarantees have become a popular alternative to these.



What are insurance guarantees for commercial property?

Businesses that enter into lease agreements are typically required to lodge some form of security in order to protect the landlord in the event that the tenant defaults on the lease.

This security sought by the landlord is typically provided to the tenant by financial institutions – mainly banks - on a secured basis. For smaller enterprises, this is usually a bank guarantee secured by working capital that is held in a term deposit account. For larger corporations, a bank guarantee is taken against established lines of credit secured by company assets.

This secured approach means that the business loses out on cash or part of established lines of credit as working capital. It also impacts the businesses financials, in that the transaction is said to be “on balance sheet”. Being “on balance sheet” means that the business’s ability to borrow more money is reduced. Despite the banks having security, they still charge annual fees for the guarantee.

As a solution to this, insurance guarantees for commercial property leasing transactions was developed so that a tenant would not have to tie up their own funds nor need to secure a bank guarantee.

Who should consider Insurance Guarantees?

Insurance guarantees are a good option if you’re an existing tenant wanting to free locked up capital, as well as replace your current bank guarantee or cash deposit. They’re also preferable if you’re a business owner and want to expand your business by leasing bigger or more suitable premises.

Benefits to Tenants
<ul>
 	<li>They free up working capital without the need for property or long term deposits being tied up as security</li>
 	<li>They’re extremely cost effective, tax deductible and can be arranged without delay.</li>
</ul>
Benefits to Landlords

As well as being of benefit to tenants, insurance guarantees also have several benefits to you if you’re a landlord:
<ul>
 	<li>Because insurance guarantees are an “off-balance sheet” transaction, if your tenant goes bankrupt, you as the landlord will get paid directly rather than sharing whatever is left of the receivers pool of funds</li>
 	<li>Cost efficiencies for tenants mean you may secure longer rental periods</li>
 	<li>You can facilitate difficult lease negotiations by allowing your tenants to redeploy working capital that is tied up in balance sheets with bank guarantees or cash deposits</li>
 	<li>Insurance guarantees give you as the landlord the same legal rights as a conventional bank guarantee but also allow a “cash in” security.</li>
</ul>
&nbsp;

Commercial Property Insurance Guarantees

Are you looking to lease office space? If so, you’ll need to manage the tenant installation allowance (TIA) usually offered to incoming tenants. Most reputable landlords offer TIAs to tenants willing to provide meaningful lease commitments (3 to 5 years).

TIAs are capital improvements made to premises in order to both improve staff workspace and convey the tenant’s corporate identity to visitors. Capital improvements include things like floor coverings, dry walling, glass partitioning, air conditioning, surface finishes, painting and wallpaper. All non-permanent fixtures are excluded from TIA budgets and are for the tenant’s account.

In most cases, landlords also offer a ‘beneficial occupation’ (BO) component as part of the TIA. BO provides a window of time to the tenant where their fit out is completed without rent being paid to the landlord. This window of time varies and is entirely at the landlord’s discretion, but is usually a period of around a month or two.

As a landlord, you can arrange these components (TIA/BO) in a number of ways, including:
<ul>
 	<li>Offering a TIA in cash, and contractors are then settled on completion of work</li>
 	<li>In the most common scenario of the three, the landlord combines the BO period with the TIA. For example, the tenant is given one month rent free plus a cash allowance.</li>
 	<li>The entire TIA is provided through an equivalent ‘rent free’ window. For example, the tenant does not pay rent for three months post occupation on a three year lease.</li>
</ul>
Landlords finance TIAs in a number of ways. In most cases this is worked as the value of one month’s rent per year of lease.Landlords typically use rental deposits as a means of financing TIAs, but with bank and insurance guarantees becoming more prevalent, this type of offset is a less likely option.

Once the TIA has been negotiated, we recommend that you engage more than one spatial planner or designer. By fostering competition to win the contract, you’ll ensure that you maximise your budget and get a quality final product.

Tenants must review the lease agreement, checking for ‘reinstatement’ clauses, as these can prove expensive when caught unawares. For example, demolition of flooring when leaving your premises can be prohibitively expensive and needs to be a consideration when negotiating lease terms.

What is a Tenant Installation Allowance?

If you have money to invest in property, should you invest directly, either by buying residential or commercial property, or should you rather put your money in property stock on the JSE?

While direct investments can give higher investment yields than investing in the stock market, rising “stealth taxes” in the form of municipal rates and taxes have eroded these yields quite substantially over the past few years. On the other hand, investing in property stock means you have to be less involved in daily management of your assets, and you can have a more diverse portfolio.

We weigh up the three options below:

1. Property Stock on the JSE

Investing in property stock on the JSE means you can have a diverse portfolio of commercial property including office, industrial, retail and hospitality assets. At this stage, exposure to the residential property market on the JSE is almost non-existent. Another advantage is that your dividends will be exempt from taxation if you’re investing in South African property (non-South African dividends are taxable, subject to certain minimum earning exclusions). Bear in mind, however, that buying and selling shares may result in you being considered a share trader. This means that profits from your share activity will not be seen as a capital gain, but will be treated under normal taxation principles.

We believe that the listed property sector will continue to produce good returns in the medium to long-term, because they’re underpinned by quality assets and covenants coupled with conservative balance sheet gearing.

2. Residential property investments

If you want to invest in residential property, you’ll need to do so directly by purchasing houses, apartments, flats or into residential schemes / syndicates on a ‘buy to lease’ basis. These assets may carry higher risk profiles because you’ll be dealing with individuals as tenants rather than business tenants in a commercial property investment. In residential property, tenant turnover also tends to be relatively higher, since residential leases are typically shorter than commercial leases. As an investor, you’ll have a higher probability of vacancy, so you’ll need to be liquid enough to accommodate periods of little or no income.

3. Commercial property investments

While commercial property investments tend to be hugely capital intensive, they do possess better fundamentals than their residential counterparts. Good quality assets with good covenants and long leases assist greatly in achieving attractive lending structures and predicting accurate forward cash flows.
However, these assets often attract significant fit out or improvement allowances as well as sizeable broker commissions over lease renewal periods. Landlords provide for these improvements and work in conjunction with the tenant to make the premises suitable for their business operations, provided the work required is of a capital nature and translates into an increase in value to their investment. Broker commissions are paid according to the length of lease achieved, the landlord must agree the tariff prior to engaging the prospective tenant.

Weighing up the pros and cons of these three options, we recommend investing in the listed property sector for the foreseeable future, unless of course you have a patient outlook consisting of large capital reserves and an appetite to get ‘hands on’ in in order to manage these assets.

Choosing property investments: Part 2

Pundits are predicting that the property market may only recover at the start of the next interest rate cutting cycle, which in reality could be years away. Rising “stealth taxes” in the form of municipal rates and taxes continue to erode direct investment yields, coupled with unfavourable lending conditions make the property market a challenging environment for the individual investor.&nbsp;In this environment, should you invest directly in property, or buy property stock on the JSE?



When deciding which option will give you the highest yield possible, consider the following:

1. Liquidity

If you need to access cash in the short to medium term, listed property stocks have the advantage of high liquidity, since their shares are easily tradable on the JSE. In contrast, direct property investment is less liquid and so suits a more patient investor with a longer-term outlook who has less need for cash in the short term. Also bear in mind that exiting from direct property investments can take considerable time with increasing sluggishness at the Deeds Offices and City Council when it comes to applying for rates clearance certificates.

2. Equity requirements

Investing in the listed property sector is an accessible mode of investment for all, with investors requiring relatively low unit values to secure stock. Direct property investment requires significant capital injection at the outset, with lenders currently looking for a minimum of 30% equity up front on commercial property transactions. Be aware too that the bulk of commercial property bonds are ten-year contracts versus the usual twenty years commonly applicable to residential bonds. For these reasons, you’ll need significant debt facilities if you’re investing directly in the property market.

3. Management

Investing in property stock means that professional property practitioners will manage your assets – so you don’t need to worry about daily management concerns. In contrast, as a direct individual investor you’ll need to manage tenants, collect rent, pay levies, rates and taxes, and oversee repairs and maintenance to your assets. As a direct investor, therefore, you’ll need to be prepared to get “hands on” in order to generate attractive returns.

4. Interest Rates

With interest rates likely to increase in the foreseeable future, it will be interesting to see if the listed sector can continue their consistent returns for investors. We believe this trend will continue and that the bulk of the listed funds will continue to produce good returns. The key to a successful ‘buy to let’ scenario if interest rates do increase is to ensure that your income stream outperforms the interest payable on your bond. To do this, you’ll need a sizeable equity injection &nbsp;in order to stay ahead of the interest rate curve and allow investments to ‘wash their own face’ in perpetuity.

Considering these factors, we would recommend investing in the listed property sector for the foreseeable future rather than buying a direct property investment. The exception exists for a patient investor with access to large capital reserves who is prepared to get “hands on” when managing these assets.

Choosing property investments: Part 1

In many cases, the net rental figures quoted to you by your landlord won’t include operating expenses related to running the premises. Instead, as a tenant, you could be charged extra for utilities such as:
<ul>
 	<li>common area charges</li>
 	<li>parking</li>
 	<li>generator contributions</li>
 	<li>cleaning</li>
 	<li>security</li>
 	<li>park levies</li>
</ul>


In most cases gross rentals should include these items. The two exceptions to this are water and electricity – these will either be metered or pro-rated on a consumption basis according to the floor area occupied within a shared facility.

These additional expenses that are sometimes left out of a quoted rental figure can add up to a significant extra cost, which can mean that the total cost of renting premises becomes unaffordable. Sometimes, though not always, landlords quote ‘net rental’ numbers so that the premises look less expensive than their competitors’. They’re then able to secure a deal while at the same time having you, their tenant, carry the risk of increases in operating expenses.

In general, this won’t happen if you deal with listed funds or larger, private landlords. In these cases, lease terms are more transparent and the saleable details are usually clearly itemised on all marketing information.
In summary then, always request a ‘gross rental’ figure from your prospective landlord, as this will give you a more complete and useful measurement of the total cost for the space you are looking to occupy. Also, always pay attention to the fine print in your lease agreement, in order to prevent “unquoted” operating expenses becoming your direct responsibility without you realising it.

What is Gross versus Net Rental?

If you’re looking for a commercial facility, it’s a good idea to engage one or even two property brokers who have the expertise to meet your requirements within a focused sector, whether you’re needing office space or looking for a warehouse facility. Here are five tips to get the most out of commercial property brokers.

1. Work on fixed timelines. Give your broker a brief window (a week or so) to service your requirement. If you’re not satisfied with their performance after this period, open the enquiry up to a new broker

2. Landlords don’t like enquiries that are ‘hawked’ around the market.&nbsp;When a buyer or tenant engages multiple brokers, landlords are less open to the deal, since they’re being contacted by multiple brokers for the same enquiry. In addition, landlords are less likely to negotiate if they’re under the impression that there are multiple enquiries in the marketplace for their assets.

3. Avoid signing onerous mandates. It’s far better to work to brief, fixed, exclusive periods with brokers, as this ensures that you’ll get good service without being bound to brokers who aren’t performing.

4. Discuss broker fees up front.In most cases, commissions are paid by the landlord or seller.

5. Make sure that the rent quoted is a “gross rental” number. Gross rental includes items such as net rental, operating costs, parking, generator contributions, park levies, rates and taxes.

Negotiating a good commercial property deal means granting exclusivity to the best brokers you can find. If you stick to the points outlined above, you’ll have the best chance at securing the right property at a competitive price relative to the market.

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