The mad dash for commercial leases

I know real estate investors in Lagos have dabbled in commercial leases for a long time now, probably before Nigeria’s independence. In Abuja, the mad dash for commercial lease seriously kicked off seven years ago and young, savvy investors are not losing steam.

I recall a transaction executed by an ex banker. You see, he took a commercial lease on a property (the owner was deceased and his estate was willing) at N10million per annum for 10 years. The gentleman -now a real estate mogul and I will come to that later- could only cough up N20million for two years which the owner’s estate swiftly accepted with a promise that he will pay another three years of the lease within the year. Ex banker probably was not sure how he will pay for the three years in one swoop but I guess he was praying for a miracle.

This transaction for him is what we call a ‘no money down’ deal, except of course, he paid N20million to get access to the property. Ex banker succeeded in getting off takers for the mall he was constructing and let us say – with a hawk like approach to construction cost, ex banker succeeded in completing project in record time and fully funded by off takers’ cash. A year later, the mall was bought by a real estate investor and ex banker was paid a substantial amount to relinquish the lease, providing him enough capital to embark on his next project. Ex banker became a real estate mogul. No wonder the dash remains unabated. No one tells the horror stories that have cropped up. We only want the good stuff!

Commercial leases are great investment products. However, they also come with risks:

1)   Costs

Property owners are becoming more astute about extracting value for their assets. Many now demand premiums for their properties. Owners demand N15 – N20 million per annum for leases that were N10million a few years ago, despite the recession. As demand outstrips supply, it was only a matter of time, the owners became the major beneficiaries. So, if you are a property owner, now is your time.

2)   Tenure

Property owners now have a preference for shorter leases which understandably impacts on investors’ returns. If you are an investor, never take a lease that is less than 10years, it rarely works for you. I have a preference for 15year leases and above. Also, remember to insist on a moratorium to cover the time spent applying for approvals and getting government consent for your construction. You can also test your negotiation skills by insisting on a moratorium to cover the construction period. Typically, parties agree a period, maybe 12months. The lease commences after this period and my advice- insist on this, it works to your advantage. Construction can be fraught with all kinds of delays, you don’t want to lose the time you should be making money.

3)   Recession

Nigeria has been in a recession since the second quarter of 2016, taking the real estate market into the doldrums. Astonishingly, demand for commercial leases in highly sought-after locations continue to rise and the cost moving in correlation to demand. Nevertheless, off takers are rarely willing to cough up money before construction and when they do, are less willing to pay two years rent upfront. The era of the ‘no money down’ deals, if they ever existed, are truly over. If you are an investor, have your cash ready. You will have to fund a large chunk of the construction cost yourself. Consider involving other investors and creating a Special Purpose Vehicle (‘SPV’). You share the returns and the risks too.

4)   Legal matters

Always remember, prevention is better than a cure, so buckle up and get a smart and experienced lawyer when entering into a lease. This appointment must be done from the onset – that is whenever you decide to enter this foray. Lawyers play a significant role in preventing disputes and possibly litigation. Dot the i’s and cross the t’s when entering a contract. Remember you are entering a ‘marriage’ of sorts and you must get it right. The relationship with the property owner is somewhat long and you definitely do not want it going awry at any point.

Look out for encumbrances, title, and any outstanding bills from relevant authorities, for example ground rent. Issues relating to permitted use must also be considered. Is the permitted use on the property residential and your purpose commercial? If so, seek the advice of the relevant government agencies. In Abuja, the department of Development Control of the Federal Capital Territory should be in the best position to advice you.

Get the warranties and indemnities into the agreement for better protection. You may need them at a later date. Lawyers are crucial in transactions like these, so get a good one and get him/her involved immediately. Litigation can be expensive and can skew your projection on returns, Iron clad agreements for your tenants are crucial so keep your lawyer busy and make sure he/she works for the money.

5)   Getting the right tenants

Tenants can make or break the profitability of your new venture. Be selective! Set the profile of tenants and stick to it. Get references and ask yourself how viable their businesses are. If tenants are not making money, they are likely to default. A defaulting tenant can be litigious too and this can be emotionally exhausting and expensive. Stand firm

6)   Letting go – the emotional connection

Remember your lease is finite. How ready are you to hand over the property to the owner when the lease expires? You created this asset, probably from scratch, now you have to hand it over to the real owner. If you are like me and get emotionally attached to your investments, this is certainly not for you. 

Commercial leasing can bring in substantial Return On Investment (‘ROI’) when you always keep the objective in mind – profit! Never overspend beyond your estimated capital expenditure. Stick to your budget and never forget you return the property after the lease term.

Warren Buffet, the proponent of avoiding the herd mentality when investing, is nearly always accurate when predicting investment trends. The ‘Oracle of Omaha’ has made tens of billions of dollars applying his investment principles when investing, I can be forgiven for heeding his advice. Overall, I have come to realise that I have a preference for joint ventures. Why? Well, not only am I avoiding the herd mentality, I also get some equity in the asset, for the duration outstanding on the title, and share the risk with the owner too. Our objectives, invariably, become aligned.

Finding suitable joint venture opportunities can be difficult. Owners find the commercial lease option more advantageous to them if they are patient enough to wait out the lease term.

 When deciding on the commercial lease option, also ask yourself the crucial question- are you ready?