A how-to guide for SMEs looking to buy commercial property.
The pandemic has supercharged commercial property. It’s now become the number one way to diversify, lock down solid capital growth and improve your cash flow in 2021, and you’re keen to get into the market. The question is, what’s the best way to structure your purchase in order to maximise your wealth? This how-to guide demonstrates how buying through the appropriate structure can potentially save you thousands in tax along with providing asset protection, while setting you up for a life of financial freedom.
If you can afford it, many SMEs look at purchasing their business premises instead of renting them and there’s a huge owner–occupier market for commercial properties in Australia to prove it. This is because many owners purchase their office, shop or warehouse and choose to rent it back from themselves, which provides security and capital growth benefits. You will be locked into your market of choice for a period of time while the property market appreciates in value over that period.
“If you can afford it, many SMEs look at purchasing their business premises instead of renting them.”
If you run an SME and are looking to purchase a commercial property as your business premises or as an investment property, there are three main ways to go about this as opposed to buying as an individual or through a partnership. They are:
- a trust
- a self-managed super fund (SMSF)
- a company.
All three provide benefits depending on your unique circumstances.
Like anything, though, each option provides its own drawbacks. Purchasing an asset through a trust or SMSF, for instance, can help shield your property from creditors. However, because a company is considered a separate legal entity, purchasing a commercial asset under a company structure opens you up to potential risk should the company become insolvent or be sued. On the plus side, a company structure provides the ability for the company to retain earnings at the flat passive corporate tax rate of 30 per cent. This may be beneficial if the company shareholders have marginal tax rates greater than 30 per cent, as profits can be reinvested.
Benefits from various structures also include the ability to minimise your taxes by distributing any profits to beneficiaries on lower marginal tax rates, and greater flexibility around distributing profits when the property is sold. As you can see, the pros and cons vary significantly, and it’s important to seek legal advice to identify which best suits your needs as an SME.
Eight tips for SMEs buying commercial property
1. Establish what the property will be used for
If the commercial property is to be used for the business premises, perform a cash flow assessment on the current rent being paid versus the cost of a principal and interest loan, council and water rates, insurance and other holdings costs. If the property isn’t going to be used as the business premises and used solely as an investment, the business should consider the investment strategy such as maximising cash flow or purchasing a value-add commercial property opportunity.
Like any method of investing, you should understand the market well before jumping in. A shortcut to understanding the market and where the opportunities are might be to engage the services of a buyer’s advocate to assist with finding the right property to suit your needs.
2. Undertake a cashflow assessment
A cashflow assessment compares the rent and outgoings received from the property against the ongoing holding costs of the property, such as mortgage repayments, rates, strata levies, land taxes and repairs. The cashflow assessment should also build in the tax effect, as rent is generally 100 per cent deductible, where only the interest on the loan, not the principal, is deductible, which may mean tax can have an impact on cashflow.
3. Future proofing
If you are looking to relocate the business premises to a new commercial premises, relocation costs, along with a loss or gain of exposure to foot and vehicle traffic, should be considered.
If the above is feasible, a mortgage broker should be consulted to advise on the borrowing capacity of the business. This is more important than ever with COVID, as the banks are paying close attention to how businesses performed during the last 12 months, along with deducting the cash flow boost and JobKeeper from income available to service the loan.
5. Get your legals in order
The business’s accountant or legal adviser should then be consulted to determine the most suitable structure to hold the property. This would usually be a family trust, fixed or unit trust, or an SMSF. From a risk perspective, the business’s trading entity should never own the property. The business’s trading entity usually enters into contracts with third parties, such as suppliers, which can expose the trading entity to legal risk if contractual issues were to arise.
Once the structure is determined and pre-approval is in place for finance, the business owners can engage a buyer’s advocate or start locating a suitable property. The landlord could also be approached for a direct sale to the tenant.
7. Risk analysis on the property
Consideration should be given to the property becoming a “white elephant”, meaning, if the business outgrows the premises quickly, what plans do the owners have in place to mitigate this risk or keeping sufficient cash aside to repeat the process on a larger premises?
Once contracts are exchanged, the SME can begin the process of having a lease drawn up between the purchasing entity and the current trading entity, for rent to be paid to the purchasing entity. Beware of the GST implications of purchasing vacant commercial property – this usually attracts GST on the sale and can be an unexpected cash flow burden.
Commercial property offers SME and individuals a genuine opportunity to lock in some fantastic cashflow and long-term wealth when done right. In this low interest rate environment the returns are amplified, which is one of the reasons you should consider this asset class for your business or as an individual investor. However, we recommend understanding the risks as well as the rewards before jumping into the lucrative world of commercial property.
This article first appeared in issue 33 of the Inside Small Business quarterly magazine