Investing in commercial properties is not the same as investing into residential properties. There are different dynamics driving commercial properties to residential properties.
- Renting an office location vs owning one– If you have a business and you are leasing an office; you’d be better off by buying your factory or office through your Self-Managed Superannuation Fund (conditions apply). Instead of paying rent to the landlord, you can effectively pay that rent back to yourself via your SMSF.
- Rent paid by your company is tax deductible at 30% and when it goes into your SMSF it’s only taxed at 15%. Capital gains are only taxed at 10%.
- Contribution Limits- Where there is a limit on how much you can contribute into your SMSF as your Super contribution, there is no limit on how much rent you can pay as long as the rental price is within market rates.
- Depreciation value– Commercial properties have much more generous depreciation rates than residential properties. This is extremely tax effective.
- Tax Free Return-If you want to earn $200,000 a year (completely tax free), just buy a commercial property that has $200,000 in depreciation. Effectively $200,000 of your received rental will become tax free.
- Leveraging your commercial properties-The ability to leverage your assets via the use of debt is an extremely effective strategy.
Example, you have $200,000 cash deposit and you could borrow $400,000 at an LVR of 67% you can buy a commercial property at $600,000. You now have $600,000 working for you instead of $200,000.
(a) capital growth is 5% pa and
(b) rental return of 6%pa.
(c) Interest rate of 5%.
In very broad terms the rental basically covers interest (neutrally geared in this example) and if we achieve capital growth of 5% ($30,000pa) we are able to achieve a 15% return on our cash of $200,000. ($200,000/$30,000)
Caution: Some properties do not achieve any Capital Gains including some residential properties.
It’s all about property selection.
- Property Leasing Options-Tenants are generally businesses and they prefer to sign long term leases such as 5 x 5. Meaning it’s signed for 5 years with an option for another 5 years.
- Commercial Property Leasing Terms– Many leases require the tenant to pay all outgoings so the rental received by the landlord is net.
- Percentage of rental increase is tied to the capital growth– Many leases have clauses that gives the landlord an automatic rental increase of 4%pa or CPI whichever is the highest. This means the capital growth of the property is also tied to the rental increases.
- Commercial property valuations are much more clinical than residential properties.
In the main It’s closely tied to the rent:
- If the rents were $60,000pa and the market was paying a 6% return on investment it the n simply values the property at $1m ($60,000 divided by 6%).
- however, if there was a lot of demand for the property and investors were willing to accept a 5% pa return the property value would be worth $1.2m ($60,000 divided by 5%).
- if rents reduced to $50,000pa and assuming a 6% return is expected than the property would have reduced in value to $833,333 ($50,000 divided by 6%)
- if rents fell to $50,000 and returns dropped to 5% pa than the property value would have increased to $1m ($50,000 divided by 5%).
As you can see it’s a lot less emotional than residential properties where residential properties are valued by comparable sales.
Founder & Non-Executive Chairman Chan & Naylor Accountants www.chan-naylor.com.au
Disclaimer: This article contains general information; before you make any financial or investment decision you should seek professional advice to take into account your individual objectives, financial situation and individual needs. Click for more detail regarding this disclaimer.