Why buying your own business premise is a no-brainer
Thursday, January 15, 2015/
So, you want to buy your business premises? Well consider carefully.
Over the years numerous clients have asked me – “should I buy my own business premises?”
My answer, which has always been the same, is – “it depends”. Invariably this is followed by the question – “why do you want to buy your own business premises?”
The issues to consider
The reason I say “it depends” is because it really does depend on a number of variables. Whilst there are many issues to be considered, here are just a few of these variables.
1. Can the scarce capital of the business owner be put to better use?
Depending on the type (and location) of the property concerned, the likely rental yield will be in the middle to high single digits (e.g. 7-8%). Sure, there is also the potential for capital gain but there is also the potential for capital loss.
The bigger question for me is – what is the alternative use of the capital? Do you have a growing business which can use (or in fact may need) the additional capital to fund that growth, and what rate of return would you achieve on the capital if it was invested into the business?
From my experience, most businesses will earn a return on capital employed much greater than 7% or 8%. This is particularly the case if you have to borrow the money to fund the purchase. However, if you’ve got the cash to spare and don’t have an alternative better use, go for it.
2. What is the nature of the business the client is engaged in?
If this is a specialised industry requiring specialised premises then there may be limited other options for you to rent the premises to someone else should you cease or sell your own business. Alternatively, you may need to spend considerable dollars to convert the premises to something that has more appeal to a wider range of potential tenants.
3. The investment risk of having all your eggs in the one basket
However, from my experience, business owners don’t see this as a risk. Many see the sharemarket as risky, even though any investment would be diversified across many blue chip shares and is easily liquidated. Many business owners don’t perceive their business to be as risky as the sharemarket.
I suspect this is because it is what they know, and after all, they feel they have control over it because it is their business. On the flip side, I’ve had a number of clients who have bought multiple business premises from which to run their business. They’ve subsequently sold the business to a much larger company and then benefited by having an excellent long-term tenant across multiple locations.
4. Compare rent to interest
Another consideration is to compare the rent with the interest that would be payable on the loan to acquire the asset. In the current low interest rate climate, interest costs are generally less than the rent that is payable. In such circumstances the rent that would otherwise be paid can be utilised to fund the acquisition. Of course 100% borrowing is generally not wise and so there is still an up-front capital cost that must be considered before making a final decision.
How to buy it
Having considered all the variables involved with buying your own business premise, the next question is – “how should I buy it? In which entity?” Once again, the answer is – “it depends”.
Invariably one entity you would not buy it in is the same structure through which the business is conducted. This is basic “boiler plate” asset protection. If something happened to the business (either going broke or being sued), then the property is at risk. You would also most likely not acquire the property in the personal name of the business owner.
The answer also depends on the extent of gearing (debt) there will be on the property and the anticipated capital growth. Companies are generally not a great entity in which to hold capital appreciating assets due to their disadvantageous capital gains tax treatment.
However, this negative is not as relevant if the business qualifies for small business capital gains tax relief. The converse to this is, of course, that there is no guarantee that the small business concessions will continue to be available.
This leaves trusts and super funds as a possible vehicle to hold your business premises. Both of these provide excellent asset protection vehicles because generally you own nothing but control everything.
It’s hard to go past the tax efficiency of holding the property in a self-managed super fund, particularly now that super funds can borrow. Business owners do need to take into account, however, that a property in a super fund is not available as security for any other borrowings that the business or its owners may undertake.
I have a number of clients for whom we have transferred business properties out of their own names (where they were paying the top marginal tax rate on the rental income) and into their super fund (where they pay minimal, if any, tax). They can generally get access to the CGT small business concessions on business premises to eliminate any tax on the transfer of the property into their super fund (depending on their circumstances). In most cases, however, this does incur stamp duty, although, in some states, primary production property can be transferred without incurring the duty. The duty varies from state to state but is often 4% or more of the value of the property.
The super fund then rents the property to their business. The super fund pays 15% tax on the rental income (or zero tax if the members are over 55 or 60 and drawing a pension from the super fund) and the business gets a tax deduction at 30% or higher for the rent it pays to the super fund. If the rent is say $100k per annum then the tax savings are up to $30k each and every year. This cash flow is ideal in the super fund to fund payment of a (potentially tax free) pension back to the owner, so the money goes from the company (as a tax deduction) to the super fund (no tax) to the owner as a pension (no tax).
When the owner sells the business, they invariably sign up the purchaser on a long-term lease. Now they’re getting tax-free rental income from a tenant. Further still, if and when they sell the business premises, the capital gain is tax free (assuming the fund is in pension mode) or at worst at 10%. If they held it outside of super the tax could be up to 24%, dependent upon what small business capital gains tax concessions they might be entitled to access.
So, next time you’re considering buying your business premises, think about the above issues.
Grant Field has over 25 years of accounting advice to businesses and is chairman of accounting firm MGI.
Be honest about your situation: How vulnerability helps businesses thrive Sue Parker DARE Group founder
Own it: The 10 things you need to do to manage your personal brand Lisa Stephenson Who Am I Projects founder
Six invaluable lessons: What 20 years in aged care taught me about being an entrepreneur Natasha Chadwick NewDirection Care founder
An entrepreneurial superpower: Eight tips to help develop resilience Adala Bolto ZADI Training co-founder
Going through a lull? Five areas you should invest in when sales drop Tamara Alaveras and Sonia Majkic 3 Phase Marketing co-founders
Stop telling us how busy you are, it's boring and charmless Ian Whitworth Scene Change co-founder
Blandification™ and the state of modern branding Jeffrey Oley The Offices co-founder
Why you should find the right role for the right person — not the other way around Bruce Stronge Outfit founder