Is it financially smart to buy the commercial premises that you currently lease?

[missmonopoly]

We have the opportunity to buy the premises we lease for our business but I'm not sure if this the best way forward?

If anyone has been in this situation or has some advice I would really appreciate it as we are having a tough time deciding what to do. To buy the property would be great for our business but just wondering if it would be the right thing to do when looking at it as an investment?

The property is roughly worth around $600K-$650 K.

It has a 3 bed 2 bathroom house that is unrentable at present. It would need about $30K spent to bring it up to scratch and then annual rent would be about $18000.

There is a separate shed on the property that we lease at $20592 a year (+ our share of council rates and water rates).

We don't really want or need the house but the shed and house are all on the same title so we cannot offer to buy the shed only.

If we buy the property at around $650000 the repayments would be about $2800 a month(interest only) so with what we are currently paying in rent and the rent from the house we would be able to cover the mortgage but I'm just wondering if this is the wrong way to do things as when you look at it from an investment point of view it is about $15600 CF- per year.

We initially only signed the lease for 12 months as we intended to buy our own premises after the first twelve months instead of paying rent.

We are interested in buying the property because there is a good chance that it will be rezoned in a few years time and it is in a great position with lots of passing traffic that has helped our business to grow and be noticed. I have spoken to council and the rezoning process is already underway and has been for a few years but there is no guarantee that rezoning will happen and definitely no idea of when it may happen but we are happy to buy it now at a cheap price and sit on it long term.

If it were to be rezoned we would set our business up on the back of the property and build commercial units along the front and rent them out which would make the property CF+ so we would eventually be able to run our business from there rent free. If rezoned the value would increase dramatically so there is a good chance for CG as well.

At present the shed that we lease is on about a quarter of the land and has a zoning for special use - only a certain type of business can operate from there and because of this it has often sat vacant for a long time in between tenants. The remainder of the property where the house is built is zoned as special rural.

We have one IP that is CF+ (slightly) and has a 80% LVR. We have just completed renos on this property and would be able to rent it out and hold on to it for CG as it is in a great area. We have a few personal debts that may affect our chances of finance for the new property so we may have to sell our IP. My worry is that we would be selling a CF+ property (value of $380K) to buy a CF- property in the hope that the new property is rezoned in the future.

Should we take the risk?

 

[mrdobalina]

You should consider what other alternatives you have and the returns you would achieve with those options.
- invest the money in your business
- buy a different commercial property
- buy a residential property
- etc

If the opportunity stacks up, then go for it.

 

[Scott No Mates]

Look at it this way:

if you don't buy this one (you intended to buy a cip anyway) you will still be paying rent to be somewhere.

rent will be paid to you (as income) not to some other LL.

you instantly have one tenant (lessening your risk) without having to pay a premium or undertake dd on the tenant.

There's the opportunity to value add to generate a second income stream, would it be leaseable?

Is a 6% yield viable? How much are similar properties selling for?

it might be worth getting a valuer to give you some guidance.

 

[Aaron_C]

It's not a bad idea as long as you think you will be in that premises long-term.

 

[geoffw]

One possibility (depending on your circumstances) is to buy the property through a self managed super fund. This is one situation where you can actually legally benefit from property in your super fund.

 

[Scott No Mates]

True Geoff however the intent is to redevelop down the track to benefit from the rezoning. Such a substantial change to the asset and the likely need to borrow funds may be a breach of the trust deed.

 

[geoffw]

True Geoff however the intent is to redevelop down the track to benefit from the rezoning. Such a substantial change to the asset and the likely need to borrow funds may be a breach of the trust deed.

Is it possible to hav a trust deed which permits such changes to the asset? Presumably the SMSF would need cash- or I have heard of a JV between an SMSF and a person.

 

[Aaron_C]

True Geoff however the intent is to redevelop down the track to benefit from the rezoning. Such a substantial change to the asset and the likely need to borrow funds may be a breach of the trust deed.

I think the more important prohibition would be the SIS Act which means SMSFs can't even borrow funds under law for development even if the trust deed permits it.

 

[geoffw]

I think the more important prohibition would be the SIS Act which means SMSFs can't even borrow funds under law for development even if the trust deed permits it.

Ok. But as per my question, what if there was enough cash in the SMSF to develop? Or at least say to get a DA to sell it?

This is as much for me as a strategy. I've been told I can't substantially improve a property in an SMSF, but is the only restriction on borrowing money- if the deed allows?

 

[Aaron_C]

Ok. But as per my question, what if there was enough cash in the SMSF to develop? Or at least say to get a DA to sell it?

If you got enough cash then go for your life but you can't borrow to do it.

 

[Paul@PFI]

My first response to the original question would be that your business should NOT buy its own premises. Instead if its a viable investment some other entity should buy it. The busienss can pay deductible rent to that entity. That way your lease continues....

You dont want a trading enterprise to own property !. If the business goes bad the assets make awesome security in a fire sale. If another entity owns it the investmnet can stand alone and may not be at risk....

Business Rule 101. Keep assets ownership and use seperate. This rule applies to real property and intellectual property. Good examp,e is a busienss name. Had a client I recommended he PERSONALLY own the business name. He had partners - They shared in business. Cost was next to nil. Years later he was asked to sell the busienss. Name was worth a motza. The partners didnt share in it at all and never had.

 

[Aaron_C]

My first response to the original question would be that your business should NOT buy its own premises. Instead if its a viable investment some other entity should buy it. The busienss can pay deductible rent to that entity. That way your lease continues....

I think he means owning himself / some other entity related to himself rather than directly having the business owning it.

 

[wobblysquare]

Investing / Gambling

As an investor you are selecting an investment as you know how to make money from it.
As a gambler you are selecting an investment because you hope it can make money.
Which approach do you prefer?

With the stated previous history of long vacancies, and limited potential tenants, you could be in a strong negotiating position?..unless the new owner just wants to live in the house !! If the new owner is an investor they will need your rental income.

Is the vendor an investor or a home owner? WHY are they selling, what are they trying to achieve?

Is there an opportunity to negotiate the right (but not obligation) to buy at say $700k, at any point within the next 5 years. In conjunction with signing a 5 year lease.

This would serve to secure your business location, AND you would only exercise the option if it gets rezoned. i.e. you can make money !!

Plus for the vendor would be
1) a longer lease
2) possibility of a higher than expected sales price.

With good legal advice you may be able to put this agreement in place (with the current vendor) AND have it remain in force even if they get a sale?.appreciate forumite comments on this possibility.

Food for thought.

 

[JacM]

Presuming the numbers stack up, have you thought about:

Using a Self Managed Super Fund to purchase the property, and leasing the property back to your business? (Your business could rent the property from your SMSF, but you as an independent person could not).

Another thought is to acquire the property "subject to" the current owner doing the repairs. That way your SMSF gets around the issue of not being able to borrow money to do improvements... because your SMSF itself would not be doing the improvements... the vendor would. I've certainly done this sort of thing on a smaller scale (eg subject to vendor installing a split system prior to settlement). You need to be very specific with your wording, to be clear about expected words, standard of finish, model numbers of products used and such, but it's an avenue to consider, best done on a slightly longer settlement to allow time for the repairs to be done before settlement.

Perhaps a tidier alternative would be to do the contract of sale with a condition saying the vendor pays your stamp duty for you. On an acquisition of circa $650k, the stamp duty is going to be around $30k anyway. So you hang onto your stamp duty cash and use it to fund improvements (which a SMSF can do... it can spend cash it already has to fund improvements, but it cannot used borrowed money to do improvements).

 

[Dazz]

Should we take the risk?

Only you can answer that question based on your research with projected likely capital gains in the outlying future years. This is where science and research goes out the window, and during the projection phase, the art of investing comes to the fore.


Short term, looking at the numbers you've presented, it's pretty horrible from my perspective.


$ 620K (assuming you negotiate hard) gets you the title deed with the other 30K allocated to fix the house up. Your effective rent then becomes 38K p.a., which from 650K outlaid is only 5.8%. Doesn't exactly set the world on fire does it ??


The cherry on the top is the future underlying land growth. If that takes off you are laughing. Not only will you insulate yourself from any further rent increases (which as the years roll by save many companies from going under) but you'll have a solid asset to rely upon.


On the other hand, if interest rates take off you won't be laughing if you buy it.


Start up a separate company and trust to hold the asset in.


The biggest question however, you need to answer is, instead of loaning 650K to buy the premises, what sort of return could you generate in your business if you allocated that amount of money to beef it up ?? Extra people, extra equipment etc.


There is a reason why most companies don't own their premises. Generally, they can make far more by investing in their company than investing in the premises that houses their operations. This is the answer to all those who scratch their heads and wonder "if it's such a good property deal for you as a property investor, why don't the Tenants simply buy it."

 

[mrdobalina]

The biggest question however, you need to answer is, instead of loaning 650K to buy the premises, what sort of return could you generate in your business if you allocated that amount of money to beef it up ?? Extra people, extra equipment etc.

Agree. Sometimes the quality of your decision is justified by the alternatives that you discard.

 

[wobblysquare]

I would suggest that you do not buy.

It doesn't stack up as an investment. Having finally filled the commercial vacancy the investor is trying to sell it off, while it has some income ! i.e. it is in its best light.
If the commercial tenant had signed for 5 + 5 + 5 instead of only one year the investment would look a bit better.

Your SMSF has better things to do with it money also.

If you like the location, try now to renegotiate the lease, for 5 + 5 + 5, at favourable terms.

 

[Deltaberry]

When I look at my folks, I think their best buys have been premises they lease

When I buy commercial, I always think, can I operate this place if my tenant left? If I can't, I need a massive yield on it.

 

[Aaron_C]

Agree. Sometimes the quality of your decision is justified by the alternatives that you discard.

Although I would say many, many businesses would regret it later that they didn't buy their building when they had the chance. As we all know, business is great for cashflow but it is a cyclical thing - most businesses don't last for that long.

 

[Deltaberry]

Harvey Norman, Myers, DJs.

For some stories of failed families/empires who probably should've seized their properties: Darrell Lea, Sizzler etc.