The equity built up can be used as collateral for additional borrowings used to fund future business growth, or possibly to fund the return of invested funds to the business owner.
If the business is struggling and cashflow does not look good, then what’s the harm in delaying or perhaps skipping a rent payment? After all the business is its own landlord.
Another compelling reason is the ability to make additions or improvements to the premises without being put through the ringer by an overbearing landlord.
And don’t forget the tax benefits. If the property is sold down the track it will not be subject to tax on any capital gain derived, provided it was genuinely purchased for business purposes and not for speculation.
Furthermore, there is no need to worry about the new five-year bright line tax rule that seeks to tax the capital gains derived on property if sold within five years of acquisition. This rule only applies to residential property, and in most cases business premises will be commercial in nature.
Then, down the track when you ultimately sell the business, you will have a standalone asset that you could retain to derive passive income in your retirement years.
Make sure there’s a business case
But before you rush off and buy a building, you need to make sure there is a sound business case for doing so.
The business should be able to not only afford the servicing of any borrowing used to fund the purchase, but also factor in the ongoing upkeep and operating costs.
The building should also be a sound investment on its own merits as it may be leased to a third party or ultimately sold in future. Due diligence should be undertaken on all aspects, including whether it is earthquake-prone, and the potential ramifications if it is.
Note also that specialised buildings designed and built to a business’ unique needs may have a reduced appeal to a future tenant. These could be include buildings with significant leasehold improvements, such as cool stores, refrigeration units, or ventilation/extraction systems, that could be costly to retrofit or make good.
Mixed-use property options that combine residential and commercial use, while gaining in popularity and appealing to some, may still have limited appeal. On the other hand, premises such as high-grade office spaces will usually appeal to a wider market and so be easier to tenant.
Similarly, consideration should be given to what an exit could look like. How attractive would the building be to a potential purchaser? Is there a quality tenant in place, is it easily accessible and is there ample carparking? Is it in a location where there could be a future glut of properties, for example due to changing trends in consumer shopping behaviour?
Finally, thought should be given to how the building is held. It is common for a related entity to own the building and lease it to the trading business.
This is good practice from a risk perspective as keeps the property separate from the trading activity and the other business assets.
In such cases it is best practice to have a lease agreement in place between the entities on commercial terms with a market lease charged. Often banks will require this from a lending perspective. It also safeguards the tenancy relationship in the event the business is sold, and you wanted to continue letting the building to the new business owner.
That said, it may be more advantageous from a tax perspective for an entity in the business of building or developing/dealing in property (or that is associated with a person or entity that is), to own the premises in the same entity as the trading business. This is particularly so if the premises may be held for less than ten years. If it’s held in the trading business, gains on the sale may not be subject to tax, whereas if held in a separate entity they may be.
The comments in this article are of a general nature and should not be relied on for specific cases, where readers should seek professional advice.