Investing in commercial properties is not the same as investing into residential properties. There are different dynamics driving commercial properties to residential properties.
Here we’ll discuss the eleven benefits of investing in commercial properties.
The rental return for owning a commercial property is generally better than residential properties and is easier to achieve a neutral return.
For example, you can generally achieve a 6 per cent net annual return whereas residential properties would only achieve a 2 per cent to 3 per cent net return after deducting all the other costs such as council and water rates, repairs, land tax etc.
Renting an office location versus 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 per cent and when it goes into your SMSF it’s only taxed at 15 per cent. Capital gains are only taxed at 10 per cent.
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.
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 per cent 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 per cent per annum and
(b) rental return of 6 per cent per annum
(c) Interest rate of 5 per cent
In very broad terms the rental basically covers interest (neutrally geared in this example) and if we achieve capital growth of 5 per cent ($30,000 per annum) we are able to achieve a 15 per cent return on our cash of $200,000. ($200,000/$30,000)
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 five years with an option for another five 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 give the landlord an automatic rental increase of 4 per cent per annum or Consumer Price Index (CPI) whichever is the highest. This means the capital growth of the property is also tied to the rental increases.
Commercial property valuations are more clinical than residential properties
In the main It’s closely tied to the rent.
If the rents were $60,000 per annum and the market was paying a 6 per cent return on investment it the n simply values the property at $1m ($60,000 divided by 6 per cent).However, if there was a lot of demand for the property and investors were willing to accept a 5 per cent per annum return the property value would be worth $1.2m ($60,000 divided by 5 per cent).
If rents reduced to $50,000 per annum and assuming a 6 per cent return is expected than the property would have reduced in value to $833,333 ($50,000 divided by 6 per cent)
If rents fell to $50,000 and returns dropped to 5 per cent per annum than the property value would have increased to $1 million ($50,000 divided by 5 per cent).
As you can see it’s a lot less emotional than residential properties where residential properties are valued by comparable sales.
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.