5 Ways to Get the Most From Commercial Property Ownership
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As a business owner, there are many options open to you when it comes to office space. Depending on the size of your business and whether you just need offices or a manufacturing or storage space, you can choose to rent offices in a co-working space, rent an entire floor or building, or purchase a commercial property that suits your needs.
If you haven’t considered property ownership before, here’s what you should know to get started — and how to determine if property ownership is right for you.
1. KEEP YOUR OPERATIONAL BUSINESS AND PROPERTY PORTFOLIO SEPARATE FROM ONE ANOTHER
“Many business owners who own their premises have two separate companies,” explains Suraj Lallchand, director at Fedgroup Ventures, a division of Fedgroup. “The first is the original company that actually runs the operations, and the second is a ‘prop co’ that owns the property.”
The reasons for this are simple: There are tax benefits, it opens a second income stream, and it keeps the two entities separate, allowing the business owner to one day sell the business while maintaining the property portfolio they have built up. In many cases, if the business is sold but remains in the premises, as the property owner they will continue to draw rental fees from the business.
For example, when Gil Oved and Ran Neu-Ner sold their business, The Creative Counsel, to international conglomerate Publicis in 2015, the deal didn’t include their building, which they own and from which the business still operates.
“We still own the building separately,” explains Gil. “Publicis Group are not in the business of property ownership, and the two businesses are entirely separate. You should always keep your property portfolio separate. If and when you sell your business, the buyer would probably not want a building as well. Furthermore, when you sell the business, you get to keep the building and hopefully get the new buyer to assume the lease agreement. Passive income is what we all aspire to.”
“It’s a simple process,” explains Suraj. “You would put the property into the prop co, take a loan against the property, and charge rent to the operations company. This then becomes a taxable deduction for the operational company, and the interest you pay on the loan for the building is deductible for the prop co. As a result, you bring your taxable income down to a minimal amount.
“We see many companies that would rather purchase their own properties and take the tax deductions than continue to rent.”
There’s a growth avenue as well. If your business outgrows your current property, you can purchase another property through the prop co and lease the previous building to someone else. In this way, many business owners slowly build up their commercial and industrial property portfolios.
If you haven’t outgrown the first property but have paid off the loan, there’s an incentive to continue building your portfolio as well. “Once the first property is paid off, you can bond it again, purchase a second property, and continue to benefit from the tax deductions on the interest you pay on that loan,” explains Suraj.
The key to owning your own commercial property is whether or not the operations company can afford the rental and has strong prospects for the future. “If you can’t occupy the building and you don’t find a tenant, the prop co will end up defaulting on its loan and losing the property,” he adds.
“We always do our due diligence on the borrower and the property in question,” agrees Rick de Sousa, Head of Commercial Property Finance at Fedgroup. “The security we are lending against is determined by the value of the property as well as the owner’s ability to service the loan. If the owner of the business is purchasing the property, then the business’s stability and projected income is an important factor for us to consider.”
2. TAKE AN OBJECTIVE VIEW OF THE PROPERTY YOU'RE LOOKING TO PURCHASE
According to Rob Fenner, National Director of Corporate Solutions at JLL, which provides experienced commercial property and investment management services for corporations and investors, many business owners decide to purchase a property because they no longer want to pay rent to someone else.
“The irritation that owners feel paying off someone else’s asset is emotional. Choosing to purchase a property based on emotions instead of for financial or business reasons is a mistake,” he says. “You need to carefully consider all the factors around purchasing property before pulling the trigger.”
Rick agrees and believes that subjective decisions around purchasing commercial properties are a key reason why a business owner could end up investing in the wrong property. “Business owners don’t always look at property objectively,” he says.
“One of the most common scenarios we see is the business owner who has been renting for years, and now wants to purchase the property from their landlord. The problem is that they’ve already invested so much into the building that they’re stuck.
“They think the property is worth more than it is, and the landlord knows the business is anchored there, which works to their advantage because it drives up the price. In these cases, objectivity becomes a problem.”
Rick’s advice is straightforward. Instead of just making an offer to your landlord, consider the pros and cons of the property you’re in and why you want to purchase it. “You obviously ended up in that property for a reason and that’s why you want to buy it, but that could be more of an emotional attachment than a strong economic or business reason to stay where you are,” he says.
“If you’re looking to buy, take everything into account. You have a market you’ve captured, and you have to be close to that market in terms of your supply chain and distribution, but consider other buildings in the vicinity and look at them objectively. There might be a much better option available.”
Over and above which property to purchase is the overriding question of whether you should be investing in property at all.
“Investing capital in your premises is something a business should look at only if they believe that the capital is of better use in the commercial property market than invested in whatever their core competency is,” says Rob. “Whether this is the case is a function of where the commercial real estate market is likely to go, and how much disposable income they have on their balance sheet.”
“We made the decision to move away from renting office space and to build our own premises for two key reasons,” explains Gil.
“The nature of our business means that we have very specific requirements. We wanted a place big enough that all the various entities within the group could be housed in a single location.
This meant we needed large warehousing facilities, but because we entertain clients, we also needed our offices to be in a convenient location for them to visit. Large warehousing facilities generally don’t exist in upmarket areas. We needed to build what we wanted.
“The second reason was a purely commercial one. To grow our wealth we need to keep things in the ‘micro economy’ – when the rental is paid to the landlord, who also happens to be the shareholder of the business, that’s wealth creation at its utmost.
“However, even though we knew exactly why we were making the decision, it was still a risk. We decided to back ourselves, but it’s not a decision to be taken lightly. The outcome for us has been positive, but in hindsight, a smaller outlay to begin with would probably have been a more prudent approach.”
3. GET AS MUCH INFORMATION ON THE PROPERTY AND THE AREA AS POSSIBLE
What many first-time property buyers don’t realise is how much information is available to them. “There is no excuse for not having the information you need when considering a property or area,” says Rick. “As a layman, I can sign up on sites like Lightstone Property, pay my R70 and have a full view of the area I’m looking at, property values and a history of commercial businesses in that suburb.”
Fedgroup always recommends that serious property buyers use the services of valuers. “There’s a lot publicly available, but professional valuation firms have so much more data.
“When the valuation comes back we get a deep understanding of the property. It takes into account macro-economic factors, the area, suburb trends, national trends, and a thousand other data points, including capitalisation rate to yields on the rent, average vacancy rates, the highest rates you can get in that area, average rates you get, price per square metre — anything and everything you need to determine whether this is a good investment or not.
“The more information you have, the more you’re de-risking the purchase. If a buyer wants a loan on the property, they’re going to need a valuation anyway, and that’s done on risk — it’s necessary for the application, whether the loan is granted or not — so why not get it done upfront?
“This one report is everything you need. You can then determine if you’re looking at the right property, or if there’s something better in the area.
“What’s a R10 000 valuation compared to over-spending by R2 million? The key to buying property is to always have as much information available as possible. Too many people walk onto a premises, fall in love and purchase — without looking at the business case.
“Business owners should take a leaf out of the playbook of property owners whose sole focus is their property portfolio. They’re never subjective. Properties are their business — not premises they will occupy themselves.
“It’s this fact that often skews the purchase for business owners. One of our clients who is purely in the business of investing in properties was recently reviewing a boutique hotel in the Cape.
“He loved it and thought the valuation of R40 million was reasonable. Our valuation was R33 million, but there was an operational hotel and vineyard on the property, and he accepted the premium based on that benefit.
“What he didn’t know was that 20km down the road a big conglomerate was selling their hotel. It was ten times the size for the same amount of money. From a pure investment perspective, this was the better deal, with a much bigger return.
“If he wanted to purchase the boutique hotel to live on the estate and run it, that would be a different discussion — but he’s an investor, and the valuation gave him the vital information he needed to make the most informed decision on where to buy.”
This is even more important for business owners whose core focus isn’t property investments. “Taking advice from a trusted consultant is critical,” says Rob. “Many CEOs and CFOs aren’t experts in the field, and yet they need to make decisions that will result in a large capital outlay and subsequent servicing of an even larger loan. Get expert advice.
“Commercial property brokers, valuators and property finance companies can give you insights that you don’t have. Many real estate consultants in our market are highly skilled and more like management consultants than property brokers.
“Forming a relationship with one of these individuals can make sure your real estate decisions are backed by strong metrics and not done on a whim.”
4. DETERMINE IF THE TIME IS RIGHT TO BUY
According to Rick, there is a completely different level of responsibility involved when you purchase premises compared to rent. “It’s a good example of risk and return,” he says.
“Your risks increase, and it becomes your responsibility to ensure the building is maintained, rates and taxes are being paid, security, insurance, health and safety — you no longer have a landlord taking care of any of these things — but the returns should be commensurate with that risk.”
Rick’s advice is that you ensure the yield of the property makes sense. “Property has proven to outperform inflation. It’s generally in the high teens. In addition, commercial property is pretty predictable when it comes to rentals as well.
“You can bank on a yearly increase of 6% to 8%. This all aligns with whether the property is well managed though, and if you’re the landlord and the tenant, whether your business can continue to pay the rentals for the foreseeable future.”
“Before you consider whether to buy, you need to take multiple factors into account,” adds Suraj. “There’s work involved in owning a property — is it worth it for you?”
Gil agrees. When he and his business partner, Ran, built their property, it took three times longer than expected. “There is a great upside in the long run but building and owning a building can also be a massive distraction from the business itself,” he explains.
“It’s also a massive long-term commitment and cyclicality in businesses is variable, whereas paying rent is stable and escalating in a predictable way annually. With a rental agreement you may only be in for three to five years. When you own, you commit for much longer.”
It’s this factor that Suraj believes prospective buyers should pay particular attention to. “You need to consider your five- to ten-year plan,” he advises. “For example, if you know you’re growing, it might be better to rent until you need a bigger property.”
He also warns that cash flow is critical. “Pay attention to interest rates,” he says. “As interest rates go down, it makes more sense to buy. But what happens if the interest rates go up?
“This could put a huge cash flow strain on the operations company. Do you have enough cash flow to handle an increase in interest rates? Consider the worst-case scenario before making any decisions.”
“These are long-term decisions,” agrees Rick. “If you know you’re going to grow, now might not be the time to buy — stay renting. You also need to find the right place with a long-term view of where it’s going.
“You could choose an up-and-coming area or an already established area — but either way, location is important. This is another area where valuation experts are critical because they don’t only look at the property, but the entire area.
“Either way though, if you do choose to buy, the returns you get from the business (or from a tenant) need to exceed the bond rate. You must be making more than 10% in profit for this to make sense. Otherwise you just slowly erode your business.”
5. CONSIDER OTHER REVENUE STREAMS PROPERTY OWNERSHIP COULD BRING
Once you own a building, there are a number of smart ways to monetise the property. “These are negligible when you’re considering buying, but after you’ve bought the property, you can be smart about how you use it,” says Rick.
“There are many ways you can bring additional revenue streams into the business through the property,” adds Suraj. “We offer a grid-tied solar opportunity, for example, that allows commercial and industrial property owners to monetise their roof space.
“You can also rent out any unused space, particularly if you’ve bought a bigger property than you need to accommodate future growth. You can also reach out to cell-phone providers — do they need a tower in the area?
“Would they like to erect it on your property? Are you well positioned to offer billboard advertising, or building wraps? “There are a lot of different things you can bring together.
“This is often what investors do better than business owners who only have one property — their premises. Investors are in the game of looking for income streams, and because they’re in the business of buying and managing properties, they get good at it.”