Usually, entrepreneurs don’t purchase commercial property until the business has matured, but as chartered tax adviser Christopher Overton explains, they should consider it right from the outset.
The early years of a fledgling business venture leave little time for idle contemplation. These are adrenaline-fuelled times for entrepreneurs when steady progress requires undivided attention and decisions are made thick and fast.
There are operational and cash-flow issues to attend to, financiers to placate and clients to be won, not to mention an endless list of start-up competitions, workshops and networking events to attend to remind the world, via social media, that you are a suave and wily tycoon in the making.
But of all the financial opportunities available to entrepreneurs in those early days, a potentially lucrative one is often overlooked.
Purchasing a property, as opposed to leasing, is arguably one of the last milestone developments in the life of a new venture.
Most SMEs that I have worked with have either left it very late in the piece to own their own premises while others don’t get around to it at all. Yet, under the right circumstances, many entrepreneurs have relatively easy access to purchasing a property, including owning it through their super fund.
Consider this example:
Christopher and his close friend Cory have left politics and have decided to partner in a new consulting business, leveraging their many years of government experience and vast personal networks.
Their plan is to grow the consultancy to accommodate half a dozen high-powered consultants, leaving them with the following options as far as business premises is concerned:
1. They could rent an office through an organisation like Regus or set up shop at a co-working hub, rubbing shoulders with other entrepreneurs and drinking as much coffee as they wish courtesy of an in-house barista with creative facial hair.
2. They could work from home and meet clients in coffee shops or at their clients’ premises, but this is perhaps not the right visual for a high-powered consulting firm.
3. They could lease an office in the city and get into a typical four-year rental agreement with all the associated risks and issues.
4. Or they could buy their own property.
It’s a no-brainer that buying a property is in the best long-term interests of the business, and in many cases, considering the costs of some of the other options listed, is also potentially one of the most cost-effective options — even relatively early on.
Leasing a $500k property at the typical commercial rate of 6 per cent to 7 per cent would see them paying around $30k per annum, or $600k in today’s dollars over 20 years, with nothing to show for it when they retire.
The major stumbling blocks to buying a property are usually affordability and a low appetite for risk. Most people either can’t afford to buy a property or the thought of acquiring a significant debt before the business has proved itself is a bridge too far.
When it comes to the latter, this is understandable, but it must be noted that the costs and inconvenience of having to sell a property because the company has gone belly up is arguably equivalent to that of breaking a lease early.
The other stumbling block, affordability, can be easily overcome if Cory and Christopher have sufficiently healthy super funds. The option available to them is to establish a self-managed super fund, with their respective partners perhaps, with the four of them pooling their super, totalling $1.2 million (for example).
They then use the $500k to buy the property and put the remainder into a diversified pool of other assets with the assistance of a good financial planner. Few know that commercial property can be acquired through a super fund (or via a unit trust that your super fund partly owns) and then rented back to the business.
The idea is for the business to pay a monthly “lease”, but in this instance, each payment increases the owners’ net worth as opposed to being a dead expense.
The $30k-per-year lease fee goes into the fund and is taxed at 15 per cent concessional rates and then gets reinvested into other assets via the financial planner. Assuming a 5 per cent (compounding) growth rate per annum (compounded), it will see the value of the property rise to around $1.32 million in 20 years.
Should they decided to retire, Christopher and Cory can then sell the property and the $632k gain will be subjected to a pension tax rate of 0 per cent.
In this scenario, for 20 years, the property owned by their SMSF has had an impeccable and reliable tenant while the business has had a benevolent and unfussy landlord. At the same time, their SMSF has enjoyed strong, stable and tax-effective returns.
Christopher Overton is a chartered tax adviser and director of Bartley Partners Accounting.
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