Considering buying a commercial investment property? Read on...
What are the differences between the residential property investment and commercial property investment?
Both residential and commercial property investment work in a similar way in that you rent out the property and receive rental income. However, there are some major differences:
- Longer term lease – compared to residential tenancy which typically goes for 6 -12 months, commercial lease can go for 3 – 5 years plus options. This means that you can lock tenants in for longer, ensuring long term guaranteed rental income.
- Potentially longer vacancy – the downside is that it is likely to take longer to find a new tenant and you may not receive any rental income for a prolonged period of time. You may also have to offer various incentives (such as rent-free and fit-outs) to attract tenants which can be costly.
- Outgoings – Unlike residential property, outgoings (such as land tax, council rates, building maintenance etc) are usually paid by the tenants. So while you have a tenant, you will have little out of pocket expenses.
- GST – Unlike residential property, rent on commercial property attracts GST. You need to ensure that you issue tax invoices and collect GST from your tenant.
What entity should I purchase a commercial property in?
This depends on your individual circumstances but in most cases, we recommend purchasing a commercial property under a company or trust name to protect your personal assets. To add more protection, it is advisable to set up a new entity (be it a company or trust) that does not own any other assets and is not involved in any other business.
Taxation is another consideration when you purchase a commercial property for investment purposes. Often a discretionary trust (such as family trust) can provide a tax benefit if you have adult family members with lower taxable income or no income.
Another popular way to purchase a commercial property is under a self-managed super fund (SMSF). This can provide great tax benefits but will lock the property and its income for your retirement only.
It is prudent to speak to an accountant to decide which structure is best suited for your circumstances and set it all up BEFORE signing any contract.
What do I need to look out for when purchasing a commercial property?
As with residential properties, you will need to look for rental yields and potential capital gains. Location, infrastructure, age and condition of the building, tenancy mixtures are some of the considerations.
Whether there is already a tenant in place or not is also important as a vacant property will not be a sale of going concern and attract GST, which will need to be paid on top of the purchase price at settlement. Having a good tenant in place will be a bonus and mean instant cash coming in but can also mean that you pay a premium on the sale price.
Be aware that commercial property investment is more easily influenced by economic downturns than residential properties. In bad economic conditions, you may not be able to fill the tenancy for months or your tenant may default and you will have to chase up arrears. You will need to factor these issues in when doing your sums.
Before you sign the contract, ensure that you will have a due diligence condition on the contract. The standard REIQ contract does not automatically contain a due diligence condition so you will need to add a special condition.
Always have your lawyer check the contract BEFORE you sign. A due diligence period is usually at least 14 – 21 days but the longer the better. During the due diligence period, do as much research as you can about the property. Here are a few basic tips:
- If there is already a tenant in place, talk to them and see what they are like.
- Check the rental ledgers and find out if there have been any defaults.
- Talk to your accountant and do up a projected rental income and expenses.
- Talk to your lawyer and obtain searches, particularly building approvals and permits.
- Have the building inspected by an inspector who specialises in the type of the building you are purchasing.
- If the building is strata titled, check the body corporate records and ensure that there are no disputes or litigation.
If you have a due diligence condition in the Contract, you can terminate the Contract and get any deposit back if the property turn out to be not exactly what you had expected.
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