Aaron Wallace, director of accoutancy firm Hayes Knight talks to Gill South about the financial case for SMEs owning their own properties.
There certainly are benefits to SMEs owning the commercial premises from which they operate. They offer:
1. Compulsory saving - paying off a mortgage on a capital asset from lease payments rather than to a third party as rental.
2. Passive investment income from a retirement nest-egg providing that you have good tenants once you move your business on - if you aren't the occupier.
3. A future capital gain where the premises is held during one or more property cycles and the purpose of the owning entity was rental income. There's no capital gains tax in New Zealand at present.
4. Being the landlord and tenant means you can potentially juggle lease payments/commitments when there is a downturn in the businesses performance. This can assist working capital needs.
5. Equity in a capital asset that could be borrowed against to fund other future income streams - banks like security over 'bricks & mortar'.
6. Choice on making property improvements, additions, or specialisation as you have a friendly landlord.
So, if a SME occupier was in the decision-making process of whether or not to own their trading premises, what could be deterrents?
1. Specialist- built buildings are often hard to rent once a tenant moves out as ideally you may need a tenant from the same industry sector.
Think premises with leasehold improvements specifically designed with refrigeration units, baking vents, or high electrical needs. Professional office spaces will generally be easier to lease out than specific use properties such as petrol courtyards, movie theatres, or historic buildings (costly maintenance) so the nature of the business may determine the owner/occupier decision.
2. The same concept applies when you want to sell the property - it needs to be attractive. This could include a quality stable tenant, numerous car parks, or easy road access. The change in shopping trends to online and just-in-time inventory warehousing has meant the attractiveness of a retail store has reduced to both lease and on sell.
3. Mixed property options, ones with both commercial and residential zoning, have a limited market place. Living at work is not generally a lifestyle choice and it requires a certain tenant and buyer to choose this option.
However, we are seeing more businesses move into the residential areas - childcare facilities are a great example. The ability to return these premises back to a residential property may assist with future sale options and banks will feel more comfortable lending on a property with a wider audience.
4. The costs associated with upgrading buildings to meet a seismic code of compliance following the recent earthquakes is a major inhibitor. Estimates to upgrade older buildings to conform are becoming material amounts and this is eroding value. In some cities, this is also impeding the ability to attract a tenant where there is non-compliance. Associated to this are the OPEX costs to maintain the standard of the building (building warrant of fitness etc.) which often aren't factored into lessee cash flow needs.
5. It's also not helpful in a sluggish economy if your tenant's business liquidates, assuming this isn't you as the owner/occupier. During these periods buildings often stay untenanted for a longer period as a wider choice becomes available to a lessor. Providing the cash flow for this tenancy shortfall can become the 'house of cards'.
One final point that is often the Achilles' heel of an SME operator owning their trading premises is the property is held by another entity, a different ownership vehicle than the one that owns the business.
Make sure you have a formal, arm's length lease agreement in place. It will not only be required to help with bank funding, but is imperative to safeguard the tenancy relationship should the business be sold, or part-sold and you want the relationship to continue at market rates.
Next week we look at SMEs who open their doors to interns and to school children looking for some career guidance. What's in it for them? Send in any of your thoughts or experiences to me, Gill South, at the link below.