Investing in commercial property is a popular option for many people wishing to diversify their property portfolio. Leases are often longer than on domestic properties, and yields can be higher than on a residential property. However, there are a number of financial pitfalls for the investor: Buying a property on instinct Finding an attractive and affordable property is exciting, but don’t be tempted to rush in with an offer. Decisions needs to be made based on the proposed purpose of the property, how it will suit a tenant’s needs and financial goals, and factors such as its location and condition. There may be pressure on you to get the transaction over the line as soon as possible, but compromising on due diligence will almost certainly cause problems later on. Forgetting to add in all additional costs There are numerous costs which need to be factored into the purchase. Ensure they have been researched and budgeted for as overlooked or miscalculated costs can quickly send the project over budget. Typical costs to build into a budget include: • Professional fees • Construction • Stamp Duty Land Tax • Operational and maintenance • Repairs and renovations • Environmental compliance certifications and checks • Waste management • VAT • Business rates during void periods VAT Commercial property transactions are one of the most complex areas of taxation and one where the services of a professional tax adviser is vital. There may be underlying tax issues with the building, and it is important to understand these as part of the due diligence process. For example, find out if there is an ‘option to tax’ on the property in place. This would most likely have been elected by the first occupier of the property and would have allowed the reclaim of VAT on the initial build cost.
Where an option to tax is in place, VAT will be chargeable on the purchase price – you can recover such VAT by putting in place your own option to tax; it will still have cashflow implications and it is important to remember the Stamp Duty Land Tax will be calculated on the VAT inclusive amount. Where you make your own option to tax you will be able to recover the VAT charged on the sale and on any works you undertake to the property, but you must then charge VAT on the rent, which in turn may make your property less attractive, particularly to tenants that will not be registered for VAT (for example, charities, educational bodies, medical/care businesses and financial services) Existing tenants Due diligence should also uncover any issues with tenancy agreements and the length of time an existing tenant may have on their lease. Obviously if the lease has a long time to run then your options for making changes are limited accordingly. Commercial properties are more susceptible to economic change so it is a good idea to ensure the building and tenants are flexible enough to adapt should the need arise. Debt Being able to service debt is a key requirement of commercial property transactions, and banks will secure debt against the property in order to recoup the money. If a tenant is already in place in the property then the income stream may be more secure, although tenancies may not always be desirable. Debt management has become an increasingly common problem on the high street as retailers struggle to survive, and even after a business has gone under (such as BHS a few years ago) their properties will often remain empty for some time. Ownership Talk to your legal and financial advisers to consider the most appropriate means of ownership. This could be through a limited company, a pension fund or as an individual. Ownership by an individual will give rise to a personal tax liability each year as any income in excess of the interest elements of mortgage repayments (if any) will be subject to the relevant rates of income tax.
Holdings within a limited company will be subject to a lower rate of Corporation Tax (typically 19%), however other taxes such as Stamp Duty Land Tax and Capital Gains Tax will need consideration if existing properties owned personally are to be moved into a limited company. Ownership through a pension scheme is a popular option and the transfer of an existing commercial property to a pension scheme can be attractive as the income is ring-fenced within the pension fund and the income only taxable on the recipient of the fund when the pension is drawn down. If there are any borrowings secured on the property this can cause issues in transferring to a pension fund and lenders may seek alternative means of security against the existing debt. Failing to consider your future intentions To go back to the first point made in this article – failing to think about your ultimate objective for the property will impair your chances of making a successful return on the project. Is it a long- or short-term venture? Is it a one-off sale? Professionals such as solicitors and financial advisers will help by flagging up possible pitfalls and helping you with due diligence and negotiating your way through documentation. The days are long gone when everything can be done on a handshake, so make sure you listen, consult and communicate to determine the most effective course of action. Scrutton Bland have over a hundred years’ experience in working with clients on their business property negotiations, and have specialists in areas such as accountancy, Stamp Duty Land Tax and other areas of tax legislation. For more information contact Ben Cussons , Business Advisory Manager by emailing hello@scruttonbland.co.uk or calling 0330 058 6559 .
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