Investing in Commercial and Industrial Property

Property brokers will tell you there’s never been a better time to make an investment in [commercial][1] and industrial property. Barring about three years ago, when there were steals aplenty, they’re probably right. Many shop, factory and office owners are sweating in the recession and are keen to offload their properties at bargain prices.

But, few will give their properties away unless the bank is about to foreclose on them. So, where do you look for bargains and what do you buy?

Cape Town-based property economist Wendy Hartshorne says that in recessionary times “any old” [commercial][2] and industrial premises are taking a knock. Niche products, on the other hand, are doing well, as are modern properties built in the last three years.

Hartshorne is the MD of Wendy Hartshorne Consulting. For the past three years she has consulted to Capricorn Business and Technology Park as an asset manager and development planner. Capricorn Park, a 68-hectare site on Prince George Drive in Muizenberg, was to be the Silicone Valley of Cape Town when it was launched in 1998. Although that isn’t exactly what it has turned out to be, it has been a success none the less, creating jobs and providing a sought-after commercial and industrial zone in Cape Town’s southern suburbs. Westlake Business Park in Tokai is its only competitor.

“Business has been constant for the past 18 months. We haven’t experienced a decline in applications or enquiries. People want to be here and our prices are still competitive.” Hartshorne says the park is favoured by owner occupants. “The trick is to offer something exceptional. And you’ve also got to be reasonably and competitively priced.”

She says Capricorn Park is achieving R40/m² for rental on industrial premises (that’s with a 25% office component). Consider that if you were to develop new industrial stock in Cape Town, land would cost you R950/m² and construction costs would be around R6500/m².

In the better industrial areas of Johannesburg and Durban the prices are much the same, although in Durban land prices in the popular Riverhorse area (along the N2 near the new airport) are double that because of the scarcity of development land.

Hartshorne says there is a difficulty in developing from scratch because the banks are reluctant to fund the purchase of vacant land.

Her advice to investors: “If you have a tenant, hang on to them – even if they’re only signing up on a year-to-year basis. A bird in the hand is worth two in the bush. People take tenants for granted. And from an estate and body corporate point of view, watch your operational costs.”

Eckart Benkenstein, is a consultant at Diamond Properties, a Cape Town-based company specialising in commercial and industrial property. He says there has been a definite increase in the number of defaulting tenants and rising vacancy levels.

“It’s very important to have personal surety and large deposits, or irrevocable bank guarantees for your leases. That said, this environment obviously opens up the market. Entrepreneurs see the opportunities at times like these.” Benkenstein says with finance being problematic at the moment those with access to cash will gain ground by buying now. “If you find the right property and the timing is right, you will be able to catch the growth from the coming tide,” he says.

An easy calculation to do when making a commercial property investment is to work out the yield the investment will give you, and having done this, work out what the yield will be by investing in another asset class.

For example, you and a syndicate of friends can afford to buy for R5 million. A small complex in High Street is for sale for around that price. It comprises a supermarket, laundry, and an office suite. It is fully let and brings in monthly income of R115 000. Your costs to pay rates, maintain and administer the building will be 10% of annual income, or R138 000. Based on these assumptions, this would equate to a return on investment of 24,8% excluding any interest costs. This is more than you would get if your money was in the bank, not to mention the capital growth on the property over time.

Having decided to make your commercial property investment, be wary of how you structure the deal legally.

Here is some advice from Bev Nelson, a partner at Shepstone & Wylie, a reputable Durban law firm:

She says there are different legal vehicles available to commercial property investors. “When a few people get together to invest in a property they must decide into which legal entity the property is going to be transferred.” The options are to register it in the name of either the individuals, with or without reference to the name of a partnership; a close corporation; a company; or a trust. The terms and conditions of the relationship between the investors will be governed either by a partnership agreement, an association agreement in the case of a close corporation, or a shareholders agreement in the case of a company or a deed of trust.

“The investors must carefully consider the advantages and disadvantages of each vehicle in relation to the cost and tax implications.”

There are pros and cons associated with each legal vehicle.

Individual buyers

If you buy in your personal capacity a simple registration process is involved. You don’t have to deal with operating a legal entity separate from yourself that may involve auditors, financial statements and resolutions. Transfer duty is charged at a lower rate, but the property will be part of your estate and will be available to creditors in the event of insolvency.

If you are married in community of property, the property will form part of the joint estate and will be available to creditors who take action against either spouse.

If you are married out of community of property you are afforded slightly more security in that each spouse has their own estate and generally creditors may only attach the property of the spouse concerned.

Nelson says any income earned from the property will be charged at the usual income tax rate of the owner and, depending on the circumstances of the owner, they may be liable for capital gains tax (CGT) exceptions on the sale of the property and a rebate if it is used as their primary residence. On the death of the owner, the property will form part of their deceased estate and will be subject to estate duty.

CC or company

Buying a property in the name of close corporation (CC) or company will carry the same consequences except that it is generally cheaper and simpler to form and administer a CC than a company.

The property does not form part of the individual’s estate but rather is an asset of the legal entity. The company/CC’s creditors may not take legal action against the individuals in their personal capacity for the debts of the legal entity unless the individual/s were asked to stand surety.

Transfer duty is charged at a higher rate of 8% on the purchase of properties by a company or CC and transfer duty will also be charged on the sale of shares or members interests if the company or CC is a residential property company.

Nelson says a residential property company is defined as an entity which holds residential property and which property’s fair value comprises 50% of the aggregate fair market value of all the assets of the entity.

A prospective buyer should also bear in mind the tax implications for companies and CCs as any income earned from the property will be taxed at a higher rate than that of individuals. CGT will be charged at a higher rate and there are no rebates on the sale of the property. On the death of the shareholder/member, the property does not fall into their estate but rather their share/interest in the entity which will then be subject to estate duty.

Partnership

A partnership is not a separate legal entity from the individual partners, so the property will be registered in the names of all the partners, but state that they are acting as partners in a partnership. Partners are jointly and severally liable for the debts of the partnership and may all be subject to the risk of creditors if one partner is declared insolvent.

The tax implications are the same as those of an individual. Therefore transfer duty is lower that that charged to companies. Income tax is charged at the same rate as the individual concerned and they will be able to benefit from the same rebates as an individual when it comes to the payment of CGT. On the death of a partner, their share in the property forms part of their deceased estate and will be subject to estate duty.

Trust

Nelson says that if a property is registered in the name of a trust, the property vests in the name of the trustees. The powers of the trustees are set out in the deed of trust.

“A trust can be quite expensive to establish as there is the cost of drawing up the trust deed, registering the trust, transferring or donating assets to the trust, the cost of administering the trust and trustees and auditors fees.”

Nelson says trust assets are protected from the founders, trustees or beneficiary creditors and the trustees are not liable for the debts of the trust unless they have acted negligently.

Transfer duty is payable at a higher rate than 8% of the purchase price and will also be payable when there is a change in the beneficiaries or the trustees of the trust.

Trusts pay income tax at the rate applicable to individuals, but they do not qualify for the same rebates and exceptions when it comes to CGT. The trust property does not form part of the estate of an individual and therefore is not subject to the state duty on their death.

“Ultimately, the choice is up to individuals, depending on their circumstances and whether they seek cost effectiveness, simple administration or protection from creditors,” Nelson says.