This article follows on from our recent post providing a checklist of essential things to do when buying a commercial property, this time dealing with the important issues of financing, risk and GST implications.
Commercial property can be a lucrative investment but it’s important to do the necessary groundwork before the purchase to reduce your risk and other potential difficulties.
The importance of finance
A major component in the process of acquiring a commercial property is organising finance well before the contract-signing stage, such as a loan covering the purchase price as well as GST, stamp duty, legal fees and any others costs associated with the transaction. It’s important for a would-be owner to understand what their loan repayments will be before undertaking more detailed due diligence on the property. A risk and return assessment should be conducted with a financial adviser or mortgage broker.
If the buyer needs a loan to acquire the property, the contract will likely be subject to finance approval, allowing the seller to terminate the deal should financing not be secured. This condition will usually be reflected in a ‘finance’ section of the contract, providing a date by which the finance condition is to be complied with – usually 14 or 21 days from the date the contact is signed by all parties.
It should be noted that commercial property is generally considered a riskier investment when compared with residential property due to its exposure to economic slumps and fluctuations. Commercial borrowers do not have the same protection as home buyers. Where a buyer of a residential property can borrow up to 90 per cent of the purchase price, most lenders require borrowers for a commercial property to have a minimum contribution of 30 per cent, meaning they will consider lending up to 70 per cent of the property’s value. Lender’s mortgage insurance is also not available for commercial property owners so a sufficient upfront deposit or equity is essential to secure the loan.
A key consideration for a lender to a would-be buyer is the commercial property’s ability to generate stable rental income from tenants. This can be demonstrated through the lease agreement with the current tenant, showing that the rent can cover the loan repayments or, alternatively, through a profit and loss forecast showing that the loan will allow your business to earn additional income sufficient to cover the repayments.
A borrower for commercial property will often need to provide a residential property as security for the loan, while most bank lenders will also insist on a General Security Agreement (GSA) over the property and any and all of the business’ assets. This requirement may be waived if it can shown income generated by the property will service the debt.
Risks associated with commercial property
The question of risk in buying commercial property is generally a reference to insurance. In many cases, taking our commercial property insurance is required before finance can be secured to purchase the asset.
The standard conditions of most commercial property contracts in Queensland state the property is at the risk of the buyer from 5pm on the next business day after a contract has been signed by both parties. A potential buyer should, therefore, arrange an insurance cover note for the property as early as possible. Likewise, a seller should maintain the existing insurance on the property until it is sold, as security against the possibility the property is not insured by either party and then becomes irreparably damaged after a contract is signed but before it becomes unconditional.
Other risks also need to be considered by a commercial property owner in the event they became unable to make mortgage payments, or in the case of a tenant defaulting by going into receivership. Life insurance, income protection or specific property insurance may be required to mitigate these realistic possibilities.
Consider how much GST adds to the purchase price
Australia’s goods and services tax needs to be considered in any property transaction, with attention paid to whether the purchase price for the asset includes GST. The GST rate for commercial transactions is currently 10 per cent. In most cases, the GST payable on the sale of property is included in the sale price and is paid by the seller.
A seller’s obligation to pay GST will generally depend on whether they are registered – or are required to be registered – for tax purposes. If registered for GST purposes, the seller is obliged to pay GST unless some special exemption applies. A buyer who is registered for GST and intends to use the property for business purposes can claim that tax component in their next business activity statement, though the requirement to pay it upfront can result in a cash flow problem in the short term.
A commercial property sale will generally be exempt from GST if the business is sold as a ‘going concern’, meaning the seller is selling an enterprise, including any assets used in that enterprise, to the buyer. Partial GST may also be paid under the Margin Scheme, an alternative way of working out the GST to be paid when a commercial property is sold as part of a business.
If a buyer purchases a commercial property where there is a lease agreement in place, they may be required to pay GST on the rental income from the tenant.
Stamp duty: A buyer should also keep in mind this state-based tax on the purchase, to be paid either on the basis of the unencumbered value of the property or on the basis of the consideration (the payment the buyer agrees to make) for the property. The dutiable value – the higher amount of the two values listed above – is the stamp duty the buyer will have to pay on the transaction.
Speak with commercial law specialists
For any of the issues raised in this article, buyers should not only contact commercial property specialists such as mortgage brokers but also experts in commercial and property law such as our team at PD Law. From the terms of the contract to what you should know before arranging financing, assessing the risks involved in making the investment and working out GST and other tax obligations, we can provide clear advice and expert guidance through to completion of the deal. Contact us today for an initial discussion.
