Before committing to purchase an industrial or commercial property its crucial to understand the upfront costs and financial implications, both direct and indirect that are involved in purchasing the property.
If you’re financing the property then it’s always a good idea to approach your bank first to get a good idea of what their expectations are from you as a client in order to secure the finance, and to have a good idea of what you can afford to buy. Commercial property is normally financed through an application via your business, whether you buy the property through the actual operation, or via a property holding company the bank will vet and determine the strength and affordability of the application.
Commercial property finance, although also a long-term loan secured by an immoveable asset, differs from a residential home loan and the application is also vetted differently. The term of the loan is generally shorter, usually 10 years, as opposed to the standard 20, or even 30 year term common to residential bonds. Which in turn means your instalment amount is higher owing to the shorter period. On the positive side the amount of interest paid over the loan term is likely to also be lower.
For example a R10m loan over 20 years (240 months) at the current prime lending rate of 7% would mean a monthly repayment instalment of R54 270.93, a total interest cost of R6,025,022.12 and the total cost of the loan over the 20 year term would R13,041,582.12.
The same loan financed over a 10 year (120 month period) also at the prime lending rate would require a monthly repayment of R 81,275.94, at total interest cost of R2,753,112.25 and the total cost of the loan would be R9,761,392.25. This means an interest saving of over R3 200 000 over the shorter period.
The exact terms of the loan (intertest rate and deposit) will depend on the strength of your application and your relationship with your bank. There will also be smaller costs associated with the loan including a once off initiation fee as well as service fees.
Commercial property finance generally requires a larger deposit than residential property finance. With residential finance you generally only need to put down a 10% deposit, although this can vary depending on the property itself as well as other factors like whether or not you are a first time buyer. With commercial property finance you generally need to put down a 30% deposit which can be a substantial outlay and needs to be taken into consideration beforehand.
A property being purchased for R10m would then require a R3m deposit and the bank will then finance the R7m balance. An advantage to this, once again, is interest costs seeing as you would only be paying interest on the R7m as opposed to R9m if you were only putting down a 10% deposit. A larger deposit also means a lower loan to value ratio (LTV) which reduces the perceived risk to the bank and can increase the chance of your loan application being successful and improve the chance of negotiating a better interest rate.
Another consideration is VAT, the odds are that if you buy a commercial property then VAT will be applicable. Commercial property owners are generally VAT registered which mean that VAT is then payable on the purchase price. The implications are that whichever entity you are purchasing the property through also needs to be VAT registered in order to claim the VAT portion back during your VAT cycle. If the seller is not a registered VAT vendor then transfer duty would be applicable instead of the VAT at the relevant current rate. Either VAT or transfer duty is applicable, you will never be required to pay both.
There are certain circumstances whereby a commercial property purchase can apply for a ‘zero rating’ of VAT. In this situation a VAT rating of zero percent is applied to the transaction. This can only happen if both buyer and seller are both VAT registered at the time of the purchase, and the property in question is a ‘going concern’. For a property to qualify as a going concern there must be a lease in place on the property whereby a tenant occupies the property and is paying rental to the seller for use of the property at the time of the sale of the property. In this case VAT is still applicable but at a rate of zero percent. An application needs to be submitted to SARS who need to approve the application before it is deemed as zero rated.
Regardless of whether you are claiming the normal VAT back the outlay together with the deposit payable can be a substantial amount. If we look at the above example of a purchase price of R10m, generally a 30% deposit would need to be payable which would be R3m, as well as the VAT on the full purchase price which would be an additional R1.5m. The total upfront amount would then be R4.5m.
Even though transfer duty itself may not be payable in the event of the seller being VAT registered, there are still attorney costs payable.
These costs include the costs of registering the bond, transfer costs, deeds office fees etc. These fees are normally set by the Law Society but you may be able to negotiate the fees with the relevant transferring attorney. According to the tariff and using the same example once again, the bond registration cost would be about R75 000 and the transfer costs about R80 000. This would increase your upfront outlay from R4.5m to R4.655m.
The benefits to owning your own commercial property, whether it be for your own business operation, or as an investment are many, but it is also one of the most important and expensive assets that you will purchase over your lifetime. Not only is it crucial to understand as much as possible about the actual property and the area the property is located, the financial implications of the purchase also need to be understood in order to make sure that you structure the deal as effectively as possible and achieve the best possible return.
Contact us today and let us source the right property for you and advise you through the entire process.