5 minute read
LEGAL
Why lease land when you can own land?
The pros and cons of being a commercial land owner by Tony Raunic, Managing Principal, Hunt & Hunt Lawyers.
When deciding where to base your self storage facility, you have the option to either lease or buy land. You should consider the pros and cons of investing in land. You should also think about the differences in how you’ll be able to use the land.
WHAT’S INVOLVED IN BUYING LAND?
Upfront spending
Unlike leasing, buying a commercial property requires a significant amount of upfront spending, which includes paying stamp duty which can be as high as 5.5% of the purchase price in some Australian states.
This expenditure will of course impact heavily on your bank balances, limiting the money you have available to establish and grow your business. Depending on the state of the land, you may need to spend more money on land and building modifications so that the property is ready to operate as a self storage facility.
Financing
Given the significant purchase cost of land, you will probably need to obtain a mortgage from a financial institution to help fund your purchase. Commercial loans to buy land may require you to provide an initial deposit of between 25 and 50 per cent of the purchase price. However, interest rates are currently at an historic low so repayments are somewhat easier presently.
Over time, mortgage repayments will generally be preferable to paying rent.
PRO’S AND CON’S FROM AN SSAA MEMBER WHO HAS EXPERIENCED BOTH LEASING AND FREEHOLD
Freehold PROS:
l Tenure. Ownership is an ‘unlimited by time’ investment l Freehold ownership allows the property to be mortgaged as security for funding l Freehold has an incremental value uplift as a general rule (but not always) l Freehold works don’t require landlord approval l Long term property play l Alternate use options become relevant over time as property market changes. Potential value uplift l Traditional SS facilities have been property based with an underlying valuation methodology based on cap rate and yield.
Known and predictable outcome
Freehold CONS:
l Large scale investment requiring significant capital. Barrier to entry l Availability of sizeable parcels of land or buildings in high density population areas is limited l SS not always highest and best use for property l Significant capital to both acquire and to fit out l Locations limited
Leasehold PROS:
l Capital deployment to business model rather than property holding.
Fit out capital only required l Availability of tightly held property to be secured when freeholds cannot, opening up locations that are otherwise limited l A true business focus model in retail sense l Capacity to adapt to hub and spoke locations often mixing freehold with leasehold to protect location from competition l Smaller sites are practical and viable l Establish facility in high density and high profile locations areas where freehold unlikely or not highest use of property l Retail leases act protections
Leasehold CONS:
l Escalating rent structures l Only security that can be offered is mortgage of lease requiring landlord approval. Banks lack of understanding of funding leaseholds l Landlord approval required for all works and fitouts l Risk of landlords changing and with that possibility of conflict l Need for long tenure to justify fitout capex, minimum tenures around 25 years to build value and justify capex l Availability of suitable leasehold premises l At end of term business relocation or closure l Loss of full control over every element of the site l Valuation methods not clear. Restrained valuations l Sale of business requires long term remaining tenure. Exit planning can be problematic
Like rent, they will be a tax deduction for your business. However, a landlord can raise rent with relative ease and frequency, in theory.
By comparison, mortgage repayments are generally more stable and predictable. These payments also contribute to you eventually gaining full, unobstructed ownership of the property, whilst rental payments are ongoing with no tangible long-term benefit.
Risks and returns
Your land’s value may appreciate over time. However, buying land for investment purposes is a long-term strategy. If the size of the land is greater than the needs of your business, you may be able to lease out a portion of the property to create a secondary income stream.
USING THE LAND – BUYING VERSUS LEASING
Flexibility
Owning your premises can make your business less nimble. If your business needs to move locations for any reason, you will be reliant on favourable market conditions to avoid making a loss on your initial purchase price. A lease is a far smaller financial commitment and allows your business to easily relocate when the lease expires.
Control
Buying land gives you exclusive control in relation to the modification of the property (subject to local council planning approval). This is important, particularly if the land requires substantial changes to become ‘self storage ready’.
A landlord may or may not be willing to grant permission to a tenant who wishes to construct a series of self storage units on the property. This is a matter which should be understood clearly before making a final decision on buying versus leasing.
Rates and maintenance
The owner of land is generally responsible for all costs associated with the land, such as land tax, water rates and maintenance. However, in practice, it is likely that a landlord will pass some of these expenses onto you, as a tenant, if you choose to lease a commercial property. So, the distinction between buying and leasing may be minor in relation to these costs.
Also, whether you lease and pay rent or buy and pay interest on a mortgage, these payments will be treated as tax deductible by the Australian Taxation Office.
As SSAA’s Legal Help Desk Lawyers in Australia, Hunt & Hunt can assist you in weighing up each of these options and making the best decision for your business.
Our expertise in property and banking and finance law can ensure your interests are properly protected, whether you purchase or lease your site. l
