Whether you are an owner of a manufacturing company, distributor, law firm, sales and service business, or retailer, owning the property which you operate your business can be a real benefit to you both long and short term. However, there are many pit-falls of owning including possible capital repairs, limited expansion, real estate being an illiquid asset and possibly hard to sell, etc. Smart business owner understand that if they are considering buying, they must now look at property not just as a place to house their operations, but must evaluate any property as any experienced investor would. Investors know “Four Benefits of Owning Commercial Property”, and so must you.
1. Cost Recovery – Also known as Depreciation is the periodic allocation of the cost of the portion of an asset that wears out. Cost Recovery can also be defined as:
- An allocation of the cost of an asset, taken as an expense against any income that the asset produces.
- The return of investment in business and income-producing property, prorated over its class life
- An annual deduction that reduces basis when calculating gain or loss at the time of disposition
- Non-cash, tax-deductible expense that reduces taxable income but does not reduce cash flow
Annual cost recovery is calculated by multiplying the amount of the basis allocated to the improvements of the property be the appropriate cost recovery percentage. The allowable cost recovery period for commercial property is 39 years. As an example, a property with an accounting basis of $1,000,000.00 would be able to take an annual $25,641.00 expense on the tax return.
2. Appreciation – Appreciation is defined as an increase in property value due to positive improvements to the area which the property is located, an upgrade in general economic conditions, or the elimination of negative factors which effect the property and the area. Although, most residential property owners can only have a limited impact on increasing property appreciation, the commercial property owner has many more opportunities available to them. A commercial property owner or investor can;
- Take an antiquated industrial facility or complex and convert it to a newer modern facility which could accommodate the needs of today’s industry.
- Older and abandoned industrial complexes located in urban areas are commonly converted to multiple residential apartment or condominium units.
- Vacant retail buildings can be converted to economical office space which may be in high demand in the market.
Although significant capital can sometimes be required to complete a successful conversion project, the upside for many property owners and investors is well worth the investment.
3. Principal Reduction – Provided that you have a standard amortizing mortgage, and not an interest only note, every time you make your monthly mortgage payment, you are paying off a portion of the debt or principal. Your monthly payments are made up of both principal and interest. “Principal Reduction” is a staple of owning any type of real estate whether it is commercial or residential
4. Cash Flow – It is every commercial property investor’s objective to generate a “positive” cash flow from his or her property. A “positive” cash flow is the income which is received from the property after operating expenses and mortgages have been paid. Of course, sometime this can be also “negative”, whereby the investor must take money out of their pocket to cover the operating expenses and mortgage. Like all investments, there are risks.
In association with our “Cash Flow” are two very important consideration that should be considered and evaluated before investing in property, they are “Return On Investment” (ROI) and “Return Of Investment” (ROI). “Return On Investment” indicates the percentage return that the investor is receiving in relation to the equity which they put in. As example, if the investor had put $100,000 equity in the property to purchase it, and is receiving $10,000.00 per year of “positive cash flow” from that, then their “Return On Investment” is 10%. A more complicated, but often considered by professional investors, is the “Return Of Investment”. That would be their ability to increase the value of the property thru re-development whereby they would be able to pull their initial investment out of the property thru financing vehicles or recover the initial investment over time thru the annual cash flow.