Business property: Rent or buy?

The decision to rent or buy your office is one of the most important any firm will take.

Numbers, naturally, are core to the decision-making. Our recent experience of raising finance from banks secured against property is that they may be prepared to consider a loan to value (LTV) ratio of 55% to 65%. So on a property valued at, say, £1 million, the bank may be prepared to lend between £550,000 and £650,000.

The shortfall would have to sourced from elsewhere. This could come from equity built up in the business or from personal assets of the directors, or possibly from pension funds. Much will depend on where such silos of cash currently exist, if at all.

The quid pro quo with the banks funding up to two-thirds or thereabouts of the purchase price is that they have become more relaxed about seeking additional security from borrowers so long as they have security in the property. Ultimately, the nature of the security would be a matter for negotiation with a bank or banks interested in part-funding the purchase of the property.

When considering whether to invest in commercial premises, a recurring question concerns what structure to use. Should a partnership be used or should the investment be through a company? There is no simple answer to this; one size does not fit all scenarios and you should seek professional advice.

Notwithstanding the structuring options, there are four commercial principles that are paramount for the business leaders:

• Affordability
• Security for the debt
• Interest terms
• Serviceability of the debt

Just as with your residential property mortgage, you will need to take a view on the best approach to interest rates. Some businesses would want to fix the rate to put certainty into their cash flow calculations. But you will also need to account for arrangement fees and consider the possibility of breakage costs.

In terms of serviceability, you can expect bank covenants around measures such as the EBITDA ratio(i.e. earnings before interest, taxation, depreciation and amortisation) e.g. the covenant might require EBITDA in the year to be 1.25x or higher when compared with the level of debt serviced (i.e. principal and interest repaid in the year).

Another key ratio for the bank is loan to value (“LTV”), and they may periodically ask a surveyor to carry out an appraisal of the building’s current value.

Of course, the big difference between renting and buying is that at the end of the lease, there is no asset owned, whereas if at the end of the debt term, there would be a property.

Using pension funds as a purchase vehicle

It is not uncommon for owner-managers of a business to use their pension funds to acquire their business premises.

Commercial property can be held within a pension / SIPP, including business property from which the business trades.

Income from the rent is paid to the pension trustees who would use it to pay debt interest and capital repayments. Any surplus funds would represent investment growth within the SIPP, and in the event rent accumulates, it can be invested into other assets.

Up to 50% of the net SIPP fund value could be borrowed for the purposes of buying a commercial property within a SIPP, although it should be noted that funds in the SIPP could not be accessed until the individuals are aged 55 or more.

Subject to liquidity in the pension fund, on retirement 25% can be paid as a tax-free lump sum. There is no income tax on any income the pension fund derives, and should the property be sold there would be no capital gains tax in the pension fund.

It can be a way for business owners to use SIPP funds to buy their own business property, and to channel net rental income back into the SIPP thereafter.

The property would be leased to the firm at a commercial rent, and the firm would get tax relief on the rent it paid to the pension fund.

There are many other factors to consider before taking the plunge on property. Harwood Hutton would be pleased to guide you through the process.