July/August 2007: by Jos Herman

Your business and the hot real estate market

As the Saskatchewan economy increases and businesses continue to grow, finding office space to accommodate an organization's growing operations is becoming increasingly difficult.

Today, more then ever, business owners are contemplating purchasing buildings just for investment purposes or for their operations, with the potential benefit of operating income from tenants inside the building.

With strong demand and limited supply, property values are increasing and capitalization rates are decreasing.

The Capitalization Rate
The Capitalization Rate or Cap Rate is a ratio used to estimate the value of income producing properties. In other words, the cap rate is the net operating income divided by the sales price or value of a property expressed as a percentage.

Capitalization Rate = Annual Cash Flow/Capital Cost

If you are an interested buyer for a particular piece of income property, the seller is trying to get the highest price for the property or sell at the lowest cap rate possible. Generally speaking…the buyer is trying to purchase the property at the lowest price possible (which translates into a higher cap rate). The lower the selling price the higher the cap rate. The higher the selling price, the lower the cap rate.

Making Payments against your Commercial Mortgage
If you are going to finance the acquisition with a commercial mortgage, understand the benefits of paying the mortgage off early.

For most capital investments, some type of financing would be required to purchase the asset. Why not consider:

• Accelerated weekly payments
• Accelerated bi-weekly payments
• Lump sum payments

An accelerated weekly payment option is calculated by taking a monthly payment schedule, assuming only four weeks in a month, and dividing the monthly payment amount by four. Therefore, over the course of a year you would be making 52 payments (4/month) instead of 12 payments. This, in effect, is equivalent to making one extra monthly payment which can be applied directly against your loan's principal.

Similar to the accelerated weekly payment option, the accelerated bi-weekly payment is calculated by dividing monthly payments by two which results in 26 bi-weekly payments.

For example, on a $2.0 million loan with a 7% interest rate, the total interest paid over a 25 year amortization period is approximately $2.2 million. Take the same loan and apply accelerated weekly payments and the total interest paid is approximately $1.7 million. This is a savings of close to half a million dollars. For this option, the business owner must consider his cash flow to determine if it can service the debt on a schedule that is not once a month.

Most financing agreements allow lump sum payments to be made once a year. Typically, these lump sum payments are 15%. The effect can save you thousands in interest and reduce the number of years on the mortgage. For the business owner, having the ability to pay off the mortgage sooner allows for investment in their company in other areas.

Tax Planning for Real Estate
With some planning, tax-efficiency can be achieved by determining:

1. Where the real estate investment is held in your organizational structure;

2. Who holds it;

3. How to maximize the benefits of interest deductibility; and

4. The effects of your investment/asset appreciating in value.

As with any investment, consideration must be given to your level of risk tolerance. In the real estate market, the key is "Location, Location, Location" but also "Planning, Planning, Planning."

Look to the next issue where the discussion will be the options of being the owner occupant verses owning and increasing construction costs to build.

. . .
About the author
Jos Herman, CA, is with Assante Financial Management Ltd.

Disclaimer
Please contact a professional advisor to discuss your particular circumstances prior to acting on the information above. The opinions expressed are those of the author and not necessarily those of Assante Financial Management Ltd.

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