Cash Flow And Annual Gross As Measure Of Business Values Things You Should Be Aware of in Commercial Property Purchases

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Things You Should Be Aware of in Commercial Property Purchases

With a number of cooling measures introduced by the Singaporean government on the housing market to prevent property prices from piling up, investors are gaining more investment potential in commercial real estate. This segment of property is exempt from Additional Buyer’s Stamp Duty (ABSD), Seller’s Stamp Duty (SSD) and foreign ownership restrictions – all of which affect the housing market.

There are two ways to buy commercial property in Singapore:

  • As an individual or
  • As a corporation [via private limited or limited liability partnership (LLP)]

The following sections continue to highlight key points that should be considered by the aspiring investor in the commercial real estate landscape.

No use of Central Provident Fund (CPF)

If you’re buying as an individual, please note that you cannot pay savings in your regular Central Wealth Fund account to settle a down payment or monthly installment on a commercial property loan.

This means that the down payment must be fully funded with cash.

You will need to be prepared to pay off the loan if the rental income is inadequate (assuming you intend to rent out the property).

Real-estate tax

The same as for another residential property or the only residential property that is fully rented out or empty, the tax is a flat rate of 10% of the property’s annual value.

However, if you do not rent out the business premises, you can apply for a real estate tax refund. This vacancy allowance also applies to residential property.

Goods and Services Tax (GST)

Unlike residential properties, the purchase of commercial premises from a GST-registered company is subject to 7% GST. The individual making the purchase will have to pay the VAT themselves.

However, if you are a GST-registered business – all businesses with a turnover of more than S$1 million must register for GST – you can claim the VAT incurred on your purchases. Thus, shrewd individual investors can set up companies specifically for the financial transaction called Special Purpose Vehicles (SPVs) to avoid paying GST.

For businesses with a turnover below S$1 million, GST registration is voluntary and subject to certain requirements. Note that registering for GST comes with responsibilities. Check what these are at IRAS.

In particular, GST cannot be financed with a property loan. Buyers will have to raise money for this.

Rental income and capital gains potential

Colliers Internationals estimates that the average annual gross yield for commercial properties is around 5%, compared to 2-3% for residential properties. However, these higher profits may be offset by the higher maintenance and renovation costs typically required by tenants. In general, maintenance costs for a commercial unit are expected to be higher than for residential properties. It may also be necessary to spend more on basic set-up, especially for commercial leased retail units.

The exception is HDB shops with lower maintenance costs of S$170 to S$250. But these properties usually have more restrictions, such as the type of businesses allowed. It is also necessary to apply for renewal.

However, low supply and high demand can raise the value of commercial real estate assets, making it worth buying.

In land-scarce Singapore, strata shops/offices are limited because most commercial space is owned by real estate investment trusts (REITs), and many of these REITs are owned by the government through trustees. In the fourth quarter of 2011, office supply in Singapore was estimated at 11.05 million sq ft, representing 14.2% of the total office stock (A bright spot in Singapore’s real estate market: Strata-titled office space, Colliers International, page 2). The stock of strata-titled stores also faces a similar low supply.

In addition, the plethora of regulations in the housing market has shifted investors’ attention to the commercial sector. Coupled with today’s low interest rate environment, these two have fueled demand.

Thus, investors can make capital gains through direct sales.

Some investors also seek to sell one block to make a profit. In April 2012, strata office units at Parkway Center and Burlington Square sold for $1,043 per square foot and $1,318 per square foot, respectively.

In addition to capital gains, investors may hope to profit from rental yields. However, official statistics on the occupancy rates of strata shops and offices are not available. This makes it difficult to reliably estimate past, present and future rental demand. Therefore, investors should be careful if they want to make money from this route.

In short, with more inventory coming in – whether from strata or non-strata development – ​​downward pressure on property values ​​and rents is possible. Therefore, only selective purchases are recommended.

Mandate

Commercial/retail premises in Singapore are usually leased for 30, 60, 99 or 999 years. Some may be proprietary. For 99-year and shorter lease units, buyers should note that financial institutions may offer a lower loan amount for units that are running out of lease.

Loans

Commercial real estate borrowers can rent loan-to-value (LTV) ratios of up to 80%, even with outstanding residential mortgages. The maximum loan term is usually 30 years. However, commercial real estate loans usually command a higher interest rate compared to residential real estate loans. Like the latter, these loans are:

  • Fixed price package
  • Variable (floating) rate package

However, the requirements for a commercial loan are stricter. For example, the LTV ratio depends on whether the property is intended for owner-occupation or investment, with some banks applying stricter criteria for the latter. The following section explains the approval conditions in more detail.

Creditworthiness and Commercial Loan Approval in Singapore

For purchases made under your name, only your income, outstanding debts and credit history will be evaluated. The maximum LTV ratio for a commercial mortgage is set at 80%, even for existing residential mortgages. But financial institutions will take a holistic approach when deciding whether to grant you an 80% loan.

For purchases made within a limited liability company or LLP, financiers will assess whether the company has a track record of cash flow over the past few years that is sufficient to finance this investment. For example, a business that earns a monthly profit of S$15,000 deposits it into the business account on time, lenders can lend up to 60-80% (typically) of that S$15,000. In other words, you can get a loan up to 60 to 80% Debt Service Ratio (DSR). This is considerably higher than the DSR for a residential property purchased by an individual.

Conversely, a purchase under a limited liability company or LLP without adequate cash flow or profits (or if the companies are special purpose vehicles) may result in banks requiring the directors to guarantee any loans the company takes out under their individual roles. Directors may also need to be permanent residents or Singaporeans. In many cases, these directors will need to provide documentary evidence that the majority of their income comes from that business. If they get income from elsewhere, some banks will not approve the loan even with them as guarantors. While others can.

From time to time, the financier’s credit officers will introduce new rules and additionally check the documentation. Credit officers can often ask for more proof if they want to do more stringent cross-checks.

References

Michelle Tee and Koh Siok Hui, A bright spot in Singapore’s real estate market: Strata-titled office spaceColliers International White Paper, March 2012, Web

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