Commercial property, with its higher rental returns, is particularly attractive to savvy, high-net-worth investors planning for their retirement.
Many of these investors choose to buy and hold commercial property in their self-managed superannuation fund (SMSF), which offers an attractive tax environment.
In the accumulation phase, earnings (rental income) are taxed at 15 per cent while capital gains tax is just 10 per cent if the property is held for more than 12 months. In the pension phase, no tax is paid on assets that fund the pension, unless they exceed $1.6 million under a Budget measure due to begin on July 1 next year.
Often business owners buy their own premises (a type of commercial property known as "business real property") and hold it in their SMSF. They then lease it back under an arm's length arrangement paying market rent.
Need at least $500,000
Nerida Cole, head of advice at Dixon Advisory, says for business owners with the financial capability, buying their own premises can be quite attractive as it allows them to grow their SMSF fund for their retirement, rather than paying rent to a landlord.
SMSF investors can also acquire leased commercial property like any other investor.
"It's attractive for people who like commercial property as an asset class," says Cole. "But as with residential property investment, you need a pretty decent size fund –typically at least $500,000-$600,000."
Diversification, however, can be a problem.
"The difficulty with buying commercial property is that it's a big amount of money for most people," explains Cole.
"If you're investing most of your SMSF money into one property, you're taking on a high level of risk because of the lack of diversification.
"A super fund invested entirely in one asset is not good if that property underperforms as it's providing income for retirement – plus there's also the lack of flexibility and liquidity.
"What if you need to access funds for a $100,000 renovation? You can't sell just one room."
From July 1 (should the proposal be passed into law), the maximum balance that can be used to fund a tax-free income stream or pension payment from superannuation will become $1.6 million.
Balances in excess of $1.6 million will need to be converted back to accumulation phase and earnings will be taxed at 15 per cent.
Investors also need to be aware that there are strict rules in place covering SMSF investment and it is paramount they obtain independent financial and tax advice before signing any sales contracts.
Stricter lending rules
Property can be acquired outright if the SMSF has the funds or the fund can get a loan to buy the property under limited recourse borrowing arrangements.
But lending rules are stricter than if you are borrowing in your personal name and a bigger deposit is typically required, with loan-to-value ratios around 65 per cent.
Also, if an SMSF borrows to buy a commercial property, these borrowed funds can be used to maintain or repair the property, but not to make improvements, which are strictly forbidden by the Australian Tax Office.
"It might be worth investigating capital gains tax concessions for small businesses. You need expert accounting advice and there are strict conditions," Cole says.
Similarly, you may be eligible for state-based exemptions for stamp duty, she says, but again, it's a complex area and you need to check with your accountant.
Cole stresses the importance of having an exit plan for the property for when you retire so you don't end up with a liquidity crisis. In other words, it needs to be an investment that produces enough income to pay you an income stream.
She adds: "Is it an investment that will hold up if you did not run a business from it? Would other buyers want to hold it – meaning do you have a good market to sell it to or another business to rent the premises to?"