How to own commercial property with others
Unlike residential property investments, commercial property investments are generally more capital intensive and therefore have a higher entry point in terms of price. While commercial properties are also generally considered to be more risky, the financial return on commercial properties is often materially higher than that on residential properties. For these reasons, investors of commercial properties often pool their resources together to make their investments.
Having more people involved in the investment would inevitably entail a higher level of complexity and administrative onus. Below are some of the key issues you need to consider if you are considering investing in commercial property with other people.
There are material regulatory differences between having a few people make the investment together, as opposed to procuring a higher number of investors from the public or a section of the public at large. The former entails less red tape and is relatively simple to set up and administer but once you cross over the line from a private syndicate to a managed investment scheme, you will be required to comply with some heavy-duty rules under the law (e.g. obtaining an Australian Financial Services Licence, managing the investment via a Responsible Entity, issuing a prospectus for the investment, etc.).
If you are thinking of having just a few investors in your investment arrangement, your situation may be reasonably clear cut but if you plan to have significantly more investors involved, trying to work out where that ‘line’ dividing private and public investment arrangements lies can be highly technical. Professional assistance is indispensable in these circumstances, which should include both lawyers and accountants who are well versed in property investments.
In a private investment arrangement, a popular structure that is often used is a unit trust with a corporate trustee. This is because a unit trust, similar to a company, provides easy division of ownership between the investors in that the investors hold a number of units that represent their proportionate interests in the unit trust that owns the underlying property, which is similar to holding shares in a company.
Unlike a company, however, unit trust may provide special taxation features that may provide a better tax outcome for the investors (refer to the section on Taxation below), which is why a unit trust is touted by some as ‘the best of both worlds’, albeit there are some less well-understood taxation downsides associated with a unit trust.
As multiple unit holders are involved, to protect the interests of all of the parties in an equitable manner, a Shareholders and Unit holders Agreement would often be entered into by all the unit holders, which provides agreed mechanisms upfront to deal with contingent future events, e.g. the initial term of the investment, who may be appointed to the board of the corporate trustee (which provides control and influence over the unit trust), the rules on how the unit holders may sell or buy more units, exit strategy once the initial term of the investment has expired, etc.
On the other hand, if the arrangement you are setting up is a public investment vehicle, the structure required, which is in many ways driven by legislation, may be considerably more complex. While the holding entity of the commercial property investment may also be a unit trust with a corporate trustee, multiple entities may often be required (e.g. there may be a need for a Responsible Entity) and contractual agreements may need to be executed between various entities to comply with the law. This is definitely not an area for the uninitiated or faint-hearted and professional advice is critical.
As alluded to above, in a private investment arrangement, a unit trust is essentially treated as a ‘conduit’ for taxation purposes. This allows cash that is sheltered by the capital works and depreciation deductions claimed by the unit trust to be distributed to the unit holders as ‘tax-deferred income’. This cash amount is treated as a ‘non-assessable amount’, which would only reduce the cost base of the unit holders’ units in the first instance, rather than trigger a taxable amount when received.
Even if the cost base of the units have been exhausted by the cumulative non-assessable amount received, provided that the units on which the non-assessable amount is paid has been held by a non-corporate unit holder for at least 12 months, the non-assessable amount would essentially be treated as a discount capital gain, i.e. only 50% of the amount is taxed; if the unit holder happens to be a complying superannuation fund, the discount would be reduced to 33.33%.
Despite this tax-attractive feature of a unit trust, there is an inherent potential double taxation issue hidden in a unit trust structure, which is mainly caused by the fact that the unit trust, upon calculating its capital gain on the eventual sale of the property, is required to reduce the cost base of the property by the cumulative capital works deductions claimed. This requirement essentially claws back the tax benefit associated with the previous capital works deduction claims but does not compensate the unit holders for the reduction in the cost base of their units or the capital gains tax paid once the cost base of the units was exhausted upon their previous receipt of the tax-deferred amounts.
As a side note, if you wish to use a complying self-managed superannuation fund (SMSF) to own the units in the unit trust, be careful to ensure that you and your associates do not have sufficient influence or control over the unit trust. Otherwise, your SMSF may breach the ‘in-house asset rules’, which could give you a headache down the track.
Another pitfall to look out for in using a unit trust are the ‘public trading trust’ rules. If your unit trust is caught by these provisions, it may be treated as a company, rather than a trust, for taxation purposes, which would remove the ability of the trust to distribute tax-deferred income as referred to above. Generally, these rules would only be triggered if the trust also carries on business activities rather than just holds the commercial property passively (e.g. if the trust also carries on a self-storage business on the premises). However, whether the activities of the trust constitute a business may be less than clear cut, which is why further analysis may be warranted to ensure that you are not inadvertently caught by these rules.
If your unit trust is a public vehicle, it is likely that the unit trust would be treated as a Managed Investment Trust (MIT) for taxation purposes, which is taxed like an ‘ordinary’ trust. However, applying these ordinary trust provisions to a public investment arrangement may give rise to some complications, eg, how the income of the trust is taxed in the hands of the unit holders. This prompted the introduction of a specific set of rules for ‘Attributed Managed Investment Trust’ (AMIT). If your MIT satisfies certain eligibility criteria, it may be treated as an AMIT for taxation purposes and may qualify for certain concessional tax treatment.
Naturally, a unit trust is not the only structure that may be used to hold commercial property investments. Other entities and structures (e.g. a company) may potentially be used, depending on the specific circumstances surrounding the investment.
The above attempts to ‘scratch the surface’ of some of the key issues you need to consider when you are considering putting together a collective commercial property investment vehicle for a number of investors.
Unlike simple residential property investment arrangements where you wholly own the investment and you might be able to get away with not enlisting any professional help at all (which is not advisable in any event), not obtaining professional advice in putting together a collective investment vehicle is tantamount to playing with fire, which may ultimately cost you a lot more down the track than the professional fees you would otherwise incur in setting up the structure correctly.
The contents of the article represent the views of the author but not the views of BDO (QLD) Pty Ltd. No person should rely on the contents of this article without first obtaining advice from a qualified professional person. This article is provided on the terms and understanding that the author and BDO (QLD) Pty Ltd are not responsible for the results of any actions taken on the basis of information in this article, nor for any error in or omission from this article. The article is provided for general information only and the author and BDO (QLD) Pty Ltd are not engaged to render professional advice or services through this article. The author and BDO (QLD) Pty Ltd expressly disclaim all and any liability and responsibility to any person in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this article.