ACT 5 - Ask Sam - Should I Own my Office?

A friend I met back in 2003 while playing in the CJFL called me today to ask a me a real estate related question, let's call him Dave.  Dave explained he runs his practice out of a rented space, and told me that his landlord recently increased his rent by 40%, citing an increase in costs. This has Dave thinking about purchasing an existing building and renovating, or building a new building and moving his practice there. 

 

I know Dave already owns a building an hour drive from where he lives, and that he keeps an office there for himself where he sees patients a couple days a week. Part of that building is rented out to someone else. 

 

Dave got a verbal quote from a local builder to build an office for his primary business about $500,000 and he wanted to know if in my opinion if this made sense, or if I he should buy an existing space and renovate.

 

I told Dave that I am familiar with the cost of building new residential property in BC, somewhere between $180-250 per square foot, but that material costs have really skyrocketed since the pandemic, with lumber moving from under $400 per thousand board feet in early 2020, to now closer to $1000 per thousand board feet.  I am not familiar with the cost of building a commercial building and told him a local builder would be a better resource to ask for an updated quote. 

 

In my experience, on a square foot basis, it’s usually cheaper to buy an existing building at the outset, but the effective purchase price is actually a lot higher than you think due to maintenance costs in the first few years of ownership depending on the extent of the renovations and upgrades needed.

 

   comparing purchasing new vs old, Red tape may be reduced with the purchase of an existing building and permits to renovate may not be needed, or permits can be obtained much faster than building new, with a faster turnaround on inspections too.  Owning an older commercial building may also make sense if it’s located in an existing neighbourhood with a demonstrated pattern of customer traffic to other nearby popular businesses. This will help attract potential tenants when Dave eventually retires. 

 

The decision on building or buying a new building really depends on Dave’s local market. He’ll need to assess the availability of buildings for sale or vacant lots available for sale in his desired business location, he’ll need to consider the condition of the prospective building he is looking to purchase, and on the intended use for the property.  If Dave plans to operate out of that building for the next 30 years, there are long term maintenance costs to consider. A new building will have very little maintenance costs, and an old building will have a lot of aging components that will need to be replaced in the coming years.  The roof, wiring, plumbing and building envelope are all large expenditures, and in an older building these have a much shorter remaining economic life, and these components were built with old building standards and building materials that may be at the end of their useful life.  Some materials like aluminum wiring, cast iron sewer pipes, or polly B plumbing are at the end of their useful life and would need to budgeted for replacement immediately after purchase. 

 

I’ve been looking at commercial property for lease for a hair salon business, and I can tell you that as a prospective tenant, newer buildings are more attractive from a design standpoint as well. They have better lighting and more modern designs, with better service, making them more attractive aesthetically and reducing the cost of tenant improvements. 

 

Commercial leases are typically triple net, meaning the tenant is responsible for insurance, taxes and maintenance on top of the rent. This means that other prospective commercial tenants will be more attracted to newer buildings because of the lower cost of maintenance. 

 

The type of building Dave buys will also dictate certain closing costs. GST is applicable on commercial buildings whether they are new or not, unlike residential building where used buildings are GST exempt, and mixed use buildings have GST applied pro rata based on the square footage of commercial space vs residential space.

 

Some investment risk to consider are:

As an Accredited professional, your greatest asset is your future income. Should you acquire more investments where the performance of that investment depends on your future ability to work?  Would it be less risky to diversify into other types of investment with a similar or better expected return? 

Is there an opportunity cost to owning your own building? 

What is your exit strategy? 

 

Business risks to consider include asking yourself:

If you chooses to continue renting, could the rent increase again? Could you negotiate a better long term lease? 

Will you lose many customers / patients by moving locations?

If you are the sole tenant of your own building, will you be able to sell or rent the building when you retire?

If you are one of many tenants in a building you own, would the investment make sense if one or more of the other units became vacant? Would you be able to fill the unit and manage the building yourself, and if not is a professional property manager available? 

Would it be a problem if the other tenants knew you were the owner? Could the potential for business disputes, spill over into your practice?  For example if you took enforcement action for non payment of rent, could the disgruntled party disrupt your office assistant or patients in your waiting room? 

 

 

 

Besides those business and investment risk questions, there are Tax implications to consider if you are determined to own your building. You should, talk to your accountant to determine the best way to purchase your office building and what ownership structure to use . Should you own it in your professional corporation, or in a separate holding company?  To expand on this, the type of building matters when considering ownership structure. A small building where you are the only / majority tenant is plainly an asset used inside the business, and it’s probably ok to own this inside your professional corporation.  Purchasing your building inside your professional corporation can be preferred because you’re investing with more money than if you pay yourself personally and use the money to set up a holding company.  To see what I mean, imagine you’ve eared $1 in your professional corporation which pays tax, leaving 85 cents. You can choose to have your professional corporation invest the 85 cents and have it own the investment. Alternatively you can have your professional corporation pay you, leaving you with 55 cents in your personal name to invest personally, or to fund the purchase through a new holding company.   A large multi-tenant building like a strip mall, or a mixed use building with residential apartments above and storefronts on the main floor could be determined to be an asset NOT used inside the business, and this is an important distinction.  While the business risk of owning your own office may be lowered by owning a larger building, thanks to a more diversified tenant base, the future impact on your Small Business Deduction when you sell should be considered. In 2018, changes to the SBD means that when a corporation has investment income over $50K/yr, the active income threshold shrinks by $5 for every $1 of passive income. If you already have investment income in your professional corporation, you may not want to add a building with rental income to its investments.  While you can use capital cost allowance to depreciate the building and reduce net income of the building to zero for most of the time you own the investment, when you eventually sell the depreciation you enjoyed is recaptured. If you sell in a fiscal year that you are still working, and your taxable gain is over $50,000, you would erode your small business deduction on all your earned income and pay a lot higher tax that year compared to if you held the investment in a separate Holdco. 

 

 

 

In summary, buying a building to operate your practice out of is an individual choice, and depends on a lot of personal factors.  The added complexity of owning the building you practice out of should produce a corresponding return on investment high enough to make it worthwhile. Get professional advice, do your own research, and run the numbers. Your path is in the math!

 

Thanks Dave for a great question. If you have a question of broad interest you’d like answered on the ACT Podcast, please email [e-mail]. That’s  [e-mail].