The Jewel in the Crown

words by Finlease

Finlease

The Jewel in the Crown

Would it surprise you if I said that the REAL ASSET, the REAL FINANCIAL LEGACY of a 30 year old business was the factory that they bought 25 years ago?

Here is a tale of 2 companies who were IDENTICAL in every way except one bought their factory and the other rented.

This simple story should be heeded by many companies, TODAY, whose decisions NOW can make a MAJOR difference in the future.

 

COMPANY: XYZ Civil

Est 1985, Owned by Mr John Smith, profitable, runs a fleet of modern equipment to service many long term clients. XYZ RENTS their yard and have been renting it since 1985.

Over the past 30 years, the business has provided good income to the Smith family, putting the kids through school & university. The kids have all left, pursuing careers in the Computer & Finance sector.

In the year 2015 Mr Smith, aged 60, decides that rather than spending his days battling the never ending challenges of business (OH&S, Head Contractors, slow payers) and ever increasing RENT, he would prefer to work on his golf handicap and do plenty more fishing.

As there isn’t really anyone in the family to leave the business to he decides to sell up. So he winds down and finishes his contracts and sells his machines.

But before he can reach for his golf clubs, he has to pay out his loyal staff their long-service leave. He is left with a small profit and his superannuation.

 

COMPANY: ABC Civil

Est 1985, Owned by Mr Bill Jones, profitable, runs a fleet of modern equipment to service many long term clients. ABC owns their yard, having bought it in 1990 & paid it off by 2010.

In the year 2015 Mr Jones, aged 60, decides that rather than spending his days working, although the business is profitable with less expenses than XYZ as he has no expense in rent or property debt (having long ago paid off his yard), He would prefer to work on his golf handicap and do plenty more fishing.

As there isn’t really anyone in the family to leave the business to he decides to sell up. So he winds down and finishes his contracts and sells his machines.

But before he can reach for his golf clubs, he has to pay out his loyal staff their long-service leave. He is left with a small profit, his superannuation and then he rents out his yard.

He grabs his golf clubs jumps on his boat and heads into the sunset sure in the knowledge that he will receive $60,000 per annum in rent from the yard he owns (which he bought for $310,000 in 1990 & is now worth $950,000).

 

The Lesson

When ABC bought their yard, it probably wasn’t part of any great master-plan. But the end result has meant an accidental gold-mine for Mr Jones.

The amazing thing about this story is that over the past 25 years:-

ABC spent, in total $718,000 to OWN their yard & now have a $950,000 asset which now will provide an income in retirement of $60,000 p/a.

XYZ spent $1.2mil to RENT their yard, have NOTHING to show for it, have been at the mercy of landlords for those 25 years and have not only helped their landlord to pay off the premises they were renting, they have also given that landlord a surplus income of almost $500,000 (possibly more).

Look at the figures:-

ABC financed $310,000 in 1990 over a 20 year principal & interest loan at an average of 10% = $2,990 p/m. (taking into consideration the high interest rates in the early 90’s) & owned the yard outright by 2010.

$718,000 paid in total over 20 years.

XYZ was paying rent in 1985 @ $2,000 p/m which has steadily increased to $2,500 p/m in 1990 with further increases to $5,500 p/m by 2015.

$1.2mil was paid in total over the same 25 years (from 1990 to 2015) & NO Property to show for it at the end.

 

The Result

XYZ paid $482,000 more than ABC over the past 25 years, was at the mercy of the Landlords & has NOTHING to show for it. RENT IS DEAD MONEY.

ABC, not only saved $482,000 but also Mr Smith has an income in retirement of $60,000 p/a and a property worth $950,000 which he can sell at any time should he want to grab the cash.

 

The Solution

Today, financiers typically finance commercial properties on a 70% Loan to Value ratio (LVR) which means that $700,000 can be borrowed against a $1mil building.

Add another $50,000 for stamp duty and incidentals, the shortfall is around $350,000 to fully finance the industrial property. This $350,000 shortfall typically can be financed via “equity” in other properties such as the family home.

If this is done, the industrial property is essentially 100% funded (with no cash in) and the entire debt is deductible.

 

The Future

Long Term ownership of property should always result in a “double benefit”:-

1. Significantly less cost over the long term

2. A valuable asset which will result in a large capital gain or a substantial income stream in retirement.

Many organisations, including Finlease will happily look at the feasibility of such a transaction for a company wanting to be more like ABC than XYZ for the next 25 years.

With interest rates at 30 year lows, the argument is even more compelling.

Where would your company like to be in 2040?

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