7 Mistakes Business Owners Make with Property

7 November 2017

7 Mistakes Business Owners Make With Property

Here is the list of seven items.  After this list, I have focussed on Points 1, 2 and 4 and included more detail and some diagrams to help explain the concepts further.
 

1.  Structure:  Often as property investors, we are looking at tax refunds versus asset protection.  Business owners can do so much better!

2.  Inter Entity Transactions: If your business goes bust, you don't want to lose your property investments too.

3.  I'll do it myself!  If you are a business owner, especially in the Trades (plumber, builder, electrician, etc), it seems easiest to mow the lawns yourself, or fix that fence yourself, or do the painting yourself.  You're saving money by not paying a contractor, right?
  

Often this is wrong, because as a business owner, you are often time poor.  So you already don't have spare time.

• Often your hourly rate is higher.  If you are going to do work, then you are better to do it for a client.  Maybe earn $80 per hour for your trade versus only paying the handyman $50 to fix a few things.
• What is your family life worth?  What is some time to yourself for fishing, hunting, or relaxing worth?  Yes, you could mow the rental property lawns, but it is also important to get a work/life balance.

4.  One Bank

5.  Not treating it as a business.  Property is not a hobby!

6.  Not understanding the numbers in business.  A business should:

• Have monthly financial statements so that you know the monthly profit.  Xero or a similar program can help.
• Have a Budget and a comparison each month between actual and budget.
• Review its Balance Sheet at least quarterly and understand its current assets vs current liabilities.
• Have a marketing plan.  This can be very simple and set out the major advertising over the year to avoid spur of the moment decisions.
• Regular dividends to move profits through to the business owners.

7.   Make a fair profit for your work and then a business profit.  So for a small business, that might be a fair market salary or similar profit distribution of say $100,000 (you should be earning more than your staff!), and then maybe a $60,000 business profit.  Otherwise why are you doing it?  If you are earning less than your staff, there is a major problem!

More profit means there is more to invest in property to obtain more long-term passive income.

Click here to view some great videos that might help you, especially if you are a Trade business (plumber, builder, electrician, etc).


So now I'm going to explain the concepts of Points 1, 2 and 4 above further.

1.  STRUCTURE

As a business and business owner, you have risks.  You could be liable for Health and Safety.  Your business could go bust and you could have personally guaranteed creditors.  These are just two examples, but there are many ways you could be at risk.

Therefore, asset protection is very important.  Ideally you want your family home protected and separate to your business and separate to you.

Two common structures:



Structure B is the Rolls Royce structure.  It means if Trust 1 has to guarantee the Company lending as shareholder, Trust 2 is still separate and, therefore, the Personal Home is separate.  BUT, often banks will require a guarantee over the personal house anyway, which kind of undoes some of the benefits.  It still provides an added layer between the business and the personal house.

So how does this link in with property?  Expanding on Structure A, a standard property structure would be:






We would often make both companies LTC's.  Therefore the profit of the business (Company 1) would flow to the Trust.  The loss (or profit) from the rentals (Company 2) would also flow to the Trust.  The Trust would then be the central point that combines the profit and loss, and then could distribute to beneficiaries.  For example,  $1,000 to each child under 16 which normally has no tax, and distributions to a non-working spouse to use lower tax rates.

LTC's are easy to get the capital gains out of too!  Where as it can be a real pain and expensive to get capital gains out of a normal company.

This structure gives both asset protection and still an offset from the rental loss!

If money has been introduced or loaned to the business or rental, then this structure can be improved slightly.  The Trust could formally loan this money to either company, with a General Security Agreement (GSA) in place.  This should give the Trust a higher priority and more chance of getting its funds back in a worst case scenario.  If you are advancing money to any company, seek advice from your lawyer and they will be able to help protect it better!



2.  INTER ENTITY TRANSACTIONS

You have a business operated through a company and some rentals in a separate company.  The business has excess cash, so you transfer it to the rental company to reduce some debt.

ISSUE:  Now company 2 (rental) owes Company 1 (business) money.  So in a worst case scenario, you have been doing this for five years and now the rental company owes the business $100,000.  The business goes bust!  The rental company would have to repay the $100,000!

How could this be done better?

 Business profits flow down to Trust through dividends.  Then Trust lends to Rental Company.  This loan could be done with security too.

4. ONE BANK

Often it seems easier to have one bank, say BNZ.

BNZ has the loan on your personal house.
BNZ has the loan on your rentals.
BNZ has the loan on your business.

You have one Bank Manager and life is good.  Right?

WRONG:  If something goes wrong, then BNZ owns you.

Ideally, you want to separate into a number of banks.  As you get more and more rentals, then you should have multiple banks for your rentals too.  For Example:

BNZ - personal house in Trust
Westpac - Rentals
ANZ - Business.

Try to have no cross securities between them.  This way, if the business goes bust, you have one major issue to deal with, but at least your personal house and rentals should be separate.


Great Free Information

I hope this has given you some great information.  Make sure you like our Facebook Page as we are putting up some great videos and information for property investors!


Kind regards
Ross Barnett