COMMERCIAL REAL ESTATE: Time to take advantage of low financing rates
Lending rates for mortgages are now at the lowest point they have been at for several years. The “Fed” is trying to jump start the economy. Perhaps it’s time for you to take advantage of the rates. After all, the government subsidizes the interest rate for you, anyway.
The interest rate market is upside down from where it was a few years ago. It used to be that a bank’s best borrowers got the bank’s “prime rate” or if the borrower was considered to have a higher risk, then a rate was quoted that was higher than, but pegged to, the prime rate. Now, borrowers are quoted rates against other indexes that are typically tied to the bond market (known as LIBOR) and, at this time, they may be a little over the prime rate.
My one simple rule of thumb on whether you should refinance is: Will your new payment be lower if you refinanced with all of the expenses of the refinance added on to your loan balance with the same amortization as the old loan?
With the current low rates it’s worthwhile making a comparison of continuing to rent or buy. If you own a retail business it might not be realistic to expect to own your own building. This is especially true for a retail stores that requires mall traffic.
But if your business occupies leased office space, it’s realistic to consider buying a building, rather than leasing. Currently there are many offices available to purchase, ranging from smaller condominiums to a few larger buildings–like a building currently for sale in Blair Township containing 7,390 square feet with a price of $75.64 per square foot.
Let’s say you currently occupy 1,400 square feet of office space. You find a building you like that’s now on the market for $178,900 (there’s currently a condominium office containing 1,392 square feet for sale at that price on Eighth Street).
For our example we will assume you’re paying rent of $14.50 per square foot on a modified gross basis. This is currently a typical rental rate for suburban Traverse City, modern offices. In addition to the base rent you also pay for utilities.
In the purchase scenario it’s assumed that you finance 100% of the purchase price at 7% interest with a 20-year amortization. This is the lowest rate that I have seen quoted recently. It’s currently available for mortgages that have a fixed rate for five years with a 20-year amortization.
I have also seen quotes as low as 6.33% for floating rate loans. It’s understood that you can’t actually buy this office without a down payment, but a down payment is not included in the example.
By requiring that interest be paid on the entire purchase price, the example is in essence allowing a return on the down payment equal to the rate of interest of the loan. The above chart shows the different expenses that you would have for both situations. Note that in the ownership situation there are add backs for 28% of the interest (I only actually added back 80% of the interest, so that this calculation anticipates a 20% down payment) and for anticipated depreciation based on a 39-year life (on improvements only, 80% of purchase price). The 28% is a fairly low tax bracket; your tax bracket may be higher, especially when you add in state taxes.
My accountant told me if I didn’t goof off so much, I could get into one of those brackets. At this time the higher brackets are 31%, 36% and 39.6%. I’m not sure these brackets are accomplishments that I want to make. Additional depreciation could be available for shorter lived items, if they’re itemized at the time the property is purchased.
This is what I meant when I wrote that the government subsidizes real estate ownership. The government allows you to reduce your income when you own business property. This increases your purchasing power. Based on this analysis it is cheaper to own an office than to rent one of equal size. Added to the benefit of ownership, of course, is future appreciation and debt reduction.
The same government subsidy is available for home owners. The interest that you pay on your mortgage reduces your income for tax purposes. They do not have this benefit in Canada. A fellow I know from Canada once told me that if he lived in the states he would own the biggest house that he could afford, just for this reason.
If you believe the business advisor on AM radio you should refinance your house for as much as you can and invest the difference in the mutual funds.
Mutual funds have shown over the long run that they have a much higher return than the cost to borrow the money, especially with the tax break. However, if I did this it would probably keep me up at night.
It’s not always possible to find what you need when you are looking for real estate, but be persistent. This is a good time to start developing future wealth through real estate ownership.
Michael Tarnow is president and partner of Northern Michigan Real Estate Consultants, which specializes in the appraisal of all property types in northern Michigan and the UP. He holds the MAI and SRA designations from the Appraisal Institute. BN