'Six or seven times greater': Returns from business ownership outweigh property - business brokerage

ABC Business sales says investing in a business provides potential for pre-tax returns six-to-seven times that of returns from property investment.
ABC Business sales says investing in a business provides potential for pre-tax returns six-to-seven times that of returns from property investment. Photo credit: Getty.

By investing money into business rather than property, people can make more money and help grow the economy, a business brokerage says. 

Following the onset of COVID-19, record-low interest rates, currently just over 2 percent have made it cheap to borrow, fueling an active property market. REINZ statistics show the national median house price is now $725,000, up 19.8 percent year-on-year. Meanwhile in September, unemployment increased to 5.3 percent and GDP fell 12.2 percent. 

ABC business sales managing director Chris Small says there's currently a disproportionate amount of money invested in property. Having some of that money put behind New Zealand small-to-medium businesses would increase employment opportunities and productivity - and could provide investors with pre-tax returns up to seven times higher.

In the year to October 2020, the average price of New Zealand businesses sold by the company in the $0 to $5 million price-range was $653,834 -  $71,000 less than the median property price.

Small said his company prices businesses it sells based on a multiple of profit, usually three times. For example, a small business costing $645,000 might return a before-tax profit of $215,000 per year. 

By comparison, a residential property costing $725,000 returning 5 percent a year (after interest, rates and other expenses are deducted) might return a before-tax profit of $36,250.   

"There's potentially a six-to-seven times' greater return on offer from investing in a business compared to investing in a house," Small said.

"The average business sales price in New Zealand of $653,000 is significantly less than the average house price of $725,000. Yet the average annual (pre-tax) return on a $725,000 residential investment property is $35,000 while the average annual (pre-tax) return on a $653,000 business is $215,000," he added.

ABC business sales managing director Chris Small said the company sets prices of businessses it has for sale based on a multiple of pre-tax profit, e.g. three times pre-tax profit.
ABC business sales managing director Chris Small said the company sets prices of businessses it has for sale based on a multiple of pre-tax profit, e.g. three times pre-tax profit. Photo credit: Supplied.

But people need to weigh up the risk. Compared to managing tenants in an investment property, owning a business involves managing customers, suppliers and staff. 

New Zealand Property Investors Federation executive officer Sharon Cullwick said investing in business is better economically, but providing a house to live in through property investment is still a benefit.

"Property investing is more hands off - you're still involved if you manage it yourself, but if you get a property manager you're involved, but at a distance," Cullwick explained.

People investing in a business may be more focused on annual revenue and profits, whereas property investment is a long-term game, she said.  

Some people buy property for cash flow, others for capital gain. Initially, rental income may be just enough to cover expenses (e.g. mortgage repayments, rates, insurance and maintenance). This means cash flow might not be positive from day one.

"It's very hard to buy a rental property - or several rental properties - and live off that income," Cullwick added.

Small said that while there are more risks owning a business than an investment property, the increased risk more than outweighed the potential gains.  

"Often in a business, you can turn that $215,000 into $300,000 or $400,000...it's a lot easier to do that than put up the rent by double in a year," Small added.

But lenders generally require 50 percent deposit for a business, compared to 30 percent for an investment property.  

"If you're buying a business for $650,000, you're going to have to have equity of $325,000 - 50 percent," Small said.

The median house price in Auckland is now $1 million. That means most investors buying in Auckland will need a deposit of $300,000 (30 percent). Small points out that as the average business costs $653,000 and the deposit required is 50 percent ($326,500), the investment outlay between the two is similar.

"The average house in Auckland is $1 million - [first home buyers] are going to need a $200,000 deposit, if you can get another $100,000 together, that's $300,000 you can buy a business that's going to return $215,000," Small added.