Is buying a business with real estate a good idea?
It depends. Once the initial excitement wears off, buyers sometimes realize they’ve bitten off more than they can chew. Acquiring a business is one thing. But acquiring a business with real estate is a whole new ballgame – and if you don’t know what you’re getting into, it could jeopardize your future as a small business owner.
Real Estate or No Real Estate?
Leasing is a common practice in the small business community. The standard practice is to secure a one- or two-year lease with an option to renew rather than purchasing the real estate attached to their businesses.
There are many reasons why it makes sense to lease commercial space. But the argument for leasing usually boils down to finances. Growing a business requires capital and most owners eventually come around to the fact that they want to be business owners – not real estate investors.
However, there are certain scenarios in which property ownership may be a better option. For example, if the business is strongly identified with a specific location or if it’s necessary to control which tenants occupy other parts of the building, business buyers have clear incentives to include real estate in the deal.
In other cases, the seller may make the decision for the buyer. If the seller has no interest in retaining ownership of the property, then the buyer has no choice but to either acquire the real estate or risk owning a business that leases space from a yet-to-be-named landlord.
Advice for Buying a Business That Includes Real Estate
The acquisition of a company that includes real estate involves two distinct components. In addition to purchasing the business itself, you will acquire real property, an asset that needs to be evaluated on its own terms.
Throughout the purchase process, carefully consider how the real estate component will impact the acquisition. Although the inclusion of real estate can present challenges to buyers, it can also present opportunities that aren’t available to buyers who lease space.
Value the business and the real estate separately.
As a buyer, it’s important to perform separate valuation processes for the business and the real estate, especially if the seller has bundled them together in a single asking price. A real estate appraisal is a fairly straightforward process that establishes value based on comparable sales data. By accurately separating the price of the business from the price of land and buildings, you gain clarity about the actual value of the business as well as data-based insights that can be used during negotiations.
Explore commercial financing options.
The inclusion of real estate often means more than the acquisition of additional assets – it’s leverage that can be used to secure financing from a commercial lender. Lenders are more inclined to approve loans for businesses with real estate. The reason? Real estate can be used as collateral to protect the lender’s interests in the event that the borrower defaults on the loan. Of course, the downside is that real estate significantly increases the amount of capital buyers will need to raise to acquire the business. However, it’s not uncommon for buyers to use a combination of commercial financing, seller financing and their own resources to acquire companies with real estate.
Count the costs of owning commercial real estate.
The cost of owning commercial real estate goes well beyond the initial purchase price. In addition to real estate taxes and property insurance, you will be responsible for the repair and upkeep of the buildings – a responsibility that can be even more challenging if you intend to lease a portion of the space to other tenants. To avoid costly improvements after the sale, conduct a professional inspection and perform due diligence to avoid environmental threats or other hazards.
Finally, if you’re on the fence about whether or not to purchase a business that includes real estate, consult a professional broker. Brokers are informed about local real estate and can advise you about the value of specific properties as well as the future potential of your region’s commercial real estate market.
By Bob House