Buying a business and purchasing real estate are two very different investments. Business ownership typically requires some management skills and knowledge about market conditions, consumer trends, staffing, and finances. Ownership of real estate, on the other hand, requires considerable due diligence up front but generally offers passive growth with fewer management responsibilities.
The skill sets needed to succeed as a business owner and a real estate investor may not overlap much. But when the business you are considering buying includes real property, it is worth considering whether it is prudent to buy both. If the seller is offering them as a package and purchasing the business alone is not an option, it is important for the buyer to understand what they are getting into to avoid becoming overextended.
Potential Benefits and Drawbacks of Purchasing a Business That Includes Real Property
When selling their business, some owners may also wish to sell the building(s) and land where the business operates. From a buyer’s standpoint, commercial space may be an attractive add-on to their business investment. The average return for commercial real estate is around 10 percent.[1] In addition to return on investment, owning commercial property can provide tax breaks, control over the space, protection from rent increases, and revenue streams.
Buying a business can alleviate much of the stress, uncertainty, and risk of launching a start-up. But acquiring an existing business typically has higher up-front costs than starting a company, particularly if the price of commercial real estate is included.
The main question to ask when considering a business deal that includes real property is how it will affect the business’s cash flow. Although an existing business often has the benefit of built-in cash flow, most new owners want to expand the business beyond its current state. However, expansion requires capital. Every dollar that is tied up in real estate is unavailable to invest in the business. In addition, at a time of higher interest rates, a real estate loan—on top of a business loan—could leave the buyer’s post-transaction cash flow precariously tight.
Commercial real estate costs include more than the loan payments. There are also taxes, property insurance, and repair and upkeep expenses. Renting out extra space to tenants can offset some of these costs, but leasing commercial space can impose additional financial responsibilities and risks on the landlord.
How to Approach a Business Transaction That Includes Real Estate
For business owners, offering the buyer an option to purchase the real estate may create a larger buyer pool. It is common for a business purchase contract to include a 12- to 24-month lease with an option for the purchaser to buy the real estate attached to the business at the end of the term at a predetermined price or price formula (or to include a right of first refusal). This allows the buyer to retain more capital in the short term while providing them the long-term option to purchase the real estate.
Creativity can help nudge a deal across the finish line. Before beginning negotiations, however, buyers should evaluate the following factors.
Business Value versus Real Estate Value
If the business and real estate are offered at a single price, it is important to get separate appraisals of their fair market prices to obtain more meaningful information about their value. This process can also generate data that is useful during negotiations.
A commercial real estate agent can assess the value of real property based on comparable sales. Valuation of a business, which should be performed by a qualified professional appraiser, is more subjective: different methods may be used, and the quality of a company’s books and records has a significant impact.
Cash Flow
To evaluate if buying a business with real estate makes financial sense, calculate the short-term and long-term costs of both purchasing and leasing the property. A purchase is usually cheaper than a lease over the long term, but that is not the case in all markets and economies. In the short term, leasing may be more attractive than buying from a cash flow perspective. A professional inspection and due diligence are necessary to accurately calculate costs (and, by extension, cash flow) because the costs of property ownership involve more than just the purchase price: they may also include taxes, improvements, insurance, and remediation of environmental hazards.
Financing
The inclusion of real estate in the purchase of a business may increase a buyer’s ability to receive third-party financing because the property may be used as collateral to secure a loan. Lenders may be willing to blend real estate and business loans, which could result in a longer repayment term. Seller financing for part of the deal is another option.
Business Acquisition Legal Advice and Guidance
Almost everything is negotiable in a business acquisition. If there are two parties willing to make a deal, there is room to get creative and complete a transaction favorable to both sides.
Deciding whether buying a business that includes real estate is favorable to you in the long run is complicated. We can offer guidance and advice on all aspects of business acquisition from due diligence to negotiations to document creation and review. Set up an appointment to learn how we can be of service.
[1] 10 Commercial Real Estate Statistics, First Nat’l Realty Partners (Jan. 10, 2022), https://fnrpusa.com/blog/commercial-investing-statistics/.
