When Does Buying the Business and Real Estate Make Sense?

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When purchasing a small business, a crucial question arises: should you buy the real estate along with the business? For many small business acquirers, this decision can significantly impact their financial future. This article delves into the pros and cons of buying real estate with a business, explores financing options, and provides guidance on when it makes sense to make such a purchase. We’ve included insights and quotes from industry experts and M&A participants.

 

Pros of Buying Real Estate with the Business

 

Asset Appreciation and Wealth Building:

Owning real estate can significantly increase your net worth over time. As Tyler Evans from Eureka Business Consultants explains, “In most cases, when you can blend the 7(a) term and include the real estate, your loan payment increase is about what you would be paying in rent anyway.” He further emphasizes that “if it’s available, buying the property is one of the best ways to build your personal net worth.

Control Over Property:

Owning the property where your business operates ensures stability and avoids the risks associated with rising rental costs or lease termination. Colin McNulty points out that owning the property gives you more control, similar to owning a crucial piece of equipment for your business.

Tax Benefits:

Owning real estate can offer various tax benefits, including depreciation deductions, which can reduce your taxable income. Joe Olson of Remarkable Freedom notes, “Part of our motivation is tax related. We also ‘just like real estate’ and the combo deals are often the most efficient acquisition model possible.

Long-Term Savings:

Financing real estate through an SBA loan can provide favorable terms that may result in lower overall payments compared to renting. Brad Hettich of Commercial Lending X explains, “If the real estate is 51% or more of the total acquisition cost, you can amortize all of the debt over 25 years. This will provide you with a substantial cash flow savings.

 

Cons of Buying Real Estate with the Business

 

Higher Capital Outlay:

Purchasing real estate requires a significant initial investment, which could be a hurdle for some buyers. Brad Hettich mentions, “Buying the real estate will typically require an additional capital outlay, so you need to judge if the real estate is really going to be of value to the business.

Complex Financing:

Combining business and real estate financing can be complex. The SBA 7(a) and SBA 504 programs offer different advantages, and understanding which to use can be challenging. Brad Hettich notes that few SBA 7(a) lenders will offer a combined SBA 504 and 7(a) solution, as most prefer having the full deal under their control.

Liquidity and Flexibility:

Owning real estate ties up capital that might otherwise be used for business growth or other opportunities. Mike Adhikari from Illinois Corporate Investments mentions, “Most business buyers want to focus on operating the business and grow it; they do not want to get tied to the real estate.

 

Financing Options

 

SBA 7(a) Loan:

This loan can be used to finance both the business and real estate. If the real estate is 51% or more of the total cost, the entire loan can be amortized over 25 years, offering substantial cash flow savings. Deb Curtis, an SBA Loan Consultant, explains, “If a business uses more than 51% of a building’s space, it’s eligible for SBA financing because it’s considered owner-occupied.

SBA 504 Loan:

This is typically used for real estate or equipment purchases. Combining an SBA 504 loan for real estate with an SBA 7(a) loan for the business can help manage the $5 million SBA borrowing cap more effectively. However, this approach can involve more complexity and a higher down payment for the real estate portion. Chad Fondriest of United Midwest Savings Bank notes, “The 504 program comes with its own strings. For example, you’re stuck with the 504 loan for up to ten years as the prepayment penalty is hefty and lasts for ten years.

Sale-Leaseback:

If purchasing the real estate is not feasible, a sale-leaseback arrangement can be a viable alternative. This involves selling the property to an investor and leasing it back, providing immediate capital while maintaining operational control of the business location. Eric Gall from Edison Business Advisors shares, “If you do buy, make sure if you move or close the business, you can sell an empty space.

 

When to Consider Buying the Real Estate

 

Integral to the Business:

If the real estate is essential to business operations (e.g., a manufacturing facility), purchasing it might be necessary. Mike Jamieson from Galaxy Mountain advises, “I’d generally lean towards buying the real estate, but you need to do the value proposition. If it’s a good location that can grow with you, you should pull the trigger.

Long-Term Ownership:

If you plan to own the business long-term, buying the real estate can be a strategic move to build equity and secure your business location. Colin McNulty emphasizes the importance of considering long-term impacts beyond just financing.

Favorable Market Conditions:

If the real estate market conditions are favorable, purchasing the property can be a wise investment that appreciates over time. As Eric Gall mentions, “Given the historical appreciation of real estate and net savings on lease payments, I’ve seldom had a seller tell me they regretted their decision to buy.

 

Conclusion

 

Deciding whether to buy the real estate along with the business involves evaluating the specific circumstances of the deal, financing options, and long-term business goals. While buying the property can offer significant advantages in terms of control, wealth building, and potential tax benefits, it also requires careful consideration of the financial commitment and impact on liquidity. Engaging with experienced advisors and lenders can help navigate this complex decision and ensure it aligns with your overall business strategy.

For those considering this path, it’s beneficial to explore detailed scenarios with professionals who understand both the business and real estate components of the transaction. The combined expertise can provide tailored advice to maximize the benefits and mitigate potential risks.

FAQ

Frequently Asked Questions

Buying the real estate can significantly increase your net worth over time, provide control over your business location, offer tax benefits, and result in long-term savings. It allows you to avoid the risks of rising rental costs or lease termination, and it ensures stability for your business operations.

  • SBA 7(a) Loan: Can be used for both business and real estate, with potential for a 25-year amortization if the real estate is 51% or more of the total cost.
  • SBA 504 Loan: Typically used for real estate or equipment purchases, and can be combined with an SBA 7(a) loan for the business to manage borrowing limits effectively.
  • Sale-Leaseback: Involves selling the property to an investor and leasing it back, providing immediate capital while maintaining control over the business location.

The primary benefits include asset appreciation, tax deductions, long-term savings on rental costs, increased net worth, and greater control over the business premises. As Tyler Evans points out, “Buying the property is one of the best ways to build your personal net worth.

The downsides include a higher initial capital outlay, complex financing arrangements, and reduced liquidity, as funds that could be used for business growth are tied up in real estate. Additionally, managing real estate can add operational complexity and potential risks if the market conditions change.

If the real estate constitutes 51% or more of the total acquisition cost, the SBA 7(a) loan can be amortized over 25 years, resulting in substantial cash flow savings. This loan combines both business and real estate financing, making it a convenient option for buyers.

Leasing might be a better option if the initial capital outlay for purchasing the real estate is too high, if you prefer to maintain liquidity for other investments, or if the real estate is not integral to the business operations. As Mike Adhikari mentions, many buyers prefer to lease to focus on growing the business without the additional burden of property management.

A sale-leaseback arrangement involves selling the property to an investor and then leasing it back from them. This can provide immediate capital while allowing you to maintain control over the business location. It’s a viable option if purchasing the real estate outright is not feasible or if you prefer to keep capital available for other business needs.

Evaluate the long-term value of the real estate, your plans for business growth, and market conditions. Consider whether the real estate is integral to business operations and if the purchase will provide financial benefits like asset appreciation and tax savings. Consulting with experienced advisors and lenders can also help you make an informed decision that aligns with your business strategy. As Eric Gall advises, “Look at your time horizon for ownership and do the business case.

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Picture of Written by Roman Beylin

Written by Roman Beylin

Roman Beylin is the founder of DueDilio, a leading online marketplace to assemble an M&A deal team. Our large and growing network of highly vetted independent professionals and boutique firms specialize in M&A advisory, due diligence, and post-acquisition value creation.

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