Businesses Owning Real Estate
28 November 2022: Businesses Owning Real Estate
Here’s a question we sometimes get, but not often enough: What’s the best relationship between a business and the real estate it occupies? Should the business own the real estate? Generally not. But if not, who’s the perfect landlord?
Of course, depending on the type and location needs of the business, the answers to these questions vary.
For instance, if is business is “impulse” retail – think gift shops, book stores or certain food stores such as candy and ice cream shops – it’s usually best to be in a high-traffic location such as a strip center, mall or downtown pedestrian shopping area. If your business is “destination” retail – think groceries or pharmacies – free-standing locations are also excellent and may even be preferable.
Office-based businesses – accounting and technology firms, real estate businesses, healthcare and many others – can be successful in office buildings with multiple tenants but can be equally successful in stand-alone real estate. And whether the business is in an urban, suburban or rural area can impact what real estate is available and where it would be most successful.
But whether the business is located in a multi-tenant building or a stand-alone, single tenant building, the question is still whether the business should own the real estate.
Owning vs Leasing
Some business owners have no option in this debate; they must lease the space their business operates in.
For instance, an accounting firm specializing in business accounting probably needs to be “downtown” in the business district and would likely locate in a multi-tenant office building. Even in a suburban area, such a firm would probably be found in an office park where many other service businesses are located. Both such locations put this type of business near multiple potential clients. But both mean that the owners of the accounting firm are tenants.
But business owners whose business can thrive in a stand-alone location have a legitimate choice and owning the premises might be worth considering.
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As professional business brokers, we advise business owners on many aspect of their business with the ultimate goal of maximizing their financial benefit when it comes time to exit their business. And given the wisdom of investing in real estate that has been evidenced over centuries of commerce, if the business is or would be successful in a stand-alone location, we look closely at how our client – the business’ owner – might best benefit by using an occupancy strategy that involves the real estate the business operates in.
First, let’s stipulate that most business owners, when their business is young, should rarely acquire the real estate needed for the business to operate. The reasons for this include the need of early stage businesses to husband their cash and buying real estate generally requires cash – cash that should be carefully guarded for the sake of the business’ health. Another good reason is that, as the business grows, it will likely outgrow its space. Leasing gives the business owner the ability to relocate that owning doesn’t.
So, unless the business owner also owns the ideal location for their business, the necessary facilities should be leased.
But at some point in the life of the business, the real estate might be better owned.
What’s the Impact?
Again, one aspect of our job as professional business brokers is to consider the long-term objectives of our clients who, in the vast majority of cases, are the owners of businesses. And while we aren’t financial planners, we have a general understanding of real estate and the impact it can have on our client’s objectives. (In fact, a number of the brokers in our network are real estate professionals; primarily in the commercial segment.)
How a business owner occupies the space their business operates in can have a big impact on how and how easily the owner can affect an exit when the time comes to sell the business. This condition exists for a couple of reasons.
One is that there are two assets involved – the business and the real estate – and there are more buyers who can afford the business than that can afford both. Another is that many buyers don’t want the headaches that owning the real estate present – or is perceived to present. They want someone else to be responsible for HVAC systems that fail or roofs that leak.
Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.
But there are reasons to own the real estate. The questions are “why” and “how”.
Owning: The Methods and Benefits
As to how to own the real estate, there are several considerations.
First, as mentioned above, there are more buyers interested in only the business than there are in both the business and the real estate; the “why”. This argues for owning the two assets in separate entities; the “how”.
Second, owning these two assets in separate entities allows the owner(s) of those entities to sell the assets separately. Both assets can be sold to the same buyer at the same time, of course, but they don’t have to be.
Third, if the business owns the real estate, selling the business can become significantly more complicated, particularly if the business buyer doesn’t want to own the real estate.
Owning the real estate your business operates in is generally a wise move, especially if the ownership of the two assets – the business and the real estate – is structured so that separate entities own the separate assets; the business itself should not own the real estate. Here’s why.
First, assuming the business is profitable, the rent it pays will go to an entity owned by the business owner. This is tantamount to taking money from one pocket of your jacket and depositing it the other pocket. Instead of paying an unrelated landlord, the business owner is paying himself. It is a way for the business to pay for the real estate – which is exactly what happens when you lease anything; the tenant is “buying” the real estate for the landlord.
Second, if the business is showing a healthy profit, it’s possible to pay the landlord an above-market rate of rent. This allows the business owner to get more of the business’ profit out of the business and into his pocket.
Third, selling the business but keeping the real estate allows our selling clients, as landlords, to continue receiving revenue from the business for years after the sale.
Fourth, properly structured – with regard to both the lease and the sale of the business – this arrangement generally allows the seller to realize a higher net at exit, even if the exit is spread out over time as is the case if the business is sold in one year and the real estate some number of years later.
The Bottom Line
We’ve been involved in structuring many transactions in which we advised the business owner on configuring the ownership of the assets in a way that benefits them both immediately – legitimately getting more cash out of their business – and in the long run – not only when the time comes to exit their business but also how to enjoy continued cash flow from the business even years after selling it.
Next week I’ll relate how we did this for two different clients, one a small manufacturer, the other a service provider. I’ll also give an example of how this concept went terribly wrong because it was not implemented properly.
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at joe@WorldwideBusinessBlog.com.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
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If any of you know of something that might fit, please let us know.
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 500 in the world. He can be reached at joe@WorldwideBusinessBlog.com