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Investing in a Business with Real Estate: A Comprehensive Guide

The realms of buying a business and investing in real estate are distinct in many ways. Business ownership necessitates management skills, market insights, knowledge of consumer trends, and financial acumen. In contrast, real estate ownership typically involves a diligent upfront investigation but offers passive growth with fewer management responsibilities.

The skill sets required for success in business ownership and real estate investment may not significantly overlap. However, when a business for sale includes real property, it’s prudent to consider whether acquiring both entities is a wise decision. If the seller offers them as a package and buying solely the business isn’t an option, it’s crucial for the buyer to comprehend the implications fully to prevent overextension.

Potential Benefits and Drawbacks of Purchasing a Business That Includes Real Property

Some business owners, when selling their business, also intend to sell the physical premises where the business operates. From a buyer’s perspective, this can be an enticing addition to their business investment. Commercial real estate offers an average return of around 10 percent. Beyond return on investment, owning commercial property can yield tax advantages, control over the space, protection from rent hikes, and potential revenue streams.

Acquiring an existing business can alleviate much of the stress, uncertainty, and risk associated with starting a new venture from scratch. However, purchasing an established business often involves higher upfront costs, especially if it includes commercial real estate. The key question to consider when contemplating a business deal involving real property is how it will impact the business’s cash flow. Although an existing business usually has an established cash flow, new owners typically aim to expand the business, necessitating capital. Any funds tied up in real estate become unavailable for business investments. Moreover, in a climate of rising interest rates, adding a real estate loan on top of a business loan could strain the buyer’s post-transaction cash flow.

It’s important to recognize that the costs of commercial real estate go beyond loan payments; they encompass taxes, property insurance, and maintenance expenses. While renting out surplus space to tenants can offset some of these costs, it can also bring additional financial responsibilities and risks for the landlord.

Approaching a Business Transaction Involving Real Estate

For business owners, offering buyers the option to purchase the real estate can expand the pool of potential buyers. It’s common for a business purchase agreement to include a 12- to 24-month lease with a buyer’s option to acquire the real estate associated with the business at a predetermined price or via a defined pricing formula, possibly with a right of first refusal. This arrangement enables buyers to retain more short-term capital while preserving the option to purchase the real estate in the long term.

Creativity can play a pivotal role in facilitating a successful deal. However, before entering negotiations, buyers should evaluate various factors:

Business Value vs. Real Estate Value: When both the business and real estate are offered as a single package, obtaining separate appraisals for each is essential. This provides a clearer understanding of their individual values and can prove invaluable during negotiations. A commercial real estate agent can assess property value based on comparable sales, while business valuation, conducted by a qualified appraiser, tends to be more subjective, with various methods available for assessment.

Cash Flow: To determine the financial viability of buying a business with real estate, it’s crucial to calculate both short-term and long-term costs for purchasing and leasing the property. Generally, purchasing is more cost-effective over the long term, but this may not hold true in all markets and economic conditions. In the short term, leasing might be more attractive from a cash flow perspective. Professional inspections and comprehensive due diligence are necessary to accurately calculate costs, which extend beyond the purchase price and encompass taxes, improvements, insurance, and environmental remediation expenses.

Financing: Including real estate in a business purchase may enhance a buyer’s prospects of securing third-party financing, as the property can serve as collateral. Lenders might be willing to consolidate real estate and business loans, potentially extending the repayment term. Seller financing is another option to explore.

Legal Guidance for Business Acquisition

In the realm of business acquisition, virtually everything is negotiable, provided both parties are willing to reach an agreement. Deciding whether buying a business that includes real estate is favorable for the long term is complex. Our team of attorneys can provide guidance and advice on all facets of business acquisition, from conducting due diligence to negotiation and document creation and review. Schedule an appointment to learn how we can assist you in making informed decisions.

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