To Own or Not to Own Your Building
— That is The Question

By

Joan M. Gruber Ridley, CFP

Nearly every business owner we know wants to own the building that houses his business. There are some advantages to owning the real estate.

Key Questions to Ask Yourself Before You Buy

You might get the numbers to pencil out if you enter the right data. But there are several factors to consider before you make a final decision: 1) Will the business own the building or will it be titled in the name of another entity such as a limited partnership, family limited partnership, trust, or a generation skipping trust? 2) What is the fair market rent? 3) What are the advantages or disadvantages of paying over-market or under-market rent? 4) What would the terms of the lease be? 5) How will owning the real estate affect the value of your business? 6) What would you do with the building if you sold the business? 7) What is your time horizon for holding this illiquid asset? These are just a few questions you need to consider before making a decision. From the outset, consult with a few key people including your CPA, attorney, investment advisor, business consultant, and a commercial Realtor®. Although their opinions might differ, each can offer important information so you can make an informed decision.

Look at All Four Viewpoints

Examine your situation from four different, sometimes conflicting, viewpoints: 1) the current landlord; 2) the current tenant; 3) the future owner of the business; and 4) the future owner of the building. As the owner of this asset, you can maximize its value by negotiating the best possible lease terms (including above-market rent) for the landlord- that’s you. However, the value of your business will be enhanced if you negotiate very favorable lease terms (including below market rent) for the tenant- that’s your business. Generally speaking, buyers of businesses are not interested in real estate because they would rather invest the funds in expansion of the business or maintain ahigher working capital balance. Real estate owned by your business is usually a value detractor to a buyer, unless the value of the real estate is insignificant in relation to the value of the business. Even then, the buyer of the business might not be interested in managing a building since running a business is challenging enough. If the business currently owns the real estate, getting the real estate out of the company will create tax issues. If you try to sell the building separately from the business, above market rent will make the building an attractive acquisition for a potential purchaser, but will reduce the value of the business.

What If You Hold The Building in Your Personal Portfolio

If the business does not own the building, you are left with the alternative of owning the real estate outside the company which means it is a part of your investment portfolio, either inside our outside of a qualified plan.. Or, you can place it in trust for the younger members of the family. This is not a bad idea if the value of the property does not interfere with the integrity of the diversification of the investment portfolio. In other words, if you have $1MM invested in stocks and bonds, with no exposure to the real estate industry, then introducing a real estate investment might make sense. But it only makes sense if the value of the building does not exceed a reasonable percentage of the value of the overall portfolio. In addition, take into consideration the risk of owning one building as you do your analysis. Concentrating this asset class of real estate in one building subjects you to considerable risk. One obvious risk is that it is illiquid. That means that you cannot quickly turn it into cash, unlike stocks and bonds. And, be prepared to continue to own the property and search for a new tenant after you sell your business. The buyer of your business might not want to invest in real estate, and might not agree to your lease terms. If you try to sell the business after the new owner of the business assumes your lease, the building will be unattractive to a prospective buyer if the rent is under the market, or if the lease terms are unattractive.

Lease Terms to Consider

The rent is an important aspect when determining the value of the building, but other provisions need to be addressed in the lease. According to Jo Thompson, CCIM, with Transwestern, whether you own the building or rent from another party, your lease needs to address issues such as: who will pay the property taxes, janitorial, insurance, utilities, and maintenance. Renewal options, termination options, expansion rights, right of first refusal, rights of other tenants, and the right to sub-let also need to be addressed in the lease. Whether or not you own or lease your space, these terms need to be addressed in the lease. Their presence or absence can add to, or subtract from, the value of the building and the business.

A Wise Decision

Before making a decision about your real estate needs, check with your professional advisors and look at the situation from all the angles. Otherwise, you might eventually find yourself in a situation that cannot be reversed without incurring considerable expense. Most importantly, be sure your decision is based on fact and not fiction or ego.

 

Joan M. Ridley is president of Business Wealth Solutions, a Dallas-based advisory firm that consults with business owners about how to successfully grow and leave their business. Visit our website at www.bwsllc.net. Call us today at 214.692.9192 for a complimentary meeting to learn how we can help you get where you want to go.

Copyright 2007 Joan M. Ridley