Investing in real estate can be risky business for owners who must set aside years worth of capital for a down payment. Not all companies can afford to sacrifice cash flow for a long period of time.
“As a business owner, you take a different view of real estate,” says Craig Johnson, president, Franklin Bank, Southfield, Mich. “Before buying, you need to review your capital needs. Are you willing to tie up your down payment, which is generally 20 percent, into a long-term asset? Or are you better served by leasing space and retaining that cash for working capital?”
This decision is one that involves several parties: a CPA, lawyer, financial adviser and your banker, who ultimately will provide the financing to make your dream office a reality.
Owning a building or office comes with numerous benefits, which is why so many professionals choose to purchase real estate rather than lease. But as with any legal and financial transaction, business owners must prepare a number of documents and understand the investment before approaching a bank for real estate financing. Here, Johnson discusses which businesses may consider buying versus leasing, and how owners can secure the capital they need to seal the deal.
During what phase of a business life should owners consider buying versus leasing?
In the long run, buying is a better value than leasing for most business owners. Generally speaking, an investor will want to earn a rate of return on the business owner’s lease payments, whereas someone buying a property figures in appreciation and the advantages of ownership.
But not every business is in a position to buy. A company in the high-growth phase of its business life cycle should not be buying its real estate.
Before making the decision to invest in real estate, owners should determine whether they can do without the 20 percent to 25 percent down payment that gets tied up in real estate when they purchase a property. Would that cash better serve the business by earning additional revenues? Should that cash flow be used to provide working capital or fund research and development for new products? Would holding on to that down payment mean the owner can borrow less on a line of credit?
What type of businesses typically benefit from buying?
Making the decision to buy is easier for some business owners than others. We notice that professionals such as dentists, doctors and accountants like to own their real estate. This makes sense because those who have practiced for a long period of time know how their business will grow in coming years. And in most cases, these professionals work a 40-hour week, so they can only book so many appointments.
On the other hand, a manufacturing facility could add another shift of employees or need to expand its operation to accommodate a new product. Some business owners purchase a building and can earn income from their investment by leasing offices to other professionals. Purchasing real estate is attractive for owners with this goal.
Other professionals use their real estate investment as a retirement vehicle. For example, a dentist may purchase real estate for his practice. When he retires, he may sell the practice to a young professional and lease the real estate for a period of time.
Once a business owner decides to buy, what should he or she prepare discussing financing with a banker?
First, we take a look at the building they are buying and what their down payment needs to be. Usually, this is 20 percent down in cash. They may not have this money today — it may take six months to amass the cash. But during that time period, they should talk to the landlord and determine what additional costs they will incur once they own the building. That way, they will be prepared to facilitate the sale.
What are some factors business owners may overlook during the real estate financing process?
They need to make sure they have done their due diligence on the building itself. Get a roof inspection make sure you get a Phase I Environmental Site Assessment (ESA). The bank will require these and other documents, unless the building is brand new. After all, the last thing you want to do is buy the old cash cow that nickels and dimes you to death. You need to understand what you are buying and make sure you have the cash reserves to make repairs, if necessary.
On the flip side, if you know you will need to make repairs to the property, you can work with a bank to build provisions into the loan. The bank can allocate funds to you so you can finance those repairs.
CRAIG JOHNSON is president and CEO of Franklin Bank. Reach him at (248) 386-9860 or [email protected].
