You’ve been in business for several years and it is profitable. You have a decision to make: Do you want to invest in the business and buy a facility, or will you continue to lease?
With the help of your accountant, you should carefully examine the anticipated capital requirements of your business. Evaluate your ability to obtain capital or loans. Don’t box yourself into being cash poor and unable to meet business obligations or take advantage of opportunities.
“The prevailing reason that businesses fail is insufficient capital. Draining capital to pay for a real estate project could be a cause,” says Howard N. Greenberg, managing member at Semanoff Ormsby Greenberg & Torchia, LLC.
“My colleague, Jeffrey Rosenfarb, a principal in Hart Corporation, a national industrial real estate firm, advises that small manufacturing firms overwhelmingly desire to own versus rent, whereas larger corporations generally prefer leasing.”
Smart Business spoke with Greenberg about some pros and cons of leasing or purchasing industrial real estate.
What issues should be examined when considering purchasing a facility?
First, what’s the nature of your business? Manufacturing that utilizes heavy, difficult-to-move equipment is where purchasing may be desirable, to avoid being at a landlord’s mercy when your lease expires. Or is it light manufacturing or distribution, that moves easily?
Second, can you obtain a facility that will remain adequate for your needs? Plan for potential future expansion. Have your counsel review the local zoning code to determine what can be built, either now or in the future.
Do you contemplate children in the business? Real estate can provide a source of income and inheritance. Counsel will need to prepare an agreement that deals with numerous issues including governance, death, disability, termination of employment and sale of the business.
Where do you want to invest your limited capital? Be sure that you will not need capital to expand your business versus acquiring a building. Lending rates are at historic lows, encouraging acquisition. Consult counsel concerning special types of financing such as tax free industrial development or state-provided financing, as well as tax abatements.
What issues should you consider if you determine to lease?
Check locally to ensure there are adequate reserves of industrial rentals available. With any lease, secure options to: extend the term; terminate early; purchase the building; for a right of first refusal; and for the ability to assign the lease or sublet in connection with your business sale.
If I decide to purchase, what entity should purchase the property, and how should the lease be structured?
Keep the building owner entity distinct from the entity that occupies it. The building owner entity should be a limited partnership, limited liability company or S corporation to enable you to utilize tax advantages like depreciation and amortization, and to permit gifting. Also, you may want to divvy up interests differently in the operating company versus ownership in the real estate company. You could decide to bring a partner into your business, but not into the building ownership.
You will need a lease between the two entities, especially if you’re going to sell the business and not the real estate. As a landlord, limit the tenant’s options and set a reasonable term.
Does new construction make sense versus purchasing and rehabbing an existing building?
With new construction or significant rehab, you must have a reliable contractor and architect. Assume that it’s going to cost at least 15 percent more and take 15 or 20 percent longer than initially estimated. Weigh the aggravation of new construction versus having your building the way you want. However, over the past 15 to 20 years, sale or leasing of existing facilities has far exceeded new construction, per Rosenfarb.
Buying and holding an industrial property usually works out well for the owner. For heavy manufacturing, building ownership, or a long-term lease with renewal options, is the way to go.
Howard N. Greenberg is a managing member at Semanoff Ormsby Greenberg & Torchia, LLC. Reach him at (215) 887-0200 and firstname.lastname@example.org.
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