How to Handle Expensive CRE?
September 06, 2024
by a searcher from Duke University in Chapel Hill, NC, USA
I have seen a few businesses recently where the owners bought their building 20+ years ago and it has appreciated much more than their business has grown. And they have not adjusted the rent they pay themselves. In one example a fair market rent would reduce their SDE 60% and in another it would reduce it 110%. Yes, they are basically working to pay themselves rent.
Ideas
1) Push for a fair market rent adjustment and pay fair market for the CRE.
2) Buy the business only and require a 10 year lease at the current low rate the owner paid themselves. With an option to buy the CRE at the end of the lease.
3) Buy the business like normal and then ask the seller to hold a note for the CRE at 1.5% interest and 25 years.
I doubt any of these would be acceptable to the seller since they have a broker. How would you handle this?
from Kennesaw State University in Atlanta, GA, USA
One idea: Create a note that allows you to buy the RE (for a price that works for you and the seller) but with two different paydown options. 1) pay fixed monthly payments based on what the business can afford today (1.5% over 25 years - like you already said) OR 2) buy the RE and pay "X%" of revenue (5% or whatever works for the business), which ever amount is greater. As you grow the business, the seller makes more each month and the debt payoff gets accelerated by whatever the growth rate of the biz is. This creates an incentive for the seller to help you grow the business and get their money faster. They'll get paid what they want for the RE but just at two different timelines. This would have to be 100% seller note, obviously. If the seller wants to keep the company alive/team employed but still wants to realize the true value of the RE, this might be the best way to go. They're just banking on your ability to grow the company.
If the RE is larger in size than the business needs, you could always buy and rent half of it to another company or parcel it out. Maybe something else you can explore.
At any rate, if the deal ends up falling through, try to lock up the RE for less than market value and assign the contract to another buyer who's willing to pay market price. If you go this route, make sure your RE contract is assignable. At least you can make some money on the deal this way. If you want to explore this, send me a DM. Happy to help.
from Bowling Green State University in Surrey, BC, Canada
Best practice is adjust EBITDA to accommodate market rents. The business and the property are fundamentally different investments.
For the property, you may or may not want to pursue it as part of the deal - might make sense for a heavy manufacturing co. where moving costs can be material, for more of a 'warehouse' or office business it's less an issue. BUT, your investment structure on the property would likely differ from that of the business and may even require different investors. Some alternative investors may already have significant real estate holdings and they go into search funds, PE, etc. as a means of diversifying away from realty. Plus, the returns of real estate (the past dozen years notwithstanding) are typically lower than returns on equity growth.
For the business, yeah, I've seen a few where it literally doesn't make any sense without the subsidized rent - there's a metal fab shop I'm thinking off - in which case best for the exiting owner to sell the realty and shutter the business. It happens.