Real Estate Lease/Buy

April 08, 2021

by a searcher from The University of Chicago - Booth School of Business in Chicago, IL, USA

Hi All,

I'm looking at a specialty construction business in which the real estate is also available for either sale or lease. My preference is to lease (at least at first), but how should I be thinking about evaluating terms? I get the sense based on real estate-only listings in the area that the payment amount the seller is asking for is high for the region/type of facility (but I'm no expert and I know that small variances in location, etc. mean a lot). Then again I'm not sure it's worth "spending" goodwill negotiating something that, for context, is on the order of 10% of SDE.

Also, how should I think about whether a sale-leaseback might make sense (seeing as purchasing the building is an option)?

Thanks in advance for any thoughts.

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Reply by a searcher
from Texas A&M University in Elizabethton, TN, USA

Start here, as ^redacted‌ mentions 504 loans may be a good route AND as ^redacted‌ mentions, there is a potentially great deal to be had with SBA if real estate is 51% of deal:
https://www.searchfunder.com/post/anyone-have-experience-with-acquiring-real-estate-along-with-the-business

Then here, ^redacted‌ recommends lease with right to buy in 1 year:
https://www.searchfunder.com/post/acquiring-a-business-purchasing-the-property-as-part-of-the-acquisition

For a business where the existing Real Estate is critical to operations (location, installation costs, etc), you're going to want it some point for control.

If your rent is 10% of SDE, at a "10% cap" RE rate, then value of RE close to 100% SDE. If you are paying 3x SDE, then real estate would only add another 1x to your deal (or 25% of total deal).

You'll need to determine "market value" of rent. I'm sure you'll get best answer by paying for an appraisal, however, I would start by using LoopNet to peruse listings of similar Square Footage, Location, and Industry. Grab PDF prints of these for your comp records. Grab these for Rental and For Sale properties in a reasonable radius. For small town areas, this is challenging to find enough comps sometimes. This will give you an "upper end" since you're looking at asking price, not what actually closes. You'll see relevant cap rates on the for sale and relevant lease rates on the for rent.

If they're asking for a lot below what you find, you may find you're getting a good deal on rent and don't want to say anything other than get a long term lease in place. Or, buy the RE (if seller doesn't know what they have), increase rent on yourself then refi, sell, etc.

I had this delay/kill a deal for me beginning of this year, as seller realized they were under market rent. They wanted to adjust, which took a lot of SDE out of the deal! What I learned: Sellers may have an incentive to make rent artificially higher in the process (especially off market deals), increasing value of real estate (at 10% cap RE value you're paying 10X whereas for business you are going to be paying maybe 3x-4x!).

In the end, do you want to pay 5x-10x on RE in addition to your 3x-4x on the business?

Reply by a lender
from University of Missouri in St. Louis, MO, USA

Lots of reasons to buy and to pass on real estate. A lot of people look at their owner occupied real estate as an investment. That can be the case but###-###-#### showed that it can be an anchor as well. Eric and Walt makes good points in that you want to make sure if you are buying that you don't have to move in the next couple of years unless you want to. That can be cost prohibitive and an unwanted distraction as you are learning the business. On the flip side, owning the building gives you control so if you need to add space or change something in the building, you don't need to ask a landlord for their blessing. Real estate financing is pretty cheap right now (rates, not cost to acquire) so the timing to buy is pretty good. However it will eat at your capital for the down payment and could bind you to the property for a while so plan ahead with real estate 5+ years down the road.

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