Related Party Real Estate Companies

April 29, 2020

by a searcher from Indiana University South Bend - Judd Leighton School of Business and Economics in Granger, IN, USA

In my experience small biz owners own the real estate in a separate entity and lease to the operating company. How do search funds typically handle these real estate holding companies that are common with small businesses?

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

Most of my customer base does it this way. The main reason is tax related (also there is some level of legal protection as well). Main points to consider: 1. decoupling these at a later date (if R/E is owned by the op co) is difficult and could cause a tax liability. 2. If you plan on selling the business and the buyer doesn't want to buy the R/E then you will have a much easier closing and will likely avoid some taxes###-###-#### Most banks file blanket liens on borrowers. So if bank A is your real estate lender and they file a ucc on the borrower it could impact your ability to borrower later since bank B would be in a junior position on assets###-###-#### your leverage will get out of whack over the years since the real estate loan will amortize slowly. This will make the business appear to have balance sheet leverage that isn't reflective of the actual business net worth. I would highly recommend separating the two legally v. owning the real estate in the business name.

Reply by a searcher
from Harvard University in Cambridge, MA, USA

This is helpful. I remember discussing this with Colin several months ago. I've looked closely at 2 opportunities that have real estate involved. It just struck me as unwise to lease from the current owner because (1) assets typically are not easily movable and (2) the current owner who will become your landlord will know your business P&L, so the landlord has a lot of leverage in the lease renewal negotiation. Not sure if commercial landlords, as a matter of practice or under the terms of the commercial lease, routinely obtain a tenant's tax returns. If so, I guess point (2) is moot. In any event, if point (1) is true for your business, it seems to me you have to buy the real estate along with the business. One other searcher told me that if the business owns the real estate, that's typically a sign that the business has done well (well enough to buy the real estate). And if real estate is involved, you can get really good financing terms from banks.

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