DON’T BUY THE REAL ESTATE

Sometimes a small business owner also owns the real estate building from which it operates.

A big mistake is trying to sell them both together to the same buyer.

We recommend that the business and the real estate always be analyzed separately. Sometimes the real estate is not normal rental real estate but is a single use building. Real estate investors usually look for a 10% or 12% return, and buildings are often appraised by capitalizing the income.

We suggest that the owner keep the real estate. He can lease it with an option to buy at today’s price. Some portion or all of the rent payments can be applied to the eventual purchase price.

Let’s look at some figures.

Let’s say the building is worth $600,000 and the business is worth $300,000 for a total of $900,000.    The net profit of the business is $180,000 annually.

The owner wants to sell them together. He wants 25% down ($225,000) and will carry a note for the balance of $675,000 at 10% for 10 years.

Let him keep the real estate, and lease it for 10% a year ($60,000). The price of the business is now $300,000 with25% down ($75,000) and a note for $225,000 at 10% for 10 years.

We subtract the debt service from the net profit to see the cash flow.

We divide the cash flow by the down payment to see the % return in cash.

Buying the building                                                                        Leasing the building

$180,000 net income                                                                      $180,000 net income

$107,050 P&I annually                                                                    $  35,683 P&I annually

$  72,950 cash flow                                                                           $144,317 cash flow

                                                                                                                $  60,000 rent

                                                                                                                $  84,317 cash flow

72,950   = 32%                                                                                    84,317 = 112%

225,000                                                                                               75,000

Which is a better return                32% or 112%?

With the real estate we need $225,000 down.  Without it we need $75,000 down.

It’s easy to borrow $75,000 when the cash flow is $84,317

Much easier than borrowing $225,000 when the cash flow is $72,950

Why buy the real estate?  Lease it with an option to buy it later.