Recently, I’ve spent time with three business owners who made a decision to own the building from which their companies operate.
The benefits are myriad, including stability of the rent the enterprise pays, appreciation, depreciation and pride of ownership. But our conversations focused on a downside of ownership such as a rent subsidy and the impact this can have on the value of the company.
Therefore, I endeavored to consider other disadvantages of ownership, which is the subject of this column. Let’s start with a rent subsidy and its impact on a company’s value.
Rent subsidy
Some would opine this — the ability to charge the occupant a low monthly payment — is actually a benefit.
In fact, one of the reasons to own a building that houses your operation is to keep the rent steady and avoid the ebbs and flows from a series of three- to seven-year leases. But, in my three conversations, the price an investor would pay for the company was affected.
You see, all of the entrepreneurs are approaching an age where “what’s next” creeps into their consciousness. Many times this means a sale of the business. But if one of the cost elements – rent – is understated and the business can’t afford to move said rent to market, the enterprise value suffers.
No agreements
Frequently, an entity is created to own the real estate and another to own the business.
Typically, synonymy exists between the two. Although the real estate ownership may be Allen C. Buchanan LLC and the operating company Allen C. Buchanan Inc. with common ownership, they are two separate companies with tax reporting, business licensing and regulatory and state registration requirements.
Since one “owner” receives payment from the other, and the “owners” have the same underpinning individual – seldom are proper lease agreements forged between the two. This lack of documentation can be particularly painful if an owner dies and her estate must now attempt to assemble paperwork justifying rent.
Maintenance
If an occupant leases space from an unrelated landlord and not one with an interest in the company – strict language as to maintenance, repair, and replacements of the building’s systems is contained in a lease agreement between the two parties. Sans such an arrangement, maintenance of the roof occasionally becomes an afterthought. No big deal unless a sale with a leaseback of the premises is considered – in which case the buyer of the real estate will want an airtight roof and functioning air conditioning.
Lack of flexibility
If a company’s capacity outstrips the physical plant of a building – ownership of real estate may inhibit growth. Should this need for additional space occur in a down market, uprooting from one building to another will be complicated? If financing requires the building to be occupied by the business – as many SBA loans do – a real quandary arises. Sure, a move might occur and the former location leased or sold but it’s more complicated than simply moving at the end of a lease.
Equity is bridled. With the amount of appreciation that has occurred in industrial properties in SoCal – many owners are sitting in mountains of equity which if tapped could be used to hire employees, buy machinery or inventory, acquire a competitor or expand out of state. But unless the real estate is sold or refinanced – the equity just sits idle providing the rent subsidy as described above and a smaller return to the owner than an alternative investment.
Allen Buchanan is a principal and commercial real estate broker at Lee & Associates, Orange. He can be reached at 714.564.7104 or abuchanan@lee-associates.com.
