When a business is offered with real estate included or available, a buyer must consider the advantages and disadvantages of purchasing the real estate vs. leasing the property from the Seller.  Everyone has heard of the business owner that owns real estate in a separate LLC and leases it back to the company.  There are many investment and tax advantages to such a structure.  In today's soft market, however, it may easier to renegotiate a lease than have to dispose of a building.  While every business is different, there are a few common factors that should be taken into consideration when evaluating the purchase decision.
 
·  Market Timing - It is best to consider appropriate timing of the real estate market (rather than business needs) when buying and selling real estate.  A lease with option to purchase may be a consideration to bridge to an optimum time to purchase.

·  Initial Cash Outlay - Typically if you are planning to purchase real estate, you can expect to make a down payment of between 10% and 25% of the purchase price, depending on the lender and your credit. With good credit, the typical outlay for a lease is the first and last months rent and a security deposit.

·  Fixed vs. Variable Cost - When you buy real estate, you have a good idea what your costs will be over the long term. This is especially true if you have a long term fixed rate mortgage. If you lease the property, the market will dictate what you will end up paying for rent over the long run.  And, occasionally there is the end of the year CAM adjustment surprise.

·  Opportunity Cost - There is an opportunity cost of the money used to purchase real estate vs. leasing that needs to be taken into consideration.  What return would you expect to receive on that money compared to the return you would expect to receive if you invested the money into the business or into other investments?

·  Appreciation - One of the primary goals of buying real estate is to generate long-term increase in value through market appreciation. This usually holds true in a healthy market over the long term.

·  Growth Considerations - The growth phase of the business should be taken into consideration in making the buy vs. lease decision.  If the company is relatively new and/or in a high growth mode, leasing might allow more flexibility and fewer constraints on that growth.  On the other hand, if the company is mature and stable, buying real estate may hold other advantages.

·  Legal Entity - The type of ownership entity you choose for your real estate will have an impact on taxes paid. It is almost never a good idea to own real estate inside a C- Corporation.  Most financial advisors will suggest an LLC or LLP, which will offer flow-through tax advantages and better exit strategies.  With a lease, most landlords will insist on a personal guarantee, in addition to corporate responsibility, which may not be released even in the event of a sublease.

·  Financing - Real estate may give business owners a tangible asset, which may be leveraged to finance a business acquisition, while leasing may preserve resources for a business acquisition down payment and/or working capital.  Real estate may also provide a lender with a tangible asset that may allow a deal to move forward when equipment and cash flow are inadequate to enable the deal.

·  Tax Factors - Lease payments are usually fully deductible in the year they are paid, but some costs of owning real estate must be written off over longer periods of time. The good news if you buy real estate is that you can take depreciation on the improvement portion of the property and can usually deduct interest payments.  Care should be taken, however, to understand the tax considerations of selling a depreciated building.

·  Cash Flow Analysis - The devil's in the details.  In order to really understand the financial aspect of purchasing vs. leasing, it would be beneficial to consider a detailed comparative net present value cash flow analysis, which takes into consideration predictions on the future including holding period, anticipated appreciation vs. lease increases, interest rates, and cost of expenses. It is a good idea to do three different analyses, optimistic, realistic and pessimistic, to help incorporate a margin of error.  While this may seem like a daunting task, there some good software programs available to help with this analysis and/or you should consult with your Touchstone Broker. 
 
Many of these buy vs. lease factors will be specific to your business situation, but having a helping hand will assure you of making the best possible decision.  We have seen real estate owners, who primarily live off the real estate corporation's revenue stream while enjoying the income tax offsets (eg, amortization, interest, depreciation, maintenance expenses, etc. that the tax system provides.  We have seen companies forced to move and incur extraordinary loss of income due to an expiring lease.  We have also seen fast growing companies expand their leased occupancy space several times during growth periods.   Call Touchstone today to talk with an advisor.

SBA NEWS...
Focus on Acquisition Financing

There are several local banks, who are active in underwriting SBA loans, including Key Bank, Vectra Bank and Wells Fargo.  Another company, Rocky Mountain Capital, assists buyers by underwriting, packaging and sourcing SBA-guaranteed financing nationwide. All of these contacts specifically focus on funding for business acquisition, as well as owner-occupied real estate, durable equipment, and business expansion projects.  There are some new developments that may affect SBA financing in the future:

SBA LOAN LIMIT-- EXPECTED INCREASE to $5 MILLION

Passage of Senate Bill 2869, permanently raising the 7(A) program loan limit from $2 million to $5 million, is widely expected to occur in February if not earlier.  With Congress eager to show support for Main Street and small business, and the Administration endorsing this bill, action should be relatively swift after the Senate's return from recess on January 18.  This bill will also:

     - Increase the maximum guarantee amount to $4.5 million (90% of $5 million).
     - Increase debenture amount under the 504 program to $5 million ($5.5 million in some cases).  This allows a total 504 financing package, including private-sector portion and 10% down payment, as high as $14 million.
     - Continue the waiver of loan fees on 7(a) and 504 loans, through 12/31/2010.
     - Continue the temporary provision for 90% guarantees through 12/31/2010.
     - Broaden definition of eligible "small businesses," to include companies with tangible net worth up to $15 million and after-tax net income up to $5 million.

LIFTING GOODWILL CAP:  HIGHER DOWN PAYMENT ON REAL ESTATE?

SBA recently eliminated any absolute dollar limit on financing that can be allocated to "goodwill," in a business acquisition.  This change was widely applauded in our industry.

Little noticed (and possibly inadvertent on SBA's part) was this fact:  in a business purchase that includes real estate, the new language on intangible assets can raise the minimum equity injection requirement for real estate, from the 10% level (formerly acceptable to many banks using the SBA programs) to 25%.  A 25% down payment on real estate can, however, be avoided--as outlined below.

In a business purchase where price of intangible assets (including goodwill) exceeds $500,000 the equity injection (sum of borrower down payment plus seller notes deferred 2 years or more) must be at least 25% of purchase price, in order for the loan to be processed under PLP delegated authority.  At the last NAGGL conference, SBA's Jim Hammersley confirmed that this 25% injection requirement would apply to real estate included in the transaction, as well as to business assets and intangibles.

He also confirmed that the 25% injection requirement on the real estate purchase can be avoided by using a 7(A) guaranteed loan for the business assets, and a separate 504 loan to finance the real estate (typical down payment with 504 is just 10%).  A less reliable alternative: process the loan under CLP (which requires separate credit approval by SBA itself, after the bank has approved), requesting an exception for a lower down payment on the real estate portion.

So, there is a workaround-but it has costs in time and paperwork: two loans, where one would do.  It seems doubtful that SBA really intended to impose higher down payments on real estate.  There are efforts underway through our industry associations to get real estate exempted from the 25% equity requirement, in the next revision of regulations.

Touchstone works with buyers and sellers to choose lenders who  are experienced in business acquisition lending and have a higher probability of successfully completing the transaction. For more information, please visit www.touchstonebiz.com or contact Touchstone at  (303) 278-7501.