One of the more difficult problems for business brokers is how to advertise a business with real estate. Should we advertise the income and price of the business with, or without, including the real estate? What adjustments need to be made in presenting the business with real estate? What should we do if the owner of the business is not paying herself a fair market rent? Here are some things that you, as a potential buyer or seller of a business with real estate should keep in mind.
First, you should recognize that there is no standard way that business brokers advertise a business with real estate. That means that you have to look into each one and look at how the business is being marketed. We usually advertise the income and price of the business only — after deducting the likely cost to a buyer of a new mortgage on the real estate. This is because, if we advertise the price of both, the price will appear high to many buyers and we get a much lower response to our advertising. Let me explain with an example.
Let’s say the business generates an owner’s cash flow (seller’s discretionary earnings) of $200,000. An average multiple for a selling price of a business is 2.5X SDE, or $500,000 for this business. Let’s say that net operating income of the real estate is $100,000. A normal cap rate for commercial real estate is 10X which would put a price of $1,000,000 on the real estate. If we advertise both together, we have an SDE of $300,000 and an asking price of $1,500,000, a 5X multiple. Since we are marketing to business buyers, they think that the price, 5X cash flow, is too high since they are used to seeing multiples of 2.5X cash flow.
If you are evaluating a business for sale with real estate, you need to evaluate each separately. First, look at the income and cost of the real estate and plug the numbers into your pro-forma for the business. Then, see what the business generates in owner’s income and evaluate the price accordingly.
Here are some other things to look out for.
- If the business does not own the real estate, a separate tax return is being filed for the real estate. You need to see that tax return and what is, or is not, on the tax return.
- The rent that the business is paying may not be a market rent. It may be higher or lower than a market rent. You need to evaluate the business with the rent you will need to pay yourself to buy the real estate.
- Watch out for the real estate taxes. If there hasn’t been a recent sale of the property, it may be under-assessed. When you buy the real estate, the property may be assessed higher and the real estate taxes on it will go up.
- An SBA 504 loan is frequently used by buyers to finance the purchase of the real estate. They typically have to put down 10% or 15% of the purchase price as a down payment.
- Keep in mind that the real estate may be an important component for some businesses. I sell a number of auto body shops. Many are located in communities where it would be very difficult to get approval for a new body shop. Many industry buyers would not buy the business unless they could buy the real estate.
- Consider what the value or use of the real estate would be if the business was not located there.
Don’t be scared off by the cost of buying a business with real estate. There is a difference in evaluating a business and evaluating the associated real estate. Be sure you do both.