Selling your business and real estate together?

There are many things to consider when selling your business, including whether to sell the real estate on which the business operates. While the business and the real estate are two distinct assets, they are, in fact, quite interdependent with respect to how a business is valued and how attractive the transaction will be to a buyer. Buyers and sellers each have their respective goals. There are several options for a seller to maximize financial gain on their real estate. Before you sell your business and real estate, consider the following:

Lease real estate to buyer
The best reason to lease your real estate is the earning potential. Typical commercial real estate returns, on average, between 8-10% of the real estate’s value, depending on its location. In markets where real estate values are climbing, collecting rental income with the intent to sell the property at a later date is a great option.

However, take caution with respect to lease rates and buildings considered special-use.  Lease rates can have a dollar-for-dollar impact on the value of your business. Every dollar in increased rent is a dollar in decreased profitability. And one dollar of cost can negatively impact value by 2-3 times, on average.

Also, some commercial properties are designated as a special-use building, meaning that its highest value is as the current business. As an investment, special-use properties such as this can be a bit risky, as suitability is limited to a few business types. Selling the business, while keeping the real estate, puts you at risk if your tenant chooses to move. You could be left with an empty building that may require extensive remodeling to repurpose for a new tenant.

Sell the real estate to a separate buyer
Some buyers, often corporate buyers, prefer not to purchase real estate. One option may be to sell the property to a third-party buyer who then leases the property back to the new business owner. While a separate transaction, it can still be seamless to you, the seller. This win-win scenario allows a buyer to purchase the business and secure a long-term lease, while you still get the liquidity from selling the real estate to a third-party investor.

Sell the real estate with the business
Most buyers of your business will also want to buy the real estate. In fact, more often, a buyer will lose interest in a business transaction because real estate is not part of the purchase. Possibly, the biggest misconception is the buyer “can’t afford to buy it all now.” While this used to be true, it is not the case today. There are many commercial lenders with funds readily available for qualified buyers to purchase the real estate along with the business, and usually with a small down payment. Lenders prefer this, as it can improve the underwriting, provides the bank collateral, and the total project can become more affordable to a buyer. With current interest rates and favorable terms available today, the mortgage payment on the real estate is often about the same as rent would be – which also protects the business value.

1031 Exchange: A tax deferral strategy
The gain on the real estate sale is taxed as a capital gain. So why not take advantage of a 1031 Exchange? This allows you to sell a piece of property, reinvest the proceeds into a new property, and defer the income tax from the sale. Properly structured, a 1031 Exchange becomes a valuable tax savings and wealth-preservation tool. Be sure to seek the guidance of your CPA and a 1031 qualified intermediary.

Ultimately, the decision to sell or hold your real estate depends on many factors, and your goals as the seller of the business and real estate. If you would like to discuss these scenarios and other valuation and business transaction topics, please reach out to our team at GAI.

Citations: Cadieux, Stacy. Should the Business and Real Estate be sold together? IBBA Insights, Spring 2022.