Jay Sachetti joined Jeff O’Brien, partner at Husch Blackwell and Dyanne Ross-Hanson, president of Exit Planning Strategies talked about the market for mergers and acquisitions, exit planning opportunities for companies that don’t end up for sale and how companies can maximize their eventual sale price during an early October panel at the first Upsize on Tap event at Summit Brewing Co. in St. Paul.
When the state Legislature passed a law requiring employers to provide paid leave and safe time for employees, Justin Bieganek started hearing differing details from friends, colleagues and peers.
SOME BUSINESS OWNERS believe real estate is a strategic asset that should be owned. Others view leases as a vehicle to avoid encumbering their balance sheets with real estate costs. Both perspectives have merit, so which is right for you? Is it better to own or lease your space?
Because real-estate investments tend to be relatively illiquid and expensive, most small and mid-size companies find it’s too costly to justify owning. With the demand for investment in such things as growing the production capacity, carrying inventory, or developing new markets, growth companies have little available resources for real estate investment.
On the other hand, if your business needs highly specialized space, ownership might be the way to go. The answer to the own vs. lease question is primarily based on operational and financial factors.
If the scale of your operation is stable enough to make a long-term commitment, ownership is a viable option. But if your operations are more dynamic, changing head count and equipment needs will probably render the space unworkable — too large at first and too small later. Buildings do not expand and contract with their occupant’s business.
Look closely at functionality and try to make a reasonable determination of how variable space needs will be. The more unpredictable your needs, the more you should avoid ownership. A lease, particularly one with expansion or termination options, might better fit the changing profile of an evolving business.
Once you’ve determined your operational needs, look closely at the financial issues. Examine your internal return on investments. If the landlord will finance improvements at 9 percent and you can earn 15 percent investing that money in the business, the easy answer is to lease. But if you have excess capital, or if the proposed facility has some strategic value (unique or critical location, specialized improvements, and so on), ownership may make more sense.
Also, if the facility can be owned with little debt or low-rate funds, owned real estate could provide a balance-sheet cushion. While there may be capital ready to be unlocked through a refinance or sale/lease-back transaction, the low basis and cheap money may be a good financial tool to carry the company through the next wave of growth. Be sure to explore all your options and always consult your financial adviser, real estate consultant and bank before making this decision.
One condition that lends itself to ownership is when the business requires very specialized improvements or major alterations to the building. This is when tenant improvements require more than some new drywall, a spot of paint and some new carpet.
If your manufacturing process requires specialized material handling equipment, an expensive fire protection system or unusually heavy utility or floor load capacity, the landlord will load the improvement costs into your rent. Amortizing those expenses over a short-lease term will drive the rents sky-high, in which case, you may be better off owning the building and financing the acquisition and alterations with structured long-term debt.
If a facility can completely house a core function that is highly unlikely to change, ownership can be a good long-term cost-control strategy.
Some business owners view a real estate portfolio as a personal investment strategy. For the growing business with busy executives, the headaches of real estate ownership often outweigh the rental income, even without considering operational issues such as potential default by subtenants and the hassle of finding new tenants whenever the space goes dark.
How hard can it be to be a landlord? Think about it. Who makes sure the parking lot is plowed and the sidewalks shoveled? Who makes sure the property taxes get paid, or appeals them when appropriate? Who collects the rent — on time and in the correct amount? Although it is possible to subcontract the property management function, the financial risks of owning a multi-tenant building fall on your shoulders.
For certain privately held companies building ownership involving a lease-back might be a personal investment worth considering. Some have tax-driven reasons for wanting the depreciation on their personal income statements; others use this arrangement as a way to pull cash out of the company if needed. In any case, the owner should consult a financial advisor regarding tax implications — personally and corporately — before doing so.
Keep in mind that leasing property to the company you already own is only a partially diversified investment strategy. If the business is successful, the real estate is a good tax shelter and a long-term investment. But if thebusiness fails, owning the building is of significantly less value without the previous rental stream.
The real test for any real-estate decision is how the space fits the financial and operational requirements of the business. What does the space need to accomplish to help the business succeed? Manufacturing space has specific functional requirements access to customers and suppliers, access to transit modes, minimum ceiling heights. Office space may have other purposes: recruitment of key employees, creation of an image statement, or easy access to key customer locations.
The financial component can be simplified. If the availability of capital is no constraint, will someone else invest in your space at a lower rate of return (or lower total cost) than you can invest in your business? If so, put your cash where the growth is! Let someone else be the real estate expert. Unless you are in the position to do so, let office investors take the risks they are familiar with — you stick to your business.
[contact] Gwen Schultz and Jim Vos are principals at CRESA Partners in Minneapolis, a corporate real estate advisory firm specializing in tenant representation, corporate portfolio services, and project management: 612.337.8498; jv**@***********rs.com; gs******@***********rs.com; www.cresapartners.com
