How To Structure Businesses With High Relative Real Estate Values
April 16, 2023
by a searcher from University of Kentucky - Carol Martin Gatton College of Business and Economics in Spring, TX, USA
How do others think about purchase prices/multiples when there’s significant real estate values. I note that I want to purchase the real estate (for longer amortization, long term security and allowing me to take advantage of some passive real estate losses I can’t otherwise deduct).
For example, let’s say the business is a $500k SDE business and the seller is asking $3mm and claims the real estate is worth $1.5mm. Assuming I’m comfortable with that price, my thought is to say in the LOI that the price is $1.5mm + the appraised value of the real estate up to $1.5mm.
Thoughts? Alternatives?
from University of North Carolina at Chapel Hill in Raleigh, NC, USA
a) Absolutely place a value on them separately in your LOI (and in your Purchase Agreement if you get there)
b) If getting SBA loan bank will require you to get/pay for an appraisal on both (the business and the RE)
c) The RE only has to be >50% of total purchase price if trying to get 504 loan (but why lock in a 30-year 504 at todays rates?). If 7a then it's my understanding you have options: a) separate RE loan but simultaneous closing to the business purchase or b) group them into one 7a loan and the amortization schedule will be weighted based on the total value of each (business on 10 year and RE on either 20 or 25 year am)
d) Only consider market rent (what the seller is paying themselves today is irrelevant - it should be above market if they're playing it optimally from their tax seat as an owner!) - SBA underwriter and appraiser will catch this anyway
e) I personally don't think it has an effect on your purchase multiple on the business side (would love to hear opposing views though as always). And yes definitely adjust business SDE (and/or EBITDA) based on market rent as others have mentioned. Think of the RE as a separate transaction with its own revenue (business rent), NOI, and cap rate - you just happen to have a close relationship with the business paying rent ;-)
f) If the numbers make sense I believe it to be a nice benefit to a) own more real estate in general, b) for the business to have a secure 'home' indefinitely (always a risk if you don't own) and c) create flexibility to do a sale leaseback in the future as others above have mentioned!
from University of Virginia in Oakland, CA, USA
Note, to qualify for SBA 504, not only must the real property be attributed to more than half of the transaction value, but also the business must occupy at least half of the building RBA/GLA.
The approach outlined by Mark/Edward is appropriate as a means of stripping out the "before-tax real estate benefit" from the business valuation (adding back effective pre-tax, real estate or space/rental expenses).
In addition, you are correct to assume the real estate is likely offsetting some of the business income in terms of passive loss/cost recovery rules, which represents an after-tax benefits to the ownership as a result of property ownership.
An appraiser will typically rely on income capitalization approach to impute CRE value, secondarily combined with sales comps and replacement cost considerations. However these means of valuation may underrepresent the full future value added potential of the property, particularly in cases when the property may be redeveloped for a "higher and better" use;
or, as others have mentioned, where the property can be recast to the capital market as a net leased investment for monetization though an SLB transaction.