What are the pros and cons of real estate in the acquisition target?

March 13, 2025

by a searcher from INSEAD in Los Angeles, CA, USA

I'm looking at a company with 5M enterprise value, and real estate worth an additional 5M. I assume I can have a bank partially fund the real estate, but reimbursing the debt will eat into the free cash flow that I would much rather prefer to use to repay the enterprise value.

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Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

I think there have already been plenty of great comments made here. Although some of this may be somewhat repetitive to what is above, I wanted to get all of my thoughts down and summarized together. First, buying the real estate will typically require an additional capital outlay, so you need to judge if the real estate is really going to be of value to the business. If it is going to be a long-term value for the business or you are getting it at a good price, then it probably makes sense to try and buy the real estate. However, if you will likely grow out of the space or the space, the business is not likely to need all of the space, or the space is not necessarily key to the business and the price is high, then it likely does not make sense to outlay cash for the property.

There are some advantages to using SBA financing for real estate being purchased with an SBA loan. Please keep in mind, the business must occupy 51% or more of the subject property for it to qualify for SBA financing. For conventional financing most lenders will only advance 75% to 80% of the purchase price, but conventional bank options are available for the real estate with standard 25-year amortizations. You can do a conventional bank loan with a conventional business acquisition loan or you can use an SBA 7A business acquisition loan and also get a conventional bank mortgage loan from the same or another lender. If you are and buying the real estate and business, you can buy both combined into one loan using the SBA 7A loan product and get an extended amortization on all of the debt. If the real estate is 51% or more of the total acquisition cost, then you can amortize all of the debt over 25 years. The new rule has it based on total uses, so you can assign any seller notes to the business purchase to get the 51% to work in your favor if close. This will provide you with a substantial cash flow savings. If the business acquisition cost (including any working capital or other business costs built into the loan) is 50% or more of the total acquisition cost, then you can get a blended amortization on the debt. The lender assigns 25-years to the portion of the debt associated with the real estate, ten-years to the portion of the debt assigned to the business assets, and you end up with a blended amortization between 10 and 17.5-years. By pushing out the business acquisition debt with the blended amortization this will typically save you between 5% and 15% in annual debt service versus doing both loans separately. Even though you can technically do an SBA 504 loan for the real estate and an SBA 7A loan for the business, with better interest rates typically available on the SBA 504 loan, few SBA 7A lenders will offer this as a solution. Most will either want both assets in the same loan as additional collateral or will want to do both as SBA 7A loans so they have the full deal under their control (no SBA CDC involved on the 504) and have the 75% government guarantee on all of the debt. One benefit here is that most SBA 7A lenders will offer better pricing on all of the debt when real estate is involved, so you do benefit from better pricing on all of the debt from an SBA 7A perspective. If you are doing an SBA 504 loan at the same time there is a change in ownership of the business, the SBA 504 will only lend you 85% of the property cost. So, you would need to put 15% down on the real estate portion of the acquisition versus the 10% required with an SBA 7A acquisition. One way to get around this is to purchase just the business and sign a lease with an option to buy the real estate and then come back six months later or more and buy the real estate at that time. In doing this you will then qualify for 90% financing on the SBA 504 loan as you will already own the business at time of acquisition of the real estate. Also, if you are buying the real estate later, the SBA 7A lender cannot require it all done as an SBA 7A loan. You can then use a different lender for the SBA 504 at a later date if need be. The only risk here is the business cash flow will need to continue after acquisition to qualify. If the business cash flow falls off, you might not be in a position where you can finance the real estate at a later date or may be delayed in doing so. Some lenders will do the real estate as a 504 loan. If you are pushing up against the SBA limits of $5 million, then doing the SBA 504 loan can help keep the total deal under $5 million. Every dollar you borrow on an SBA 7A loan counts against your $5 million SBA limit. However, only the SBA guaranteed portion of the SBA 504 loan counts against your SBA limit. As an example, if you are purchasing a 51% or more commercial owner-occupied property for $1 million, then under the SBA 504 program on a change of ownership transaction you would put down 15% or $150,000, the Bank would fund 50% or $500,000, and the SBA 504 would fund 35% or $350,000. Only the 35% piece or $350,000 of the $1 million purchase price would count against your SBA limit of $5 million. So, using the SBA 504 loan in theory allows you to borrow more on SBA debt and leaves you more dollars for the SBA 7A guarantee on the business acquisition. Under normal circumstances (no change in ownership) using SBA 504 dollars, and assuming 10% borrower capital down, you can get a total of $12.5 million between SBA 504 and Bank debt under the SBA 504 program, but those funds can only be used for owner-occupied commercial real estate and equipment (excluding most vehicles), and not for business acquisition, working capital, etc. One last thing to keep in mind. If you are buying a company with an NACIS code that is in manufacturing, you can qualify for an additional $5.5 million in SBA 504 borrowing in the future. However, you cannot access that additional capacity at the same time you access your base $5 million in borrowings. If you are buying a company in manufacturing and will be exceeding your $5 million SBA limit, then this would be a good situation to lease the real estate and look to buy it at a later date. Not only will this allow you to finance 90% of the real estate purchase six months or later from closing using the SBA 504 loan program, but if the business is in manufacturing, you could borrow up to another $5.5 million in SBA guaranteed debt. With only 10% required down using SBA 504 financing that would open you up to $13.75 million in additional capacity for the real estate or future equipment needs. Of course, the cash flow has to be there to support this request. You do get to add back historical rent expense to adjusted EBITDA when financing the real estate. Hopefully this information is helpful. If you have additional questions or would like to walk through any scenarios, you can reach me here or directly at redacted

Reply by an investor
from The University of Chicago in Chicago, IL, USA

It is important to keep in mind that the decision to purchase the RE should be separate from the decision to purchase the operating business. Many look to purchase RE since the owner wants to sell both the business and the RE. While sometimes unavoidable (read: deal killing), that is an inferior reason to seek to acquire the RE. Any RE needs to be evaluated on its individual merits (growth capacity for the business, access to transportation, local employee pool, condition, etc.). Sale-leaseback transactions are interesting and available. All RE parcels, however, need to match the investment criteria of the underlying fund. Many of these funds only invest in AAA+ properties with AAA+ tenants (in this case the operating business you are purchasing, now levered). As a result, sale-leaseback transactions are not particularly easy to put together for a small co. As indicated here by another, a local RE investor (possibly family) looking to acquire RE as a long term RE investment (think NNN lease with 6% - 10% return / lease cap rate) could be an attractive option, again, if both the underlying attributes of the property and tenant are in order.

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