Buying The Real Property with The Business

In another article called ROI and the Tax Multiplier, I suggested that the way for both buyer and seller to find a reasonable sale price is by deciding what return of money you want for you invested money. I suggest 30%, but you may be more aggressive or conservative. Divide that percentage into the expected net profit for the year and that is a reasonable sale price. A business that will yield a $50,000 is worth $166,000 using 30% as the ROI factor.

But that is for the business only. What if you want to buy both the business and the real property? "Real property" means the land and building.

Price the Real Estate

First, separate the price into two parts. Ask two questions:

  1. What is a reasonable price for the business?
  2. What is a reasonable price for the commercial real estate?

Start first with the commercial property. You will need an informed commercial real estate agent to tell you what is the market value of the real property. Is it likely to go up or down in the near and distant future? Then ask the real estate agent what is a reasonable rental value of the property? One convenient rule-of-thumb is this: the monthly rental amount should be 1% of the real estate value. If the land and building are worth $200,000, then the monthly rent should be $2,000. Notice, though, that your ROI is only 12%. There is a long-held notion that part of the income from commercial property is the fact that the value of the property steadily increases over the years.

So, in our example, let's say that after consulting with the real estate agent, you decide that the property is worth $200,000 and the rental value is $2,000 per month. Now go to the second step, the business.

Price the Business

When you study the prior owner's income statement and from that make your own projection of what you think the business will do under your management, make sure that one of the expenses you considered is the rental value of the real property. Do not value the business as though there is no rent. You will seriously overrate the business if you do this.

In fact, I want you to even consider forming two separate corporations: one for the real property and one for the business. Keep the two distinct. Talk to your attorney. He will probably strongly suggest you do this as a way of adding extra protection in the case of a lawsuit.

Sale and Lease-Back

Did you really only want to buy the business but in order to get it, you had to buy the real estate? Maybe you would rather have the money now tied up in the real estate to invest in another location. Talk to your commercial real estate agent about a financing technique called Sale and Lease-Back. You find an investor, one who owns commercial real estate. You approach him with the idea that you sell the real property to him and you become his tenant.