How to Sell A Business with Attached Real Estate

It is not uncommon for South Florida business owners to own the physical property (either a stand alone building or a unit such as an industrial bay or office condominium) housing their business. Indeed, when the business owner also owns the attached real estate it generally signifies that the business has a strong track record of profits. Otherwise, the business owner would not have had the means nor the confidence to have purchased the real estate housing the business. When it comes time to formulate an exit strategy, the business owner may choose to combine the sale of the business with the attached real estate or may choose to only sell the business while renting the use of the real estate to the buyer.

Seller May Choose to Only Sell Business

In many cases where the seller of a business also owns attached real estate, the seller only desires to sell the business while renting the real estate to the buyer at a predetermined rental rate. Often this is because the business owner does not want to sell the real estate. They would rather keep the real estate as a source of retirement rental income or as an investment that will hopefully go up in value over time. A professional business broker should educate the business owner that it is more difficult to find a buyer of their business who is also ready, willing, and able to purchase the real estate.

When Real Estate Value Exceeds Value of Business

Most business buyers are not qualified to purchase a commercial real estate property.
This is especially the case if the value of the real estate meets or exceeds the value of the business.
For example, many owners of auto shops also own the industrial bay or building which houses their shop.
If the value of the auto shop is $250K and the value of the building or bay is $300K, then the combined asking price of both the shop and the real estate is $550K.
This then requires the buyer to somehow fund a deal for $550K compared to just $250K for only the shop.
Many buyers will be priced out of such a deal for lack of funds.
Moreover, the buyer’s return on investment (profits divided by total investment) goes significantly down if the buyer is forced to purchase both the shop and the real estate.
In our auto shop example, let us assume that the total profits of the shop is $100K/year.
This gives the buyer a 40% ($100K/$250K) return on their investment when only buying the shop.
When including the real estate in the deal, the buyer’s return on investment is about 18% ($100K/$550K).
It is still possible to sell the attached real estate with the business in such circumstances, but the sales process may be more lengthy and difficult.

Benefits to Seller of Selling Business Without Attached Real Estate

When the business seller only sells the business without the real estate, they can benefit in a number of ways. First, the seller will receive rent from the property, providing a stable and relatively secure income source for many years. Next, the seller will avoid nasty tax consequences from selling the real estate. The capital gain taxes from the sale of commercial real estate can be 20% or more. This will be avoided if the seller keeps the real estate. Of course, the best benefit to the business seller who keeps the real estate will be if the value of the real estate goes up significantly over time after the sale of the business.

Depreciation Deductions from Real Estate

Moreover, if the seller of the business chooses to keep the property and rent it to the buyer (or someone else if the buyer does not want to remain on the premises), the seller will be able to take depreciation deductions from the real estate. The depreciation deduction schedule from a commercial real estate building (not the land) is 39 years, meaning that if a building is worth $390K, the seller may take $10K/year in depreciation deductions off their income taxes.

Value Business and Real Estate Separately

If the seller chooses to sell their business and attached real estate as a package deal, then it is imperative that the business and real estate be evaluated separately by a professional business broker. The evaluation process for the business should only focus on the merits of the business, while assuming that the seller is paying the fair market value of what the rent would be for use of the real estate. The evaluation process for the real estate should take into account the comparable sales, the condition of the real estate, and the best and possible economic use of the real estate.

Target Right Buyers When Combining Business and Real Estate

A key segment of buyers who would be willing and able to purchase the attached real estate of a business are buyers funding the transaction through the Small Business Administration (SBA) and E2 Visa buyers (foreigners seeking to gain entry into the United States by purchasing a business).
Procuring an SBA-backed loan is far easier if commercial real estate is included in the deal.
This is because physical assets such as commercial real estate may easily serve as collateral for the SBA-backed loan.
Likewise, it is very beneficial for a prospective E2 Visa buyer when the sale of the business includes commercial real estate.
The general tests of procuring an E2 Visa are that the business opportunity be a ‘substantial’ (roughly $100K or more) and ‘bonafide’ (meaning not a sham) investment.
Including commercial real estate in a business purchase will greatly aid E2 Visa buyers in convincing the immigration authorities that their investment meets the ‘substantial’ and ‘bonafide’ tests.

It is always best to seek the best legal, accounting, and business brokerage advice when considering selling your business with attached commercial real estate. Choose the best option that works for you!

Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.