Tips to Buying Your Building
IS IT TIME TO BUY A BUILDING FOR MY BUSINESS?
So, it is time to own your own building? Why not pay the rent to yourself? Are you going to Buy or Build?
Before we answer that question, let’s look at some general truths:
If you operate in a strong growth market;
It may be cheaper to build than buy,
If you build, you will have a superior product than the competition and,
probably be able to command a higher rent however,
building takes an immense amount of time – time you could use to increase business.
If you operate in a static to weak market:
It will probably be far cheaper to buy than build or,
It will also be cheaper to buy and modify than build.
OK – we’ve answered buy or build. Next how do we structure ownership? Easy, we take Two Steps:
We separate ownership of the property from ownership of the business – they become two distinctly different entities. You decide with counsel and/or your accountant who and what the building ownership is.
If your company is the sole tenant – you write a true triple net lease for usage of the building. A true triple net lease places all of the burden of property use on the tenant (Rent, Utilities, Taxes and Repairs).
Establishing a separation of ownership accomplishes several ends:
It allows for a variance of owners,
It avoids comingling of income,
It avoids a comingling of liabilities,
It appropriates the benefits of expense and income where they can best be utilized and,
It allows for the separate sales of each asset.
Can I buy a building for my business?
The answer to this question is also pretty easy. What does your cash flow and P&L say? Over the last year, what was your P&L profit? Over the last year what was your increase of cash on hand. Does cash on hand increase at the same pace as P&L profit? Is it lower? Why? Let’s assume Cash on hand is increasing commensurate to profit.
Next let’s add the yearly increase of cash on hand to the annual current business rent, utilities, taxes and maintenance. The resultant sum / 12 is what the business can afford to pay monthly. So now let’s figure it all out.
Jenny’s Catering company generates $108,000 profit and her cash account increased last year by $12,000. Jenny’s total annual rent burden is $123,000. Jenny’s Catering can afford to pay $135,000 total rent.
The building Jenny wants to buy is $750,000 and Jenny will need to spend $120,000 to make it work. Annual cost of maintaining the building is as follows:
Property Tax$ 8,000Utilities$36,000Insurance$11,000Maintenance$ 5,000TOTAL COSTS$60,000
Balance available for Debt Service: $75,000 can be used for the annual lease payment.
Value based on income at a 7.5% cap is $1,000,000 however, the lender won’t let Jenny use the difference as equity – they will require Jenny contribute the $120,000 for modification – Jenny has the cash and a little more.
Jenny’s total purchase and remodel price is $870,000. Jenny needs annual mortgage payments no greater than $62,500. The difference between the mortgage payment (expense) and lease payment (income) is a required profit that lenders call a debt service coverage ratio (DSCR).
Jenny has been promised a mortgage rate of 5%, and a term of 20 years. The annual payment should be $59,500. It’s all going to work. Then she gets turned down – WHAT?
I forgot one little important item – this takes place in 2022. Jenny barely kept her doors open in 2020. But we finally get control of Covid in 21’ and then we get a proven vaccine. The hard climb out of another recession begins. Luckily for Jenny, people want a big dose of what they had to do without, and Jenny’s Catering becomes stronger than ever before. “Too bad” says the bank examiner “I need three years of steady income – you only have eighteen months.
So Jenny has a choice, she can strike a hard money deal – 12% interest only, 3 points, one year term. Hard Money wants $91,250 in interest and $22,500 in fees – that’s $39,000 more than she has available from rent, AND – there is no guarantee she can refinance in 12 months – OR she can talk with –JVM Capital. Jenny paid her bills (good times and bad), she has excellent credit. We arrange a loan for Jenny’s Real Estate LLC at 7.25%, with a 30 Year amortization and $15,000 in fees. Her annual debt service is $61,400 and it is fixed for five years. If Jenny wants to get out of the loan quicker, we can arrange it. But bottom line is this – We make it work for Jenny.
JVM Capital – we are experienced former investment lenders and small business operators. We’ve been there, take advantage of our experience and our approach to helping you and your business. We take the long view – we are here in your corner for all 15 rounds.