Selling the Business When You Also Own the Building

An owner who holds both the operating company and its real estate is selling two assets, and they should be valued separately even if they are sold together. The business is worth a multiple of its earnings. The property is worth what the real estate market will pay. Combining them without analysis usually causes one of the two to be mispriced.

Start with market rent

Many owner-occupied businesses pay rent to a related entity at a figure set years ago for tax or convenience reasons. Some pay nothing. Before either asset can be valued, the business's earnings must be restated as though it paid market rent.

If the company pays $3,000 a month and market rent is $7,000, its true earnings are $48,000 a year lower than reported. A buyer will make that adjustment, and at a multiple of three it reduces the business value by $144,000. The reverse also occurs. Where rent has been set above market, the excess is added back and the business is worth more than its statements suggest.

The adjustment does not destroy value. It assigns value to the right asset. Earnings that came from occupying a building at below-market cost belong to the real estate.

Option one: sell the business and the property together

A single buyer acquires both. This offers the seller a complete exit and one closing.

Financing often works in the seller's favor here. SBA 7(a) loans can include owner-occupied real estate, and the real estate portion can be repaid over as long as twenty-five years, compared with ten for the business portion. The blended, longer maturity lowers the buyer's monthly payment and can make a higher total price affordable. The property also gives the lender collateral, which makes approval easier.

The drawback is a narrower buyer pool. The buyer must want the property, qualify for the larger loan and supply a larger equity injection. Some otherwise capable buyers cannot.

Option two: sell the business and lease the property

The seller keeps the building and becomes the buyer's landlord. For many owners this is attractive. The purchase price is lower and easier for a buyer to finance, the seller retains an appreciating asset, and the rent provides income in retirement.

The lease terms then become part of the sale negotiation, and they matter to all three parties.

• Rent should be at market. A lender will check it, and rent above market reduces what the business can borrow.
• Term. Lenders generally expect the lease, including renewal options, to run at least as long as the acquisition loan. Ten years of secured occupancy is a common requirement.
• Structure. Whether the tenant pays taxes, insurance and maintenance in addition to base rent.
• Escalations over the term.
• Purchase option or right of first refusal, which many buyers request so they can acquire the property later.

The risk in this option is concentration. After the sale, the seller's rental income depends on the success of a single tenant, who may also owe the seller on a note. If the business fails, the seller holds an empty building. Owners should weigh how specialized the property is and how readily it could be leased to someone else.

Option three: sell the two separately

The business goes to an operator and the property to a real estate investor. Investors pay for a stream of rent, so a building with a creditworthy tenant on a long lease commands a better price than a vacant one. In some cases the best sequence is to sell the business with a new long-term lease in place, then sell the leased property to an investor.

This approach can produce the highest combined value. It also requires two transactions, coordinated so that each buyer is satisfied with the terms the other depends on.

Valuation and appraisal

Real estate should be valued by a commercial appraiser or supported by a broker's opinion based on comparable sales and rents. Applying the business's earnings multiple to the property, or folding the property into a single asking price, obscures what each is worth and makes offers difficult to compare.

When a lender is involved, it will order its own appraisal. A seller who has obtained one in advance is less likely to be surprised.

Environmental and physical condition

A lender financing real estate will require an environmental review. For properties with a history of fuel storage, dry cleaning, auto repair, manufacturing or agricultural chemicals, a Phase I assessment is standard, and further testing may follow. Environmental findings are a frequent cause of delay.

Owners of such properties should consider commissioning the assessment before going to market. Known conditions can be addressed or priced. Conditions discovered three weeks before closing tend to end transactions. The same reasoning applies to roofs, paving, mechanical systems and code compliance.

Tax considerations

The real estate and the business are taxed differently on sale, and several features are specific to property. Depreciation taken on a building is subject to recapture at a rate different from the general capital gain rate. An owner who sells the property separately may be able to defer gain by reinvesting in other real estate through a like-kind exchange, which is not available for the sale of the business itself. The property's ownership structure, often a separate LLC, also affects the result. These questions belong with a tax advisor before a structure is chosen.

How to decide

Four questions clarify the choice.

1. Do you want continuing income or a complete exit?
2. How specialized is the building? A general-purpose warehouse is easy to lease again. A purpose-built facility is not.
3. What can likely buyers finance?
4. How much of your net worth would remain tied to the success of one tenant?

Many owners begin by offering both alternatives, sale or lease of the property, and let the buyer's circumstances guide the outcome. That flexibility widens the pool of buyers. What should not vary is the analysis: market rent established, each asset valued on its own terms, and the lease drafted with the same care as the purchase agreement.

Twelve31 Advisors values operating businesses and their real estate separately and structures transactions that address both.