The Real Estate Question!

Let's consider a subject that is not directly related to the “how-to” and “what about” of business ownership transfer, but which is often a major line item on a company's balance sheet and/or becomes a major point of negotiation in a transaction: real estate.

There are countless business owners who own the real estate their business occupies or feel an overwhelming need to do so. In situations where there is a sound business reason for ownership (e.g. because the location is critical or because of major-related investments in leasehold improvements), this is perfectly reasonable.

It is necessary to question real estate acquisition, however, when its ownership is not critical to the successful operation of the business. A business should consider real estate just as it would any financial investment. It should determine the rate of return and the risks, and compare those findings to other relevant alternatives such as leasing, investing the capital in other areas of the business or even in other investments personally available to the shareholders. If a business owner can expect real estate to appreciate at, say 5% per year with moderate risk, he can invest the same funds in Treasury bonds and get a similar rate of return with less risk.

Of the many businesses now in private hands, many have capital tied up in real estate that is probably virtually unsaleable. Even worse are those who own sites with environmental problems. If this capital had not been committed to real estate, it could have been invested elsewhere at a better rate of return. Businesses in this situation need not necessarily despair: they have probably received a reasonable rate of return on their owned real estate (in terms of the money saved relative to leasing it), but they cannot expect a capital gain windfall upon its disposition.

The same situation exists with residential real estate; it was only in the 1970s and 1980s that homes experienced considerable price increases, driven by demographics and inflation. Before that time, home prices were remarkably stable, and homeowners did not expect to profit from the sale of their residences.

The point is simply this: look before you leap. Real estate investment is a different game than business ownership. If you don't know the rules and don't have staying power, don't have unrealistic expectations of gain. More generally, watch out for long-term capital commitments in real estate (or any fixed asset, for that matter) in an environment characterized by rapid and unpredictable changes for which you may not be prepared.

Before you add more real estate to your personal or business asset, think about both the potential appreciation and the potential difficulty of disposition.