If you Sell your Business, Should you Keep the Commercial Real Estate?

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The Background: I provide location advice to owners and occupants of industrial real estate in Southern California. Frequently, this advice results in a company buying a building to occupy. With prices notching up but with cheap financing, this in many cases can result in a rental rate cheaper than a market rental rate.

The rental rate I am referencing is the debt service achieved when applying the purchase price financed at today's low interest rates. When an ownership structure involves the owners of the business that will occupy the real estate - a terrific union is formed. The company pays the rent (debt service), and the owners benefit from the appreciation, depreciation, and stability of facility costs. What happens if the owner decides to sell the company (tenant)? Should the real estate be retained?

 

The Misconception: When the owner of the company and the occupant of the real estate are identical - but defined by entity - the owner of the real estate controls the decisions of the tenant - length of lease, annual increases in rent, tenant improvements considered, etc. When an owner of a company decides to sell the company (tenant) and retain ownership of the real estate some misconceptions occur.

• The new tenant will run the business the same as the original owner
• The new tenant will decide to stay in the real estate for many years
• The new tenant will pay rent in a timely manner
• The new tenant will care for the real estate the same way as the original "tenant"

While owning commercial real estate and the company that occupies the commercial real estate may prove to be a sound financial decision, owning commercial real estate while not owning the company may not be as sound. As an example, I encountered a private company that purchased a 50,000 square foot building for their use. The company occupied the building for eight years until the owners decided to sell the company. The owners retained the commercial real estate and signed a five year "leaseback" with the new owners of the company. The owners of the commercial real estate enjoyed a nice cash flow for five years. At the end of the five years, however, the company decided to vacate the building and relocate to a facilty in another state. The owner of the commercial real estate was now forced to compete with other owners of 50,000 square foot buildings - in many cases better capitalized - to secure a new tenant. The owner could not secure a tenant and the owner was forced to sell the building in an undesirable dip in the real estate cycle. 

The Solution: We advise many owners in this situation to write a new lease with the acquiring company and then sell the building as a leased investment to an owner whose core assets are similar. We then suggest reinvesting the proceeds of the building sale through a tax deferred exchange into an asset class with less risk...IE a multi tenant project OR simply paying the tax on the proceeds and investing in a non-real estate asset.