From these reasons it should be fairly straightforward to derive the small business owner’s real estate wealth building strategy. First, look for a property in which to locate your business.
The Small Business Real Estate Wealth Building Strategy
Thus far I have been talking about the advantageous financing that a small business person can access to acquire real estate for business use. Before doing so, you have to be sure that it makes sense to own your business location, rather than lease it. Let’s look at the reasons for buying business-occupied real estate versus leasing.
Reason 1: ControlWhen you own the location for your business you have a greater degree of control over what you can do with the space. In lease situations, you always have a landlord who is concerned with the condition and state of the property who may attempt to limit your use.
Reason 2: DiversificationThe business real estate is a separate asset from the business itself. In purchasing the building, you have automatically diversified your asset base. Now a portion of your net worth is in commercial real estate and on a different growth path than your business.
Reason 3: Equity CreationWhen you make those monthly lease payments you are doing your landlord a great favor by either helping him pay down his loan or increase his net worth. Either way, that money is put to better use if YOU are the one whose loan is being paid down, building your equity in the property.
Reason 4: Payment AssistanceWouldn’t it be nice to be the owner AND a landlord at the same time? If at all possible, try to purchase a building with additional space for other tenants. You can use their cash flow to help you acquire a larger property, pay down your loan faster, increase your personal cash flow, or a combination of the three.
Reason 5: Estate PlanningSince the building is a separate asset, there are different approaches to managing its position in your portfolio. Common strategies include putting the building in personal or trust name and leasing the space to your business. Also, keeping the building in a separate ownership name gives you some further protection in the event things don’t go as planned with the business.
The Wealth Building Strategy
From these reasons it should be fairly straightforward to derive the small business owner’s real estate wealth building strategy. First, look for a property in which to locate your business. The property should meet your business’ immediate and medium term growth needs.
Second, attempt to find properties that can accommodate or have existing tenants for payment assistance. Obviously, this step should not conflict with the first one. However, a little patience in finding a multi-tenant property that you can use for your business will pay off significantly down the road.
Third, acquire the property with advantageous financing that maintains working capital at acceptable levels and allows for accelerated pay down of the loan principal for equity build-up. In other words, assuming it makes sense, get high leverage or LTV financing that keeps cash in the business. At the same time, make sure that the loan you obtain allows for extra “pre-payments” without penalty so that you can accelerate equity growth in the property and increase future cash flow.
Fourth, position the property to meet your estate goals. How you take ownership will have a significant effect on your estate planning. You should get both your tax and estate planning advisors involved before you close the purchase escrow.
Fifth, implement and accelerated repayment strategy to maximize equity creation. As mentioned in the third step, this is where the smart investor uses his excess cash flow to reduce overall interest expense on the property and increase equity. Properly “reversing” the amortization principal used by lenders reaps massive gains in wealth over relatively short periods of time. I will cover this topic in the next article.
Where Have all the Commercial Lenders Gone?
Government Agency guaranteed or sponsored transactions, including: SBA 7(a) and 504, HUD construction loans for multifamily projects, Community Reinvestment Act loans, USDA Business and Industry loans, and to a lesser extent, Fannie Mae and Freddie Mac multifamily loans.
Trading Up Using the 1031 Exchange
A powerful method for building real estate holdings is the use of 1031 Exchanges, which lets investors defer capital-gains assessment on investment property.
Segregate Costs for Better Cash Flow
While costs such as office equipment and furniture are easily recognizable as personal property, construction-related costs that are often included as part of real property may also qualify.
