Real Estate in M&A: Sell or Lease?

In this episode, we discuss the role of real estate in business transactions and explore the key decision: should you sell or lease the property? Our guests dive into the tax implications, financing options, and how real estate affects the value of your business. Tune in to learn how these factors can influence your business sale and help you make informed decisions.

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TRANSCRIPT

Welcome to Integrated Insights with ICCG. For more than 30 years, our team has partnered with small business owners to prepare for and navigate the business transaction process.

Pull up a chair as we share stories and insights from our experience on all sides of the M &A table. Welcome back to another episode of Insights and today I've got Dave Parker and Grant McWilken.

How are y 'all doing? Doing good. We're good Mason. How are you? Hey, I'm doing great. Are you doing great? I'm doing so good That's good. You're gonna have a baby pretty soon.

I Am gonna have a baby pretty soon. Are you and your wife are gonna have a baby pretty soon? Yeah, that's cool Yeah, she's the real hero. So it's So today we're going to be talking about real estate within a business transaction,

just kind of what that looks like. And so one of the questions that you guys get, we get from business owners all the time is, should I lease it or should I sell the real estate? That's a great question.

I'm going to let Grant deal with that because so much has to do with tax stuff, right? So it really depends on the deal. I mean, it depends on what they on what they want, which is always important.

But the structure, we just recently closed a deal that the sellers decided to hang on to the real estate, but they also plan to sell it in the future.

So there were some things done for that planning. In another case, I know we've held off a seller who's wanting to sell the real estate because of some tax consequences that Grant So,

I mean, wouldn't those two things really matter the most, Grant? Yeah. Well, the financial, the overall financial goals of the seller, typically, if we're representing a retiring sort of guy or lady,

then it really does matter the overall financial picture, right? You know, Dave, you and I chose to keep some real estate in the businesses that we Um,

because it accomplishes a diversification of our own portfolios. So I mean, it just depends on the goals. That's why you have to go back to sitting down with advisors who are wanting to accomplish,

really help you figure out what those goals are and then help you accomplish them. Um, but I think, uh, you know, sometimes Dave, you and I have been in businesses where the real estate is really key to the business.

If they have a license attached to it, some of our businesses in the old days were licensed storage facilities. It's just hard to separate that out.

If you do, then a buyer will want a longer term lease, so he doesn't lose those licenses, right? And so it's not just a decision by the buyer on whether he wants to keep it or whether he wants to sell it.

It's also the buyer has to make a decision as well. Yeah. And that also increases value in that business if it's going to continue to be used for that purpose because in that particular case,

you can't find those licenses. you can't find land that will allow those licenses. Right. Zoning has something to do with that as well. You know, sometimes businesses, you know,

the zoning is very rare in the city and to doctor body shops, for example, the cities that don't want necessarily paint booths in certain neighborhoods or near certain real estate.

And so the value of a secure position in that real estate by a buyer is very important because he doesn't have to go apply for zoning in an area that doesn't allow it.

And then through the years, you and I have talked about should we sell that piece of property, should we not? And it's something we revisit quite often. It's always based on return, right? Pretty much. But through the years, we've picked it up at a good price because an option we held when we bought the business and when We sold it,

we kept it. - Yeah, because it's such a predictable, particularly on the leases that we hold, that we, on the buildings that we own, Dave, we have triple net leases,

so we don't really worry about it. We pick up a rent check, they have to pay for insurance taxes and repairs and maintenance and those kinds of things. And so it's a great investment that yields a steady retirement income,

if Mason would just get his button gear, then maybe we will be able to retire, you know? Well, let's talk about that instead of real estate for a while. Okay. Should we go ahead and do Mason's review now?

That's exactly right. Let's do all of our reviews on the podcast episodes. We'll do that on the next, we'll do the, yeah, let's do all of our, let's do all the employee reviews, Michael and Andrew and and Mason all in the next series of podcasts.

- There you go. - There you go. - We'll pick up the listeners. - I know, we'll go number one on the charts for sure. So what are some of the potential tax implications when you are buying the real estate or selling the real estate versus leasing it out?

- Yeah, you know, obviously when you lease real estate, you're gonna get to deduct the rent payment. When you sell real estate, it will result in taxes.

And so typically a business is not housed on raw land. And so it's a building that you've depreciated. And when you have depreciated assets that are sold,

whenever you recoup that amount that you've expensed, it's ordinary income and it's do the day you sell it. It's not something that you can put off with a payment or something like that.

You have to consider the taxes that are due. If you sell the property and your business in the same year,

you're likely paying the highest tax rate possible on that depreciation recovery. And so you just need to plan it out and make sure that you're considering a huge tax bill.

How do financing considerations differ when it's leased versus zoned And when,

you know, banks will tell you they land on cash flow, but it's not really what they land on. I mean, they land on cash flow formula -wise,

but they want collateral. And so a buyer, sometimes, especially in your smaller transactions, a buyer needs the property so that he can get a huge amount financed.

It's just easy for the banks to collateralize real property. In larger transactions that we typically deal with, a buyer that maybe is a private equity group,

they typically don't want to spend capital on real estate unless they have that in their portfolio, but generally they don't. They want to come in and buy the business and lease the property from the owner.

But that's because they have collateral in other businesses that they own that will help them leverage more of the cash flow that the business produces. So,

the only time that it affects that transaction is the larger the rent that you acquire the P group to pay,

the less cash flow they have in order to finance. And so they're not going to pay as much. So you have to know whether you need to raise the rent or whether you need to decrease the rent in order to get the most out of a sale of a business.

Well, and oftentimes, if a business owner's own that piece of property, they may have inflated their rent. I mean, you know, this is just kind of one of those things that people do.

They inflate their own rent so that they're taking more out of the company, right? Which then that could bite them in a sale because they're expecting that increased rent, which may be above market value.

I won't say inflate, I'll just say above market value rent. And so it'll happen just like you said, Grant, it'll affect the sale price and someone has to say, well, if they're going to sell the business in a couple years,

it may be worth it because it's going to be a factor of the multiple at that point. How it affects the price. Yeah.

I was thinking about the conversation Corrine was having the other day with actually a client of ours and just kind of explaining to him the rent that his agent was telling us about was,

you know, increased rent price, which was going to affect the valuation of the business. If that's what we were having to the expected buyer was going to have to pay. So touch on that.

But that's good. So if I'm a buyer, how would you structure the transaction differently than just a regular business purchase? Yeah.

And this This is a question I wish buyers would ask their advisors when they go out and buy a business because we face now two in the last year,

Mason, you and I specifically have faced two where we've had C corporations have appreciated property inside of the C Corp,

which is just really hard because it produces, you know, no capital gain income. It's all ordinary income and it's double taxed because it's inside of a C -Corp and so the first thing I would tell a buyer do not buy the real estate inside of the same entity specifically not a C -Corporation entity and keep it separate and lease it it to the business.

That would be and make sure that entities like an LLC or some sort of pass -through entity. And it's just so much easier, so much cleaner.

And even in a situation where you're actually buying the real estate and the business, even with an SBA loan, we've seen it possible where you can separate that out into a separate entity.

So for sure, structured that way. - Yeah, that's great. Well, I think that's all we have for this episode. We'll pick back up in our next episode with more real estate considerations.

- And that wraps up another episode of Integrated Insights with ICCG. Be sure to subscribe and stay tuned for more stories from our team. We love hearing from our listeners.

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Until next time there's always a seat at our table.