Offer, Due Diligence and Escrow

Most small business owners can negotiate the purchase price fairly effectively.  However, when it comes to negotiating the contact they do a lousy job (unlike residential real estate, many commercial contracts are not standard).  Make sure you read the contract and have a professional take a look at it with you, otherwise you may find yourself in a horrible pickle.  Due diligence begins following execution of a proper purchase and sale agreement and continues until the opening of escrow.   This period is critical for you to complete all of your investigations on the building and to ensure that financing of the deal on the table can be arranged, so don’t make this period too tight and make sure that you complete your investigaions before your deposit becomes non-refundalbe and escrow opens.  In terms of escrow, once escrow opens, most small business owners just sit back and expect escrow, title, appraisal and the bank to coordinate efforts to get the deal closed.  Someone in your camp needs to babysit the escrow period to ensure that everything goes smoothly and that any hiccups are dealt with quickly.

The Cost of Improvements

Most buildings require some improvement to be properly outfitted for a new business.  Some buildings just need some refurbishment internally, some need to be built out from shell condition and some require major retrofit and renovation.  Regardless of the situation, most small business owners grossly underestimate the cost of the required improvements for their new office building.  Please understand that a full office build-out on a small shell building with high level of finish can easily exceed $100/sq. ft.  On the other hand, carpet and paint is usually only around $5/sq. ft., so the question of the cost of improvements has a wide range.  Bottom line, get several contractors to bid on your plans before you close on the building.  Don’t take anyone’s word for it, nobody can eyeball-estimate a substantial construction job, even if they tell you they can.

Buying and Financing

Most small businesses today buy their buildings through SBA funding.  You still go through a bank or lending source, but the loan is ultimately split and the SBA finances a portion of the loan (usually a little less than half).  The advantages of an SBA loan are 1.) a long term – up to 20 years, 2.) an inexpensive rate – usually about ½ point lower than the bank’s rate, and 3.) a low down payment – usually about 10%.  The primary disadvantage of an SBA loan is that the points to fund the loan are high – usually between 2.5-3 points on the SBA portion of the loan (note: often the points can be rolled back into the loan) and the SBA can be challenging if you ever need to restructure in the future.  Lastly, in addition ot financial quilifications, to qualify for an SBA loan, a business typically needs to occupy at least 50% of the building/condo being purchased.  Conventional financing is an alternative, but the rates will be higher, the term will be shorter and the required down payment will be higher.  Just like buying a home, it is a good idea to get prequalified before you begin your search for a new building.

The Cost Between Leasing and Buying

You may be surprised to know that most people who buy their own building for their business never do a comprehensive cost comparison of buying vs. leasing.  They just decide, “I want my own building” and move forward.  Before too long they’re emotionally tied to the concept of buying and may even get stuck buying a building due to business and time constraints.  You’ll not only need to consider the price of the building, but also the cost of any improvements, the closing costs and loan points, all ancillary and continuing costs like taxes, insurance, utilities, association dues, maintenance, janitorial, common area expenses, etc.  Also, don’t forget to include the opportunity loss of your down payment if it were otherwise invested.  Put it all in a model and compare it against a comparable building that is available for lease.  More often than not, the all-in cost of owning is quite a bit higher on a monthly basis than leasing a comparable building.  Yes, you can offset the costs with tax savings, structure depreciation and possible assett appreciation, but typically unless you plan to hold for a long time (5-10 years +) or unless appreciation is rampant, the cost of ownership will likely be higher in the short run.

Buying and the Personal Guarantee

Many business owners think that they can just buy a building to house their company simply based upon the strength of their businesses.  While this is true for very large businesses, for most small to medium-sized businesses, any bank will expect the business owner(s) to guarantee the loan with their personal net worth.  Like all real estate, commercial property goes through cycles and typically when there are a lot of new small buildings and/or office condos going up or being refurbished, the market is hot.  You need to anticipate a downturn in the market.  You can’t just bet on inflation forever, unless you have a tremendous amount of staying power to ride out a down market.  In your modeling of buying vs. leasing, don’t assume big appreciation.  If it happens, it is gravy, but run your models with minimal expectations of inflation.