Exiting or Selling Your Business- What to do with the Real Estate
Knowing when to cash in your chips and walk away is the hardest decision that anyone will have to make in their career, whether they are an entrepreneur, an investor in a business, or even a professional athlete. When it comes to businesses that own & occupy industrial real estate, the major question you face is what to do with your property(ies) after a business exit. In general, you often face one of three options: lease the property to the new business owner, sell the property, or re-tenant the property. As with so many business decisions, there is no one right answer, and different advantages and disadvantages for each choice. Issues like taxes, depreciation, and personal investment objectives for you (and sometimes your siblings) will all influence which option is best.
Option 1: Sell the Business, Keep or Exchange the Property
If you sell your business but still own the real estate it is located on, you can still gain value from the property even if you are no longer calling the shots of the business itself. This decision depends on how much immediate equity you want to get out of the equation and if rent payments are suitable. If you find that the business cash flow is adequate with no credit concerns, maintaining it can be an easy choice -- follow the money and you’ll rarely be disappointed with no tax implications on the real estate. However, if you want to capture the value out of the business and the property, your best bet may be to sell the building with a new lease in place. As a new lease is concerned, the value of of your building is maximized by strong credit, 7+ yr lease term, high year-1 rent, and NNN rental rate structure. In this circumstance, you can then effect a 1031 exchange of the building with a new lease in place to maximize building value and defer capital gains treatment. This would allow an out-going owner the opportunity to sell a ‘leased asset’ and purchase a new property that provides a return that better aligns with the new investment objectives of the owner and their family. There are several advantages to a 1031 exchange. First and foremost, it delays capital gains tax treatment. It also allows an owner time to select and purchase an asset they think will perform better - to diversify their holdings to other commercial property types such as retail, multi-family or other ‘Like-kind’ property. A 1031 exchange does require a relatively high minimum investment, necessitates holding time, and is recommended that a real estate broker and exchange accommodator handle the details. However, it can be a good solution to a major sale and purchase.
Option 2: Sell the Real Estate, Structure the Financing
There are plenty of businesses who would prefer to own the property they operate on rather than lease. Nevertheless, not all businesses have the capital needed for such a major purchase. If you are thinking of selling the real estate to the new owners, there are several financing venues that can be attractive to both parties. A carryback option is particularly useful in industrial real estate because it allows the buyer to finance from the seller directly, so that both parties can negotiate the rates, down payments, or duration of the note. It also has a ‘slower’ tax horizon since you don’t collect all of the proceeds from sale immediately upon closing. While both parties should use an attorney for a carryback deal, they can nevertheless reduce the middleman of a financing institution, and save everyone money. Additionally, this option relinquishes the owner from any lease obligations that could be a liability in the future.
Option 3: Move the Business and Re-tenant the Building
In some cases, the owner and the tenant may not be able to come to a suitable agreement. A more suitable location may be better in the first place, or a more lucrative tenant may be knocking on the door. Upping the business is hard, but can be worth it in the long run, especially since demand for industrial real estate is rising steadily, even in the pandemic. Since you are structuring the business sale, a seller can plan for the gap in occupancy by marketing the building for lease while collecting payments from the outgoing tenant. So long as there is a well thought-out plan, a new tenant could substantially increase the value of the asset.