Buying a Business with Commercial Real Estate: Is It The Right Move?

I recently explored a multifaceted deal surrounding an established business that came with commercial real estate. I’m sharing this experience and analysis to foster discussion and gather perspectives from fellow investors navigating similar opportunities.

Let’s break down the deal:

Business Overview:

• Revenue: $2.3 million
• EBITDA Margin: 24%
• Seller’s Discretionary Earnings (SDE): $690,000
• Industry: Stable with modest single-digit growth
• Customer Base: B2B with a solid recurring revenue stream
• Business Age: Over 20 years
• Financial Health: Strong, with well-maintained books
• Purchase Price: $1.85 million
• SDE Multiple: 2.7x
• EBITDA Multiple: 3.35x

Real Estate Details:

• Appraised value: $2.7 million
• Property Type: Single-standing industrial building, fully renovated
• Triple Net Market Rent: $185,000 (Business currently pays market rent)
• No adjustment needed in rent

Financing Structure:

• One SBA Loan for both assets, one price.
• $500,000 cash available for equity injection
• Total Acquisition Price: $4.55 million
• Terms: 10% Down, 25 years, 8.5% fixed interest rate for 5 years

Scenario Analysis:

• Scenario #1: Without Real Estate:
  • Purchase Price: $1.85 million
  • Net SDE: $353,000 annually
  • Term: 10 years

• Scenario #2: With Real Estate:
  • Purchase Price: $4.55 million
  • Combined SDE: $840,000 annually (Business + Real Estate)
  • Debt Service: $430,200 annually
  • Net SDE: $409,800 annually
  • Term: 25 years

In contrast to Scenario #1, Scenario #2 offers a $56,800 higher net SDE, stability against rent fluctuations, and potential real estate appreciation, enhancing its attractiveness for investors. But let me explain why I think it’s best to steer clear of a deal like this.

First off, I like to keep a balanced outlook. I’m not one to dwell on worst-case scenarios like bankruptcy, but I also don’t like banking too heavily on optimistic growth projections. Sure, it’s great if the business takes off, but I think it’s wise to consider a scenario where it stays stable. After all, we’re buying based on historical performance, not just hoping for future success.

Now, let’s say the business stays steady for the next decade. Without the real estate, you’ve got a fully paid-off business that brings in $690k a year. But if you throw real estate into the mix, you’re looking at another 15 years of payments. And here’s the kicker: for the first ten years, most of what you’re paying is just interest.

By the ten-year mark with real estate, you’ve forked out around $3.5 million in interest but only about $850k toward the principal. That means you still owe the bank around $3.6 million.

So, after a decade of hard work, if you skip the real estate, you fully own the business, paid way less in interest, and can start enjoying the entire profits. But if you include real estate, you’re still on the hook for a lot more interest, and you’re only a fraction closer to owning the whole deal.

Of course, it’s not all cut and dry. There are other factors, like the increasing value of the real estate over time. But for me, that’s a different game altogether, more about real estate investing than business.

Ultimately, the goal here is to buy a profitable business, grow it, and pay off that loan ASAP to start reaping the full benefits. If the business cash flows comfortably with a 10-year loan, adding expensive real estate into the mix and merging everything into a 25-year deal just pushes that goal further into the future and jacks up the financing costs.

In the end, there is no right or wrong answer here. It depends on your goals. Are you investing in real estate with a business or in business acquisitions? They are just entirely different profiles (as reflected in what happens in the first ten years). If owning a cash flowing business outright in less than ten years is your goal, purchasing CRE and merging both loans contradicts it.

Now, a much better scenario is to have two separate loans, one for the business and one for the real estate, as long as the rent and the RE loan cover each other without putting additional pressure on cash flow. But let’s save that for the comments. For this post, I’m focused on comparing the pros and cons of buying with or without real estate under one SBA loan and why, for me, it would be a pass.

What do you think?