Archive for the 'Real Estate' Category

Claim the stealth benefits of small business ownership

The classic financial benefits derived from small business ownership typically fall under two categories:

1.  Earned income: salary and bonuses reported on a W2 each year.

2.  Unearned (investment) income: distribution of profits from the operation and/or sale of the business.

But there are other small business ownership advantages that I call “stealth benefits,” because they’re not as evident as operating opportunities. Arguably the most dramatic stealth benefit, which often has the most wealth creation potential, is for the business owner to also personally own the real estate in which that business operates.

Here’s the classic scenario: Every business is a tenant of some landlord, likely under the terms of a commercial lease. There are many financial and strategic reasons for a small business to lease property from an unrelated landlord. But that arrangement offers the business tenant only tax deductions of the lease payment and associated disbursements, and essentially no financial benefits for the owner of the tenant business.

Now let’s consider the stealth benefit mentioned earlier. As long as the business you own is legally structured as a tax reporting entity, like an S Corp or LLC, you can accrue stealth benefits by personally owning the real estate your business operates in and leases from you. For example: Smith Enterprises, Inc. (SEI), a small manufacturer, has one shareholder, Tom Smith. SEI enters into a long-term, formal lease of the improved real estate it operates in, and the landlord, the individual who owns that property, is the same Tom Smith. Several of the stealth benefits these two entities accrue from this legal arrangement include, but are not limited to:

  • SEI doesn’t have to worry about prohibitive rent increases, or getting kicked out because its landlord, Smith, won’t renew the lease.
  • As with any lease, SEI deducts lease payments and associated disbursements as operating expenses.
  • As owner and landlord, Smith personally deducts expenses necessary to deliver on the lease agreement, including mortgage interest, depreciation, maintenance, etc.
  • Profits arising from this venture are taxed as unearned (investment) income for Smith, calculated at his personal income tax rate, but – and this is important – not subject to payroll tax.
  • It’s possible that Smith could receive cash distributions from the property, even if the investment delivered a loss.
  • Over time, as inflation causes rents to rise against mortgage payments that may be fixed for that period, cash distribution will likely increase each year.
  • When the mortgage is paid off, the income-producing property becomes a cash-producing annuity for Smith.
  • Upon the ultimate sale of the property, basis-adjusted profit is taxed at the current capital gains rate, which is typically lower than Smith’s personal income tax rate.

In my long career, I’ve seen many family businesses that Mom and Pop founded and operated for decades. But at the end of their business careers, it turns out that the business itself had little or no value to a prospective buyer, and the founders just locked up the business one last time.

However, concurrent with operating their business, Mom and Pop also went about acquiring the property their business operated in, and leased it back to the company. Over those same decades, that corner of an intersection, in a once-sleepy section of town, became a valuable piece of commercial property.

In the end, Mom and Pop made a good living from operating their business, which ultimately was worth essentially nothing. But they retired well by selling the real estate they’d bought for thousands, for millions. Oh, and they actually have one other option that might be preferable: Just continue to lease the property to the next business.

And almost all of this, including years of rent distributions, was taking place under the marketplace radar, as a stealth benefit.

Write this on a rock … Take advantage of the stealth benefit of owning the real estate your business operates in.

Small business ownership has stealth benefits

The classic financial benefits derived from business ownership typically fall under two categories:

  1. Earned income – salary and bonuses as reported on your W2 form each year.
  2. Unearned (investment) income – distribution of profits from the operation and/or sale of the business.

But there are other ownership advantages that I call “stealth benefits,” because they’re not as evident as operating opportunities. The stealth benefit that is not only the most generally accepted, but which has the most wealth creation potential is to personally own the real estate in which you operate your business.

Here’s an invariable: Every business is a tenant of a landlord under a commercial lease. There are many financial and strategic reasons to lease property from someone else. But this arrangement offers only tax advantages – deducting expenses associated with the lease – no direct investment benefits.

Now let’s consider a lease relationship that includes stealth benefits. As long as your business is legally structured as a tax reporting entity, like an S Corp or LLC, you can accrue those stealth benefits by personally owning the real estate your business operates in, and becoming the landlord of that legal entity. For example: Smith Enterprises, Inc., tenant of Tom Smith, property owner and sole shareholder of tenant.

The first stealth benefits are your business doesn’t have to worry about prohibitive rent increases, or getting kicked out because the landlord won’t renew the lease. Other stealth benefits are tax and investment related:

  • As with any lease, the business deducts lease expenses before net profit passes through as income to shareholders.
  • As owner and landlord, you personally deduct expenses necessary to deliver on the lease agreement, including mortgage interest and depreciation.
  • Profits arising from this venture are taxed as unearned (investment) income, subject to income tax, but not payroll tax. And unlike your business sometimes, most profits – and even some losses – usually come with distributable cash.
  • Upon the ultimate sale of the property, basis-adjusted profit is taxed at the current capital gains rate, typically lower than income tax.
  • Over time, as rents rise against constant mortgage payments, monthly cash distribution is possible.
  • When the mortgage is paid off, you property becomes a cash-producing annuity.

Take advantage of the business owner’s stealth benefit of owning the real estate your business operates in.

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Last week on The Small Business Advocate Show I talked more about the benefits of owning your business’ real estate with Chris Hurn, CEO and co-founder of Mercantile Capital Corp. based in Orlando, FL and author of The Entrepreneur’s Secret to Creating Wealth: How the Smartest Business Owners Build Their Fortunes. Click on one of the links below to hear what he had to say.

Real estate as part of a small business retirement strategy

Get financing for your commercial real estate acquisition

Check out more great SBA content HERE!

Commercial real estate leasing: Part II

This is the second of a two-part series on leasing commercial real estate for your small business. Last time we talked about how to start the due diligence process of narrowing your search down to two or three options. Let’s wrap this up by focusing on the final steps.

In the first stage, you built a comparables spreadsheet and started populating it with basic information for each property, like square footage, base rent, notes, etc. Now we’re going to finalize the expense picture by identifying who pays for what.

There are three classic lease structures: net, net-net and triple net. But the leases you’ve been reading won’t actually say “net lease.” The type is determined primarily by how expenses are allocated.

  • A net lease means the tenant pays the base rent and possibly some or all of the utilities. This is the simplest and most common lease, and the easiest to evaluate. Be sure to ask how much to expect incremental expenses to be, so you can build that into your comparison.
  • A net-net lease has the same elements as the net lease, plus the tenant will typically have some maintenance and replacement expenses, as when an air conditioning compressor goes out. Like the net lease, estimate what these extra expenses will be for comparison and budget purposes.
  • A triple net lease means the landlord is merely making the building available, and all expenses associated with that availability are obligations of the tenant. This includes insurance and property taxes, plus all maintenance and replacement. These are long-term leases, such as 20 years.

Of the different properties you find that work for you, it’s likely that one will be offered as a net lease and another as a net-net. The net lease base rent will be higher, because maintenance, etc., is not included in the net-net lease base rate. This is where your spreadsheet pays off, because it reveals the total annual lease expenses for each property, regardless of the lease structure.

Every property has maintenance, grounds keeping, utilities, insurance and taxes that someone has to pay for. So don’t sign a lease until what you’re responsible for is spelled out, in plain English, in the lease. Also spell out who is responsible for getting the work done.

Just like in the 1st grade, when negotiating a commercial lease, there are no dumb questions. And let your attorney look at the lease before you sign.

Don’t sign a commercial lease until you know the total annual expense. Good luck.

Commercial real estate leasing: Part I

This is the first of a two-part series on leasing commercial real estate for your small business.

In most markets, one of the sectors that a small business can get a good deal on these days is commercial office and retail space. Whether you need more room or a better location, now is probably a good time to think about finding and negotiating for those new business digs.

But just in case you’re a little rusty on where to start the process, let’s focus on the initial steps of commercial real estate leasing fundamentals that will help you find and compare leased space that works for you.

1.  Don’t stop looking until you find at least two or three places that work. The extra shoe leather will pay negotiating dividends later.

2.  Don’t sign any lease until you know the entire expense picture, including maintenance, which we’ll cover next time

3.  Avoid emotional attachment until after you’ve negotiated lease terms you can live with. At this point, the only emotion that should enter into your decision is whether customers will get excited about the location. Love is for lovers - this is business.

4.  Ask for a pro forma copy of the lease as soon as possible and read it. Commercial leases are like belly buttons - each one is different.

5.  Create a comparables analysis in an electronic spreadsheet that allows you to compare the details of prospective properties. The basics include: leased square footage, unit lease price, incremental expenses (including maintenance), lease term required (how many years), plus pros-and-cons notes about each property.  The notes will come in handy later if you need a tie-breaker when you’re making the final decision.

Since every leased space is different in size and price, here is a handy rule of thumb to help you start the elimination process. Ask the agent or landlord for the unit lease price - $8, $14, etc. - which is the price per square foot of the space per year. Multiply those two numbers and then divide the product by 12 to get the monthly base rent. Use this only as a quick tool to compare properties of different size and unit price.

Taking these numbers and your preferences into account, by now you should be able to get your list of prospective properties down to a manageable list.

Now is a good time to look for a good deal on commercial space, if you know how.

In the next column we’ll wrap-up this project with the rest of the financial analysis and lease details, including types of commercial leases.

What happens in Vegas … is happening around the country

We’re in Las Vegas for a conference (honest) starting on Monday. When we were here two years ago, in June 2008, there were many construction cranes still operating at full tilt. When we arrived in June last year those same cranes were still standing, but idle; their projects having succumbed to some of the worst effects of the Great Recession. This year the cranes are gone and, with the exception of a few derelict properties those cranes used to stand over, the Vegas skyline looks pretty clean.

The cab driver said the housing industry is still in the tank, which is too bad for those whose home value got upside-down with their mortgage requirements, resulting in thousands of foreclosures here. But as with any ecosystem or economy, the misfortune of one is opportunity for another. In Vegas today, as in many markets around the U.S., the foundations of future fortunes are being laid by entrepreneurs who are buying foreclosed properties to rent and hold as unemployment wanes and home-buying waxes.

As we continue to move - day by day - from recovery to expansion, there are similar opportunities appearing in virtually every industry. But in order to take advantage of them you have to: 1) be looking, which means you’re not still hunkered down in your bunker; 2) recognize the opportunity; and 3) develop a strategy to take advantage of the opportunity in a way that allows it to become a growth event and not a catastrophe.

Today, everything that is happening in Vegas doesn’t have to stay in Vegas. Open your eyes and look around; the foundation for your next fortune may be right in front of you.




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