Unless they have a franchised business that requires the inclusion of real estate (such as a flagged hotel, for instance), most businesses won't be ready to investigate this strategy in their first three years. It often takes that much time to prove their concept, establish a firm footing in the marketplace and reach predictable profitability. Shortly thereafter, however, it's probably time for them to stop making their landlord wealthy, paying his mortgage with their rent checks, and instead pay those rent checks to themselves, the business owner.
Why is this a good idea?
When businesses require a brick-and-mortar presence, then eventually it makes more sense to have that facility expense (monthly rental payment) work for them and build equity in an appreciable asset such as commercial property. Often times, this requires no additional expense, but it makes a substantial difference in the net worth of the business owner. And sometimes such as in current market conditions using this strategy can actually save business owners money. That's because it's generally cheaper to own than rent with today's much-lower commercial property valuations and record-low interest rates. I would argue there's rarely been a better time to take action on this simple strategy.
What is the best way to finance the purchase?
By using what I call the "best-kept secret in commercial financing" the Smart Choice Loan (a.k.a. the SBA 504 loan). It requires one-third to one-half the down payment of a conventional bank loan, while offering longer terms and with below-market, long-term fixed interest rates. Using this loan is best because it allows business owners to keep more of their precious capital (to do with it what they want), allows them to have lower monthly payments (so as not to impact their business cash flow), and allows them to pay less of their monthly payments toward interest expense.
Explain the "five Cs" that lenders consider before making a loan.
The first is "collateral." A reputable commercial lender will want to make sure the property being bought is worth the sales price. This offers protection for all the parties and is best determined with a commercial appraisal. The next "C" is "cash flow" (sometimes referred to as capacity), in which a lender tries to determine how much cash the operating business generates and has available to pay for the existing and proposed debts. Often, a lender reflects this "debt service coverage" figure with a ratio of cash available to annual debt payments. Then there is "credit analysis." It simply provides a history of the borrower's credit scores. The fourth "C" is "character." This is the reputation of the borrower, how well he or she is known and so forth. The final "C" is "conditions." A lender will attempt to determine how favorable factors are that are outside the control of the borrowing business owner. Issues such as the local economy, the health of an industry and so on are typical conditions to consider.
Successfully complete the five Cs, and it's time to buy.
Dawn House Chris Hurn, author