As published in Scotsman Guide's Commercial Edition, July 2005.
Perhaps the most-striking feature about the money homeowners make from their houses is how little of it is intentional. For many home- owners, a mortgage payment simply has been a substitute for a monthly rent payment. But over time, loan balances went down, values went up and suddenly, homeowners had a half-million in equity sitting on the table.
Although a similar opportunity exists for small businesses, fewer entrepreneurs take that leap. They might think that running a business is challenging enough — why add the headache of owning additional property?
This view might be true for some small-business owners, but buying real estate to house your business — as opposed to renting — can have a material impact on your return from the business, as well as on your overall wealth.
To see this concept in action, consider the performance of a hypothetical automotive-products retailer, The Speed Shop, before and after a real-estate purchase.
For years, The Speed Shop provided a nice living for its owner. Renting space in a suburb of a major metropolitan area, the business — a Subchapter S corporation — consistently generated $750,000 in sales. It distributed net profits of 5 percent, or about $37,500, after paying a $60,000 annual salary to its owner. The business was stable, so the owner typically took the net profits out of the business as a cash payment.
One day, the owner received a call informing him that Speed Shop’s building owner died. The executor of the estate wanted to know if the business-owner would want to purchase the building for $750,000. The Speed Shop owner had invested his bonuses wisely in the past 10 years, so there was no question that he had the cash to make a 40-percent down payment of $300,000.
The question became whether purchasing the building would have a positive or negative effect on The Speed Shop’s owner. Assume the owner bought the building personally and rented it to his business. Let’s see how far ahead he might be after 10 years, as opposed to if he continued to rent.
If the $450,000 balance was financed with a 6.25 percent ARM, the monthly principal and interest payment would be $2,770, if amortized on a 30-year basis. Adding the annual taxes of $7,200 increases the monthly payment to $3,370. This is less than the monthly rent of $6,500 that the company paid, so the transaction would be off to a good start.
But let’s be conservative and assume that The Speed Shop’s owner spends $37,500 annually on maintenance and operating expenses for the building. This amount is the annual difference between the old rental payments and the new mortgage and tax payments.
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