Unless you’re buying an online, home-based or relocatable business, you’ll have to consider real estate as part of the buying process. The landlord may be the business owner or a third party. If the business owner owns the property, the real estate may be available for purchase with the business or in the future.
Will I deal with a Business Broker or Real Estate Broker When Buying A Business with Real Estate or a Lease?
Whether you buy a business including real estate or just a lease, you could see any of these scenarios:
- Just a Business Broker
- Business broker handles the sale of the business
- Business broker handles the real estate sale or lease *
- Just a Commercial Real Estate Broker**
- Real Estate broker handles the sale of the business
- Real estate broker handles the real estate sale or lease
- Both a Business Broker and Real Estate Broker
- Real estate broker handles the real estate sale or lease
- Business broker handles the sale of the business
- No Brokers
- Owner handles the sale of the business
- Owner handles the real estate sale or lease
- Owner and Real Estate Broker
- Real estate broker handles the real estate sale or lease
- Owner handles the sale of the business
- Owner and Business Broker
- Owner handles the real estate sale or lease
- Business broker handles the sale of the business
In the scenarios above, there may be an additional business or real estate broker representing the buyer. However, it is more common in business sales for a business broker and/or commercial real estate broker to “dual-represent” both the buyer and seller.
If there is no broker for any part of the transaction, you are dealing directly with the seller. This is not a common scenario, but if it is the case, it is highly recommended that you consult a professional business broker or attorney.
*A license to sell businesses may or may not be required depending on the state, but any business broker handling a real estate sale or lease must have a real estate license. Read this article to learn more about License Requirements for Business Brokers.
**When a commercial real estate broker lists real estate for sale, they use different metrics to advertise the listing than a business broker uses to advertise a business. They will use commercial real estate metrics such as cap rate versus business broker terminology such as multiple of earnings. Here is an example of a commercial real estate ad for a business. You can see that they are catering to a pool of investors with significant lower expectations on returns, perhaps because of the large size of these deals and the tendency for investors of this type to be passive rather than active owner-operators.
If a commercial real estate professional also lists the business that occupies the property, hopefully they have the additional terminology, marketing channels and expertise required. Similarly, if a business intermediary lists the real estate for sale along with they business, they need the requisite skills AND a real estate license.
How Do I Buy a Business and Take Over the Lease?
Gather lease documents and look for the lease end date and clauses that pertain to transferability. Consult with the seller or broker regarding communications with the landlord. Based on the documentation and a conversation with the landlord, you’ll know if 1) you can assume the lease, 2) you can start a new lease, or 3) you have an issue that needs to be addressed before proceeding any further with the purchase of the business.
What are the Required Lease Documents?
I recommend you make a thorough request since many sellers will often send incomplete documentation or unsigned versions. If an intermediary or broker is involved, they should have this information or are actively working to obtain it and your request gives them ammo to push for a complete set of documents. I wouldn’t be deterred at this point. While other buyers may lose their patience with disorganized sellers, this may be an opportunity for you. Here are the documents you need.
- Original lease
- All amendments if any
- All attachments if any
- Commencement certificates if any
- Estoppel certificates if any
* all documents should be fully signed by both parties, otherwise they cannot be relied on to be the agreed upon documents
What are the Key Items to Look for in the Lease?
- Find the clause regarding transferability
- Verify location and square footage
- Look for monthly rent and built-in increases
- Look for additional monthly charges
- Look at the term of the lease, renewal periods, and length of renewals
When Should the Landlord Be Notified of the Sale of the Business?
You can ask the seller or broker if the landlord is aware of the sale or if there is a time the seller intends to bring it up with the landlord. Sellers and brokers can vary on when they feel the appropriate time is to contact the landlord. They are often balancing the need to communicate with the landlord and a desire to not bother or inform a landlord too early. As the buyer, you should have some say in the matter and you may want to ensure that the timing of contacting the landlord is addressed in the purchase agreement. Typically, you should be able to review lease documents before addressing the landlord. However, if the seller does not have all the documents, the seller may need to request them from the landlord which may tip off the landlord about a potential sale.
Can a Landlord Prevent the Sale of the Business?
If a lease is not transferable, a landlord may choose not to continue the lease with a potential buyer of the business. The landlord may want to negotiate a new lease or the landlord may want a different tenant than the Buyer. Even if the lease is transferable, it typically allows for landlord approval of the new tenant. If the landlord denies the buyer of the business, then the only way the sale can continue is if 1) the buyer is willing and able to relocate the business, and 2) the seller is willing and able to continue to honor the lease and 3) the buyer and seller agree to any adjustment in the purchase price or terms to account for the sale of the business without the lease.
Is it a Good Idea to Lease From the Seller?
If you are successful in buying a business that includes a lease from the seller, it is likely you have an amicable relationship with the seller that will continue into a tenant-landlord relationship. The seller/landlord is aligned with your success because they are counting on your lease payments. If you utilize seller financing or earnouts to buy the business, the seller is doubly incentivized to help you succeed in order to ensure future payments on the business as well as monthly lease payments on the real estate.
Is it Better to Buy a Business With Real Estate or a Lease?
If the Seller of the business owns the real estate and is open to either selling you the real estate or leasing to you, then consider buying the real estate in order to have more control. That said, many business buyers lack the financial ability to buy both the business and the real estate. If this is your situation, ask for a clause in your lease giving you a first right of refusal to buy the real estate. Many successful business buyers purchase the real estate after a few years in business. Meanwhile other buyers, especially many financial buyers, prefer to lease and focus on operating businesses and preserving investment capital to run or buy more businesses.
Can I Get a Loan for the Business and the Real Estate?
If you qualify, and the business qualifies, then you can get a loan to buy the business and the real estate. As far as qualifying you personally, the bank wants to see a solid financial background as well as sufficient business skills for the type of business you are acquiring, including a business plan. As far as qualifying the business, the bank wants to see sufficient profitability and collateral such as equipment and real estate. Therefore, a package deal with real estate may look more attractive to a bank. Furthermore, an SBA loan for the real estate can be a significantly longer term than the loan for the business.
Sidenote: I listed a low profit dealership with real estate and the sellers preferred to sell both together, although a second option was to sell just the real estate and liquidate the business. Because the dealership’s profitability was low, lenders would only lend to a business buyer who did not need to take a salary. This would be a buyer who was already taking a salary with a successful business they already owned.
If there was a buyer interested in only the real estate, they would need to pay all cash for the real estate or relocate an existing business to this location with sufficient profitability to support a loan on the real estate. The ultimate buyer fit that profile. They expanded a proven auto-related business into this location.
How are the Business and the Real Estate Valued?
In most cases, the valuation or appraisal of each is separate. The common approaches to appraising real estate are:
- Sales Comparison Approach
- Cost Approach Appraisal
- Income Approach Appraisal
- Price Per Square Foot
Appraisers often show multiple approaches in an appraisal report and then consider all of the outcomes, perhaps with some weighting on a certain approach. Real estate typically has many more comparables than businesses so the sales comparable approach is often useful. This looks at recent similar closed real estate sales and applies adjustments for the variations between each comparable and the subject property.
As you can imagine, valuing businesses this way is less meaningful due to the wide variation in characteristics of businesses and the lack of concentration of similar businesses within a geographic area.
The common ways to value businesses include:
- Market Valuation (public companies)
- Discounted Cash Flow (DCF) Analysis (larger M&A deals)
- Comparable Transactions Method or Multiples Method
- Asset Approach
As far as multiples, the item being multiplied may be
- P/E Multiple (larger companies)
- Earnings Multiple (EBITDA in M&A deals or SDE in business brokerage deals)
- Revenue Multiple (typically applies to certain industries)
In some cases, the business and the real estate may have a multiple applied to both. This can make sense when the business and real estate are inextricably tied together, such as gas station / convenience store. Because of the fuel storage and delivery infrastructure of gas stations, the site is likely to continue in the same way through multiple owners. These owners may change the variety and scale of the convenience store, or may offer services such as automotive repair, smog checks, or moving truck rentals, but are likely to continue selling fuel.
The following is from a broker of gas station / convenience stores who represents targeted niche buyers nationwide.
Most buyers buy based on sales and how much that location generates in profits/EBITDA. A sale price is determined based on a multiple of 4-7X the EBITDA for that location if sold with Real Estate. If the business only, multiple of 1-3X. California and Oregon are higher multiples.
There are other factors that can increase the price such as if the property is very large or the location is really good. … sites that trade at that high multiple must be very good sites (class A from location to condition of building-new) with good financials. Mostly high volume sites sell at a higher multiple.