When Is Your Company Ready to Buy a Building?

CDC Small Business Finance, a lender to owner-occupants, lists signs that a business may be ready: a clear reason for ownership, stable operations and repayment ability, enough cash for upfront costs and reserves, confidence in location and space needs, a realistic timeline, and internal capacity to manage brokers, lenders, attorneys, inspectors and contractors.

For most companies those sort into four tests: horizon, stability, cash and agreement among the owners. Each can stop a good deal on its own, and a strength in one rarely makes up for a gap in another. A cash-rich company with a five-way partnership dispute is not ready. Neither is a highly profitable company that may be sold next year.

Buying and selling a building both cost money and take time, so ownership generally needs a long enough stay to earn those costs back. Truist suggests that confidence in staying about seven years is a reasonable point to consider buying. That is one bank’s rule of thumb and not a rule. What matters is how confident you are in your own number.

Test it by imagining specific events. If the largest customer left, would you need this much space? If the company doubled, could this building hold it? Would you be happy with this location for recruiting in ten years? Could the company be sold, and would a buyer want the building? A plan that only works if nothing changes is not much of a plan.

A lender on an owner-occupied building looks mainly to the company. The Comptroller’s Handbook, written for examiners of national banks, says the primary source of repayment is usually the cash flow generated by the occupying business, and that owner-occupants with uneven earnings may warrant a higher coverage ratio. It also expects cash flow to be assessed on a global basis, which may draw in business financial statements, tax returns and Schedule K-1 forms. Expect similar questions from many lenders, though each sets its own standards.

So readiness means more than having had a good year. Can you show several years of statements that tell a consistent story? Would earnings still cover the loan if your weakest recent year happened again? Are you depending on one customer or contract? Have the books been prepared in a way a lender can use?

A thin record does not automatically end a deal, but it does make the story harder to tell. One buyer described the role that story played in reaching a contract:

SBA programs may be an option for some operating small businesses. The SBA’s 504 page lists eligibility standards that include size, qualified management expertise, a feasible business plan, good character and the ability to repay. Confirm the current requirements with a Certified Development Company or lender. TAG is a broker and does not provide loans.

The down payment is the visible cost, not the whole one. Truist’s comparison says down payments are often 20 percent of the purchase price, though the figure depends on the lender, the program and the borrower, and it can change. CDC Small Business Finance adds closing costs, appraisals, environmental review, inspections, legal fees, title costs, permits, design costs, renovation and working capital during the transition.

The bigger test is the balance after closing. CDC Small Business Finance names using all available cash and leaving too little working capital as a common mistake. Build your own figure with these items:

• Your required down payment or borrower contribution.
• Closing, legal, title, survey and third-party report costs.
• Renovation, moving and technology costs that are not financed.
• Any overlap or exit cost on your current lease.
• Operating reserves for the company, at the level your CFO or CPA is comfortable with.
• A separate reserve for building repairs that you could otherwise not absorb.

This test can take the most work for a company with several owners, because a building can outlast a partnership. Before making an offer, the owners should agree on who will own the building. It might be the operating company, or a separate company owned by some or all of the partners. The OCC handbook notes it is common for the owner of the business to own the building through a separate entity and lease it to the business.

A separate structure means the rent must be set with care. The IRS says rent paid to a related person is reasonable if it is what you would pay a stranger for the same property, and the OCC cautions lenders about rents not set at arm’s length. Settle these points with your attorney and CPA while everyone is on good terms:

• Who contributes the equity, and who signs any personal guarantee? Truist notes that financing may require one.
• How are capital calls handled when the roof fails?
• What happens to a partner’s share on retirement, death, divorce or departure?
• If the operating company is sold, does the building go with it, or does the buyer become a tenant?

Answer each question honestly with the people who would sign. A few "no" answers can be fixed, and a list of them is your plan for the next 12 months, not a failure.

• ✓Are we confident of staying at this location and about this size for as long as the comparison requires?
• ✓Have we compared buying with leasing over several years, with costs beyond rent and mortgage?
• ✓Could we cover debt service and building costs if earnings fell to our weakest recent year?
• ✓Do we have clean financial statements and tax returns ready for a lender?
• ✓After every upfront cost, will the company still hold comfortable reserves?
• ✓Could we pay for a major repair with no warning?
• ✓Have all owners agreed on title, equity, guarantees and a partner’s exit?
• ✓Is a lender or CDC willing to discuss our situation now?
• ✓Is there someone with time to run a building project and then the building?
• ✓Does our current lease allow a realistic exit in the time needed?

Tenant Advisory Group can help you turn this list into a timeline, starting from the end date of your current lease to work out when a search has to begin, whether or not the answer is to buy now.