Q I own a machine shop and sell fabricated metal parts to a number of Valley manufacturers. I'm paying 40 cents per foot (industrial net) right now for an 8,000-square-foot building. The owner has asked me to purchase the building for $500,000. Does that make sense for me? How can I evaluate this decision?
A If $500,000 is the asking price, chances are you would have to put at least $50,000 down if you can qualify for an SBA-guaranteed loan. Closing costs will run about another $1,500 to 2,000. The balance $450,000 would be financed at the prime rate plus 2 percent over 20 years for a monthly debt service of $4,569 and that doesn't include property tax (another $6,250 per year) and insurance ($2,500 per year.)
You now pay rent of $3,200 per month with no property taxes or insurance for the property. The difference is roughly $24,000 a year more. Is it worth it? That depends on the following variables;
- Does your corporation pay taxes? Do you personally pay more than 30 percent a year in taxes? Would the depreciation and interest deduction lower this tax liability?
- Is real estate going up? Will this property meet your needs in the future? Are your tenant improvements irreplaceable? Some locations are critical to companies and freeway access is always an important consideration. Find out what would happen if you had to move. Are there vacancies around you for the same price?
- How much can you earn on $50,000 if you invest it in inventory or added sales efforts? Can your company return a high yield for invested dollars or are real estate values increasing faster where your building is located? In a flat real estate market, business investments often make more sense.
Investment advice for this sort of decision can be looked at all sorts of ways but the simplest is the pay-back. In other words, if you invest $50,000 and an extra $24,000 a year, how long will it take to recover this investment in both tax savings and property appreciation? But that doesn't take into account the value of leasehold improvements you now have, the cost of moving, or the business problems associated with being forced to relocate.
A good accountant can perform the type of lease/buy analysis which factors in several variables at the same time and gives you a highly quantified answer. The problem with that is, the best answer can't always be quantified. You may just want to own the property as an estate planning decision for your kids who, chances are, won't be running the business in the future.
A widely held belief among small businesses is that the purchase of real estate is next to a religious experience in terms of an absolute good. That's not always the case. A calculated approach that really compares cost and benefit is your best approach. It often costs more to own. Understanding how much more and whether you're buying value for your money is the key. Real estate is not the best investment of capital for everyone.
Please write to Editor, The Weekly Briefing, 5700 Wilshire Blvd., Suite 170, Los Angeles CA 90036. Bruce Dobb is the chief credit officer for the Valley Economic Development Center's revolving loan fund. His column appears alternate weeks.
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