A basic perceptive of the interrelationship amongst real estate, business, and finance is vital to any endeavor. Understanding each of these structure and their associations to one another is indispensable to maximizing profits, implementing successful growth strategies, and maintaining strength throughout fluctuations in business cycles.
The significance of gaining a firm grasp on the interrelations between real estate and business should be self-evident. A main reason why most businesses fail is that they are unable to afford their high fixed cost. In other words, they cannot pay the high rent or real estate acquisition costs and therefore cannot repay their debt. Thus, by making better decisions regarding real estate, companies are far more likely to succeed.
A business will also be in trouble without the combination of sharp business acumen with sufficient financial know-how. One can have a good business concept but nevertheless a high probability of failure without an in depth understanding of the workings of real estate and finance. Lots of people are juming into distressed assest purchase without understanding the financial part of it. For example, assume that one seeks out financing to purchase a retail property of $2 million and plans to hold the property for five years before selling it at a profit. He or she will apply for financing at 7 different institutions and receive rates ranging from 7% with 0 points to 9% with 1.5 points. At 7%, 25-year amortization, he or she would pay $14,135.58 monthly, and $169.626.96 annually. At 9% with 1.5 points origination, 25-year amortization, he or she would pay $30,000 up front, $16,783.93 monthly, and $201,407.16 yearly. If he or she chooses the first term sheet, he or she would surrender $188,901 over the term of the investment, simply due to lack of knowledge of the business of financing.
The links between real estate and financing are equally essential. Assume, for example, that one is using property to build a resort. He or she pays $100/sq ft for the real estate, which is 50% below the market price because he or she took time to learn the market. In addition, he or she chose to purchase the real estate in a separate LLC and lease it to his entity that will operate the business. By owning the property, he or she can receive 100% financing for the cost to build the resort with interest reserve, amortize the construction cost in the lease to his or her business entity. As such, he or she owns the real estate and business for the same equity he or she would have invested in the business only.
With control of the business and real estate lease, the owner has greater flexibility in the rate he or she charges the business for the lease, determining the real estate value. For a small cap company such as this, it may make more sense to have a higher lease on the real estate, as real estate trades on multiples over 7 and the business itself may only trade at 3-5 times its present value. In addition, the owner can also make the terms of the lease attractive to renters, making the business easier sell to the next investor or increasing the probability of obtaining better refinancing value.
It is critical to understand the returns to businesses from real estate, business, and finance. Knowing the values of these variables and how they interact with one another will enable managers to make knowledgeable decisions that will best promote the success of their businesses. Financing is an art and a game. It can make a lot of money if played it correct.
Robin Trehan is a financial expert. More information www.keyfunds.com
