61
addition, any cash taken from the corpo- ration would be double-taxed (if taken as dividends) and subject to payroll taxes (if taken as management fees) — neither scenario is tax-efficient. The only advantage of corporate
ownership is the limitation of liability; however, this can also be achieved by holding the property in an LLC or a lim- ited partnership.
Lease agreements Regardless of the form of owner-
ship, M & G’s attorney and accountant strongly urged them to have a written lease between the entity and M & G Consulting. A lease protects both the firm and the landlord by spelling out the rights and duties of each, and it would provide uninterrupted tenancy for M & G Consulting in the event the landlord sells the building.
The decision M & G decided to hold the building
as a tenancy in common. Each partner (and his wife) owns a half interest in the building. Because California (and eight other states4
) is a community property
state, each cotenant holds a community property interest in the building.5
Loan or cash? This question is probably one that
every entrepreneur looks at with disbe- lief — after all, paying cash is not some- thing an entrepreneur does willingly. Perhaps the question is better rephrased: How much cash will M & G have to pay for the building, and how much of a loan can they get? One of the most attractive attributes
of commercial real estate is the ability to leverage (or encumber) the property. His- torically, commercial banks have loaned (debt capital) up to 80% of the appraised value of the real property, depending on the quality of the tenant and in-place
Trends magazine, November/December 2010
rental rates compared with current mar- ket rental rates.6
So, if a commercial prop-
erty is valued at $1 million, the acquirer would need a $200,000 down payment, with the remainder of the purchase price provided by a bank loan. The amount of leverage a commer-
cial property can sustain is much greater than on a typical business balance sheet, because real estate is tangible and sta- tionary and can be utilized in multiple contexts. High leverage is generally desired by commercial real estate own- ers, because the greater the amount of leverage a real estate asset can sustain, the greater the return the entrepreneur will earn on his or her invested equity.7
Getting the loan M & G found that acquiring a loan on an
owner-occupied commercial real property was fairly straightforward because they met the five main criteria that banks require: 1. Loan-to-value ratio that does not exceed 80%
2. Debt-service coverage ratio (DCR) of at least 1.20×
3. History of the business’s profitable operating performance
4. Stable and recurring cash flows of the business
5. Guaranty or recourse clause from the borrower A bank loan will be secured by a first
deed of trust on the real property; thus, a bank must be certain that the value of the property is sufficient to repay the loan. In the event that the investor defaults, the bank assumes control of the property and sells it to repay the loan. Another important step in acquiring
property is obtaining an appraised value sufficient to satisfy the bank’s requirement that the property be appropriately priced. Appraisers base the value of a commercial property on its rental value (i.e., the cash flows that the building provides to cover its operating costs, including debt service).
Continued on page 85
The addition of real estate to a typical “stock-and-bond” portfolio often provides a reduction in portfolio risk without the sacrifice of return.
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56 |
Page 57 |
Page 58 |
Page 59 |
Page 60 |
Page 61 |
Page 62 |
Page 63 |
Page 64 |
Page 65 |
Page 66 |
Page 67 |
Page 68 |
Page 69 |
Page 70 |
Page 71 |
Page 72 |
Page 73 |
Page 74 |
Page 75 |
Page 76 |
Page 77 |
Page 78 |
Page 79 |
Page 80 |
Page 81 |
Page 82 |
Page 83 |
Page 84 |
Page 85 |
Page 86 |
Page 87 |
Page 88 |
Page 89 |
Page 90 |
Page 91 |
Page 92 |
Page 93 |
Page 94 |
Page 95 |
Page 96 |
Page 97 |
Page 98 |
Page 99 |
Page 100 |
Page 101 |
Page 102 |
Page 103