Is the real estate worth it?

Real estate plays an important role in any business. As a significant long term asset, real estate represents a major financial investment. Whether it is owned or leased, real estate is one of the largest fixed expenses for many businesses. But is investing in real estate worth it?

Unfortunately many owners do not give enough thought to the role that real estate plays in their business strategy. Whether your plan is to stand pat, buy, or sell, the financial management of real estate plays a significant part in that strategy.

Many owners I speak with are surprised when they learn that a potential acquirer has no interest in buying real estate. To an owner who has acquired a multi-million dollar asset by allowing a business to pay off the note on the property over time, the idea that a multi-million dollar institution would not be interested in acquiring land may seem outright strange.

But it is increasingly rare to find businesses that acquire both real estate and operating businesses. In an industry that is rapidly consolidating capital is often scarce. Growth, especially growth through acquisitions, requires significant capital. In an industry where rapid growth is key to success, most consolidators are not interested in investing in property. Real estate ties up large amounts of capital, is illiquid, and generates much lower returns relative to an operating business.

In rapidly growing industries, many large consolidators are backed by large sophisticated private equity investors. While these PEGs have access to what at times seems like infinite capital, the reality is they also face constraints on the allocation of capital. Funds have very specific investment and growth strategies, and are often contractually obligated to invest in specific types of assets, and conversely, prohibited from other assets.

These investment strategies are often carefully designed to diversify specific risk to build an optimized portfolio of financial assets. An investment fund that invests in operating businesses, for example, is separate and unique from the fund that invests in commercial real estate. The nuances and risk factors involved in an operating business are unique to that business, and share little if any similarity with the risk factors associated in investing in real estate.

Yet real estate remains a key part of any business. For many small business owners, it has been a great source of wealth creation over many decades. For business owners that are not constrained by managing an efficient portfolio of investments, real estate still provides some attractive investment features. But understanding the role real estate plays to other investors is critical to maximizing the value of that asset over time.

But as the industry evolves capital requirements will continue to increase as vehicles become more complex. Margins will continue to be compressed. The pressure to expand to multiple locations to remain viable will increase. Simultaneously funding growth while investing excess capital in real estate will become ever more challenging. Small business will also face capital allocation decisions – choosing whether to invest in expansion or to invest in real estate.

I can help you navigate these, and other tough business questions. The industry is changing at an unprecedented pace. While there is no one size fits all answer to how to best manage real estate, I want to help you think through your options. Subscribers, hit REPLY to get in contact, or you can always reach out to me via my contact page.

Until next time!