Real estate investing vs Franchise investing

[Chris Lynch]

With a fairly low income (43k) I have been searching for investments that will increase my income so I can then snowball the larger amount of income into more investment's ultimately creating long term wealth. 

After some research in Real estate I noticed my area is not a huge application area. With that said I know I there are tons of deals that will cash flow nice. I like Real estate because it is a tangible asset that keeps paying and provides you with tax benefits. 

I have also been browsing on Bizbuysell.com and I have seen some local franchises for sale that seem to provide great cashflow/Net profit. For example there is a semi absentee subway that makes 55k per year * Cashflow not gross* for 140k with financing.  Also a couple dry cleaning business's with great margin. 

My question is will it make more sense to use my investment capital to purchase something that cash flows like a business and then roll that into investment property's? Or am I missing something here all together?

[Joel Owens]

Hi Chris,

I have been looking at the same things for the last few years.

The problem with the small businesses is most are owner operators. I don't want to buy a JOB for an investment.

What you can resale the business for down the road is tied to the net profit after expenses.

So if the business does 100,000 net profit the owners try to get a 3 times multiple of 300k. What I shoot for is 2 times multiple with half down and let the seller carry 50% with favorable terms to me. So in this instance 100,000 down and carry the 100k additional. Actually would try to go for 60,000 down first. Usually the sellers will take just enough to pay the brokers commission and take the leftover for what they could have made in a year working etc.

Would throw in a kicker for the remaining 100,000 note where I could buyout the note early for a preset discount. Example 100k for seven years on the note but if seller decides they want money in year 3 I give them a discounted note payoff of 50,000 to retire it early with first right of refusal. If I don't exercise then they sell the note to someone else.  Many sellers will hold for 7 years but after a few years in decide they just want all cash today even if less than what's owed.

The real estate will have tax depreciation and more forced equity potential. With businesses you have to worry about franchise re-imaging costs and also equipment reaching end of life and having to replace. Make sure concept is big enough to have FFC's ( fixed food contracts ) where food cost stays the same for product regardless of market fluctuations. That is what kills the little guys from cash flowing. One minute they are making bank and the next they are breaking even as they can't fully pass on the food distribution companies hike in pricing to their customers.

I was in the food business for decades before getting into real estate. I have to buy a business where I am not an owner operator and I have management in place and it still throws off a few hundred k a year. Most businesses say 50k net earnings but you find out it's owner operator and you take that out and pay a manager and you are at zero profit. You can't scale those small businesses for owner operators either which Is why I like larger businesses and numbers.  

I don't pay for opening a new franchise either. Way too expensive and it's like a car in that you spend a ton for the new item and once it gets used the first time the value drops like a rock. Some of my friends watch new franchisees put their retirement IRA money in for a 250k build out after they have retired. After 6 months in the retirees are pulling their hair out not knowing the realities and demands of the food business. They just want out even if sales are decent. A "white night" jumps in and the sell for 90,000. You get a brand new 250k product for 90k..... : ) You only want super motivated sellers when buying businesses to increase your yield. Businesses have to meet much higher metrics for yield payout because of the work involved versus real estate. I looked at opening a Steak-N-Shake. Lot's of requirements and only the top 20% of stores seemed to make 35% gross profit margins. The rest were at about 15% and the others had break even numbers. I can get 15% NNN retail strip centers and have no employees or headaches to deal with. 35% is worth my time for a business but 15% is not.

I generally like existing building for businesses versus new because you have a history of sales and what the area thinks about the concept. With a new location it's pot luck and it can go boom in sales or bust.