Should I buy the building for my business even if it breaks even as a rental?

Question

Hi,I have the opportunity to purchase the building where I run my music studio. Off the market, the owner is in a 1031 exchange. He's open to selling it to me. He's currently looking for another property to roll over into. It's an old brick triplex (1909) in the middle of Kennett Square PA. It's a great corner location just a block from downtown. Each floor could use some remodeling but is in okay condition. Some delayed maintenance I imagine based on things we've noticed in the year we've been there.The first floor is commercial and the 2nd and 3rd floors are apartments. I use the first floor to teach music lessons with my wife and a college student we hired. We want to hire more people to work for us but the layout is odd and someone would have to walk through another person's lesson to get to their room. I could fix the layout with a bathroom renovation while creating a hallway to separate the entrances to different rooms. This would create a 3rd studio for us to have someone teach out of. At his asking price the building would only be positive $74 per month but by renovating the first floor slightly to open a 3rd room We could make $144 a day with another teacher working 4 hours. If we had the room at max capacity (4 hours a day, 6 days a week) that would be $44,928 a year for our business. (Profit before taxes)There's also the potential of renovating the basement and adding another 2 studios which could make a max of $134,784 per year for the business. (Profit before taxes)On top of the business growth, the 2nd and 3rd floors could have some renovations done eventually to increase rents. We could really use the space to grow because we are essentially maxed out with little to no room for more students based on our current schedules. There are also the tax write-offs I could take by purchasing it through an LLC and renting it to myself.It seems like a good idea to me even at the current break-even cash flow because of the room for growth.What are your thoughts, should I buy it?Thanks,Alex Pollock

Alexander F Pollock · Answer

He purchased through a 1031 exchange so he likes the idea of selling to me because I can wait until he's ready to purchase the next property that he'll roll the 1031 into. Doesn't have to put it on the market and can wait until he's ready.

Aristone Louxz · Answer

It seems like a no brainer to me! The value add is in the potential extra income from the commercial unit. Plus I assume you’d save on paying rent for the comercial space yourself? There’s also a possibility of remodeling the residential units and adding value there. Additionally it’s a great location. Sounds like Perfect timing, I say go for it !

Alexander F Pollock · Answer

That's a good point as well. We'd have better control. We have 2 more years on the lease so we'd have time to find another building. They may even let us break the lease whenever we find a different property if they have plans for the building.

Dave Skow · Answer

@Alexander F Pollock- thanks and this sounds like a great opportunity ....assuming you need to use a loan - make sure you find a lender that can 1) get you pre approved for what you need and 2) that is familair with the property and is OK with the commercial / resendential mix aspect ( as not all lenders are comfortable with this ) - thanks and good luck

Craig Janet · Answer

Keep in mind. If he sells it to someone else the new owners may have other plans for the building and not renew your lease.

Dave Foster · Answer

@Alexander F Pollock, there you go! That is a fantastic opportunity for you to structure the most advantageous for you. Get a deal struck with him that includes a period of time for both you to line up you financing. And for him to find his next property. In the mean time part of the structure is a lease of the entire property to you. so you can upgrade, get your business growing and run the entire property without having to take title. You'll probably have a lease that stands alone. And a contract for sale with those contingencies.

Alexander F Pollock · Answer

I'd been contemplating getting out but it's been fun growing the business so I'd like to continue growing it. The easiest way to do that is with more space and more teachers. Eventually if I stop teaching myself and just have others working, I could potentially sell it, or I could continue just running it with just a little teaching here and there.

Mason Weiss · Answer

I think you should take the leap and buy it. If you have concerns about your reserves, consider finding a partner who can help with the financial impact. This way you can acquire the property while also having others to shoulder the financial burden on day 1.

Dave Foster · Answer

@Alexander F Pollock, Owning the building that your business leases is a fantastic opportunity to unleash a bunch of tax advantaged scenarios. And of course the added volume for you and flexibility of being your own landlord if your business ever sustains a turndown. I'm curious about the sellers statement that they are in a 1031 exchange. Unless they are doing a reverse exchange of some sort their exchange does not start until they sell the property to you. So there may actually be some other advantages you could get from their situation.

JD Martin · Answer

I don't really see too many downsides here, unless you think you might be getting out of the business soon and can't sell the business itself. Otherwise, it's a great way to set yourself up for the day in which you want to sell the business to someone else - you keep the building and lease it back to them, and sell them the business itself. I know a lot of local business owners where I am that made a nice killing for themselves off their business by keeping the RE and just selling the business itself.