From a small northwestern observatory…

Finance and economics generally focused on real estate

Archive for February 15th, 2020

Seven Biggest Real Estate Mistakes — Part 3

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Regular readers know that I inaugurated this series last month, linked in no small part to my forthcoming book, Real Estate Valuation and Strategy.  (Click on the icon to the lower right for more info.). By the way, the electronic version of the book is already available from both Barnes and Noble (nook book) and Amazon (kindle).  The hard copies should be available next month.

Mistake #3 — Not realizing you own real estate

OK, I’ll admit it, that sounds awful, but it’s all too commonly true.  I had a client a number of years ago — a very smart guy, by the way — who bought a manufacturing business that, from all indications, was a real steal.  (Corollary to Mistake 3:  If it sounds too good to be true…) Anyway, the manufacturing firm sale included the real estate, and (have you heard this story before) the deal was so good that the investor skimmed over the environmental audit.  I’ll cut to the punch line — the environmental remediation costs far exceeded any benefits and profits they every got from the business itself.

Just in case you think this is an isolated incident, I helped another family in an estate issue — they’d owned a manufacturing firm for decades.  They sold the BUSINESS side of this, but (sigh…. ) kept the real estate.  Of course, the real estate was dirty as could be, and for the rest of their lives (I’m not making this up) they had to deal with the dirty real estate.  I have lost track of the families I’ve worked with over the years in identically that same situation.

Of course, some investors “get it”.  One of the wealthiest families in the world are the Waltons, thanks in no small part to the Walmart chain.  However, the Walton family long ago bifurcated the business into a publicly traded corporation (owned by millions of folks, including them) and a private Real Estate Investment Trust (owned by people generally named “Walton”).  Before the stores operating in buildings owned by that trust (not all of them are) ever declare a profit, they pay the trust a rent check.

This sort of bifurcation is helpful for a lot of reasons.  First, and particularly in small family businesses, the interests in the real estate may be very different from the interests in the business.  Some family members may want to work in the family business — and should rightfully share in the business related profits.  Others may want to simply enjoy the fruits of the real estate ownership.  Recognizing how much fo the assets are tied up in business and how much are tied up in real estate helps settle these disparate claims.

Recognizing and bifurcation the real estate portion of the investment also aids in measuring the business profits versus the real estate values.  I’ve worked with many types of businesses — car dealers and retailers are common in this arena — who mistakenly think their businesses are still profitable, when in fact the real financial issues are masked by under-paying the fair rent on the real estate.  Forcing a rent payment out of the income statement, and re-evaluating that payment as if it is being paid to a third-party landlord, can give clarity to the business value in changing economies.

Finally, the real estate may no longer have the same highest-and-best use it had when the business was founded.  I dealt with one business (again, a car dealer) who had owned a site for many years that was now highly desired for high-density housing.  Other car dealers had moved out to the suburbs to an “auto mall” where people when shopping for cars.  The profit-maximizing strategy for the dealer was to sell the land and move the dealership, but it took years for this family owned business to realize that the business and the location no longer had a sound nexus.

By the way, I regularly get calls, e-mails, and texts from folks who just need to ask a simple question about this stuff.  I probably answer a half dozen or so random questions a day.  E-mail is the best way to reach me.  Let me know if I can help.

Written by johnkilpatrick

February 15, 2020 at 2:57 pm

Posted in Uncategorized

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