While this may sound counterintuitive to a small business owner, you should NOT invest every dollar back into your business.
Important disclaimer: I am not a certified broker-dealer and any shared wisdom in this article should be consulted with a certified investment professional or tax preparer prior to making an investment decision.
Your investment in your business is the “same” as investing in stock of a publicly traded company. When investing in the stock market, there is one golden rule: DIVERSIFICATION.
Diversification happens when an investor spreads their investments across high to low-risk assets. The larger the risk, the higher the potential return. The lower the risk, the lower the potential return. The trick is to find a good balance between low- to high-risk investments that meet your risk appetite.
Like buying shares in the stock market, small business owners reinvest their profits into their own business. By reinvesting into their business, small business owners are more likely to succeed as long as these investments turn a positive profit by making the business bigger, more profitable, and more defensible against competitors.
So why wouldn’t a small business owner invest every dollar back into their business?!! Let’s go back to the golden rule: DIVERSIFICATION.
Starting and running a small business may be the riskiest investment you’ve ever made. In fact, 70% of all small businesses fail within their first 10 years in operations. Sounds risky, right?
The good news: small business owners can use their business as a platform to diversify their investments across multiple opportunities. One of many areas where a small business owner can diversify their investments is in real estate. In fact, a small business owner is uniquely positioned to have an advantage in investing in real estate compared to an individual investor. Below we outline 3 reasons why small business owners should consider investing in commercial real estate.
3 Reasons to Invest in Commercial Real State
Reason #1: Access Government Subsidized Debt
The Small Business Administration (SBA) offers two programs (504 and 7a) to invest in commercial real estate. This offers small business owners an advantage since the government guarantees a portion of the loan. Thanks to this government guarantee, a combination of the following will benefit the small business owner:
- Lower down payment: 10% of equity required for down payment (compared to 20-35% for a conventional loan)
- More money: Banks are usually willing to extend more capital as a result of government guarantee
- Limited to no personal collateral: For 504 Loans, the property and equipment purchased with the loan are typically used as the collateral with limited to no pledges on personal properties required.
It’s worth noting these SBA loans cannot be used for speculative, short-term investments in real estate or debt consolidation. In particular, SBA 504 loans are meant to be used to purchase real estate (or equipment) that will directly benefit the borrower over the long-term.
Reason #2: Tax Savings
In today’s expensive real estate market, it is VERY likely that you would need to pay out more upfront on a monthly basis as a real estate owner vs. a lessor. However, when taking into account the tax savings of owning a commercial property, the cash payout of owning vs leasing may be cash neutral on an annualized basis.
Check with your accountant to make sure you can deduct the following prior to purchasing a commercial property:
- Interest expense
- Depreciation expense
- Non-mortgage related expenses
Even if the tax savings do not completely offset the cash outflow of owning a property, don’t forget you are effectively diversifying your investments and building equity in a low-risk asset. Always remember the golden rule!
Reason #3: Sub-lease up to 49% of the Commercial Space
The typical commercial real estate loan requires the business owner to occupy at least 51% of the property. This assures you are using the property to increase the productivity of your business and not making speculative bets on real estate.
Now, what you do with the other 49% of the property is up to you 🙂
As the owner of a commercial property, you have the flexibility to sub-lease up to 49% of the property to other tenants. Sub-leasing real estate may result in significantly curving the cash outflow of the property and tenants building equity for YOU.
Sub-leasing commercial property is an increasingly popular practice with high demand among business professionals, entrepreneurs, and even food-service companies seeking to rent-out commercial kitchen space.
If you are considering making some exciting investment using your business profit, we hope that this three solid reasons put you in the right direction and encourage you to do it in commercial real estate. Tell us what you think in the comment section!