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The Power of Commercial Real Estate for Small Business Growth
Steve Nabity
The Power of Commercial Real Estate for Small Business Growth
Stability in an Uncertain Market
Running a small business is tough. There are plenty of uncertainties and moving parts that constantly impact the business and its finances. Collecting receivables from large customers, paying suppliers, managing regulatory changes, and handling the working capital cycle can be tricky. If any of these get stretched and elongate the cash conversion cycle, it can push the business owner into a tight spot.
Then, there are also black swan events like a pandemic or a major financial crisis that can hugely impact demand. Customer acquisition is always an ongoing endeavor that constantly requires time and resources. Knowing when to make capital investments by understanding the overall business cycle is also a skill business owners hone over years of experience.
Amidst all these uncertainties and challenges, some predictability and stability on the financial side of things can be a great leveler. It can give business owners some comfort and allow them to focus on things that matter the most to a business: long-term strategic planning, expansion, and growth. It allows the business owner to free up some mind space from the day-to-day pressures and dedicate that freed-up space to instead think about the longer-term direction of the business.
An investment in commercial real estate can provide consistent and predictable cash flows. If good quality tenants with long-term leases are in place, then a steady income stream can be expected. Such cash flows can help maintain operational stability, especially during market uncertainty.
Passive Income Opportunities
There is a completely different way that business owners can think about real estate investments. By investing in a commercial property which can then be leased out to a business, an investor can create a business with an income stream without actually getting into the day-to-day operational demands of running it. Business owners can appoint a professional property manager to handle the day-to-day operations. Skyline Point Capital works with entrepreneurs and business owners where it acts as the sponsor and manages the property while investors participate passively and earn regular cash flow.
A passive income stream can either be personal income from a real estate investment business or a source to fund the growth of another business an investor may own. It can also be used to pursue completely new ideas. Whatever the end use of the income, it certainly helps ease any financial pressures. It allows a business owner to move away from constant cashflow management and focus more effectively on his/her business, or to fund a new venture. If time is money, then a passive investment in commercial real estate creates more time for a business owner.
Scalability Potential
Scalability is an important aspect of any growing business. Successful entrepreneurs tend to pursue scalable business ideas. The cost of scaling up a business is also of great importance. Expanding an office, hiring more employees, setting up plants and machinery, etc. all cost money. The day-to-day running of a business also requires working capital. So, to fund growth, there needs to be cash flow. This capital can come from the existing business that earns a rate of return superior to the cost of capital. Alternatively, growth capital has to come from outside the business.
Seeking capital from outside involves either giving up equity or taking on debt. But, if a business owner has an additional income stream from a real estate investment, then there may be a possibility of funding business growth from such cashflows.
If the business owner views the real estate investment as a business and wants to scale up the investment business, then cashflows from his/her traditional business can be used to purchase properties in newer geographies or in newer subsegments to diversify. For example, if an investor has a multifamily investment in Nebraska, he/she can diversify by buying properties in Iowa, Texas, or elsewhere. Alternatively, the business owner can invest in a retail or industrial property. Such diversification acts as a hedge and mitigates the risk of owning a property in a particular city or a particular segment (e.g. residential).
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Tax Benefits for Investors
We have discussed the stability and predictability of income generated from real estate. But, commercial real estate also offers some important tax benefits for investors. Skyline Point Capital has worked with its investors to take advantage of them. Depreciation is an accounting expense that can help lower the taxable income. A commercial property (the structure and not the land) can be depreciated over 39 years. So, the value of the building divided by 39 is the amount of depreciation that can be claimed when filing the tax return. If applicable, a real estate investment may also be eligible for accelerated depreciation. In such a case, a higher depreciation can be taken in the first year of investment to offset taxable income.
Another tax benefit offered in real estate is the 1031 exchange. This benefit is great for investors looking to scale up their real estate investments and acquire a larger or a different property. The 1031 exchange exempts capital gains tax as long as the proceeds from selling a property are reinvested in a like-kind property. The capital gains tax gets rolled over to the newly purchased property and there is no need to pay the capital gain tax on the sale of the existing property. The taxes saved (albeit temporarily) can be used to renovate and upgrade the newly purchased property or for any other purpose.
Most real estate investments are leveraged. They are acquired using debt. The interest expense arising out of such debt offsets taxable income. So, that is another tax benefit that a leveraged real estate investment offers.
Small Business Growth Strategies through Real Estate
We have mostly talked about real estate investments as a source of cash flows that can be used to stabilize an existing business. However, real estate investments can also be viewed from a small business growth strategies perspective. Holding a property for the long term has the potential for capital gains. It can also provide a business with a consumer-facing presence. For example, think of a consumer brand with a physical location in a popular retail cluster. An industrial property like a warehouse in a strategic location can help make operations more efficient and scale up business in a particular geography. A business can own real estate, use a portion of it, and lease out the rest to another business to generate passive income. There are many strategic ways in which real estate investments can be leveraged by businesses.
A business where the layout of the physical store is important will prefer to own real estate than rent it. Owning would give the business more control and flexibility over how it designs and uses the property. This, in turn, will allow it to offer a superior customer experience. Owning an office building, for example, can help optimize the space and the work environment to ensure high employee productivity.
Owning real estate instead of renting may free up cash flows and make financial sense. Although the capital outlay to purchase real estate is a lot higher than rent, over the long term, it can be cheaper. Rents are constantly on the rise and can eat up into the cashflows. Instead, if there is no rent expense, the saved cash can be used to hire more employees, spend more on marketing, or invest in new product development. The value of the asset also appreciates over time and inflation works in favor of an asset owner vs a renter.
Skyline Point Capital works with entrepreneurs and business owners to help them realize their financial goals through real estate investments. We have extensive experience investing in multiple real estate subsegments across geographies. Our team of experts brings promising investment opportunities to our clients while our network of professionals across different states helps us manage our portfolio.
We encourage you to know more about Skyline Point Capital by checking out a range of complementary resources that we have compiled to educate potential investors, business owners, and entrepreneurs. We also have something called the Founders Investor Club, which we encourage you to join to be in the loop on live deals we are looking at. If you want to get in touch with us and speak to us about anything real estate, then feel free to set up a call here.
We hope that you found this article useful. We discussed why it makes sense for a business owner to consider investing in real estate. We looked at the several benefits that the real estate asset class offers and how it can be a strategic investment for a business. We wish you good luck growing your business and achieving your financial goals.
