Business Owner and Real Estate: A Winning Combination

Real estate is an outstanding investment. Let's count the ways:

1. Durable Value: Unlike businesses, where value may swing wildly with the ebb and flow of profits, real estate has value aside from the cash flow it generates. Businesses almost always are valued on their profits. Real estate almost always is valued on the comparable sales method. That is, what do other properties of this type go for per square foot?

Another example of durable value is that, with a business, if something bad happens, the value may go down to zero. Take a restaurant: Serve some really bad food for just a day or two, and the business may be ruined. In contrast, improvements to real property can burn down and the land still has substantial value. It doesn't go to zero.

2. High Loan-to-Value Ratio: There are two types of value in any asset - tangible and intangible. Tangible value is far less volatile and risky. Banks will lend up to 80% on tangible value. Why? Because it's safe. Not so for intangible value, which is the difference between total value of your business and tangible value of underlying assets. Real estate is 100% tangible value. Banks will lend more against real estate than almost any other asset.

3. Liquidity: Now don't get me wrong. Real estate is an illiquid asset. But compared to a business, it almost could be considered liquid. Many more people are comfortable buying and owning real estate. And real estate sells more quickly than a business.

4. Low Relative Transaction Cost: Buying and selling real estate is relatively inexpensive. Owning it can be expensive, but marketing property for sale is quite easy and inexpensive.

5. Consistent Appreciation: Over the long term, real estate has proven to be one of the most reliable types of investments. As long as you don't overpay and are careful to buy in desirable areas, it is almost impossible to lose money in the long run on real estate.

6. Low Employee Count: Owning real estate does require some work, but compared to a business, it's a piece of cake. And one of the most difficult, expensive and time-consuming elements of business ownership is labor. You may not have to hire a single person to manage your real estate investment. Now that is beautiful.

7. Tax Advantage: Hold real estate for more than a year and, when you sell, you'll enjoy long-term capital gains tax rates. This is the same as most other investments, but couple this with the fact that, if the real estate you purchase has improvements (i.e., is not raw land), you will be able to depreciate over time the value of the improvements. This will shelter income from tax as you own the property. When you purchase stocks or bonds, this is not possible.

8. Source of Capital: Over time, as you own real estate, you will no doubt pay down the debt you used to purchase it with. Couple this with likely appreciation in value and you build equity. This equity can become a valuable source of capital when times get tough or you need cash to take advantage of an investment opportunity. As we said above, banks stand ready and willing to lend on real estate. It's something they do every day and are very comfortable with.

Most business owners suffer from a lack of diversification. So most of their wealth is tied up in their business. Real estate is highly recommended as a first step toward diversification. Probably retirement account contributions should come first, but real estate is a very close second. First your home, then the space your business occupies.