04/01/08: Own or Rent For Your Business
By Benny L. Kass
Q: I own a small business in Virginia. I have been in this business industry for 18 years . I currently rent a building with a month to month Lease . Although my Landlord is not the best, he is not the worst. Business is good , and I can’t complain. With all the foreclosures in the area, I am pondering the idea of buying a small house in my area and converting it for business use . I have excellent credit, so I know I can do this. However, I an not sure where to start. How does one find homes that are in foreclosure? Is a Realtor needed for this? I am also not sure where to find laws/regulations on opening a small business in a residential area ? There are already a few small business’ running out of previous residential homes in the area that interests me. I am aware of the responsibilities that will be upon me for owning rather than having a Landlord to call for problems. So, in your opinion, is it wiser to own than rent for Tax benefits ?
A: I can write a book and still not answer all of your questions.
The first thing you must do is retain an attorney who understands zoning issues. You want to find a house – in a residential neighborhood – to be used for your business. The zoning laws in your area will impose restrictions on the kinds of businesses that may be permitted, and obviously you don’t want to buy a house only to find out that you cannot use it for your business.
You are looking at homes in foreclosure. Talk with some of the local banks. They would have a listing of these properties and would be happy to unload them. Real estate companies in your area may also have listings of properties that are scheduled for foreclosure. Additionally, search “foreclosure properties in Virginia” on the internet, and you will find many more listings. In fact, some real estate companies are sponsoring bus tours of these properties, for the convenience of potential buyers.
But I would be very cautious about buying foreclosed properties. Many homeowners who are faced with losing their home have been stripping it bare – taking plumbing and electrical fixtures, and anything else that may have salvage value.
If you find the property that is attractive, there are a number of steps that you must take. The real estate contract that you enter into must contain a number of contingencies.
First, you must carefully inspect the house, using a professional inspector. Many homeowners in trouble will bury their heads in the sand and will be unwilling to allow such inspections. They believe (perhaps naively) that some miracle will occur and they will be able to keep their home. If you cannot have access to the house, walk away immediately.
Second, you have to be satisfied that the applicable zoning laws will permit you to run your business. Don’t rely on what the agents tell you; you (or your attorney) must review the local zoning regulations, and talk with the appropriate zoning officials. You must determine not only what the current zoning is but whether there are any plans to change the rules in the future. Many governments have Planning Offices, and you must contact them also.
Third, there must be an appraisal contingency. Real estate prices are down, and mortgage lenders are becoming very conservative. You don’t want to find out that the house has appraised for less than your contract price.
Finally, there has to be a contingency for financing. You must disclose to your potential mortgage lender that you will be using the property for business purposes. That means that you will not get the residential interest rate. That also means that some lenders will just not want to get involved in a commercial loan.
If you have a good banking relationship, it would be a good idea to discuss your situation with your banker before you sign any real estate contract. You want to make sure that you will be able to get the loan you need.
You also asked about the tax benefits of buying instead of renting. You should discuss this with your own accountant. Clearly, it is beneficial to own. But the rent that your business would pay to a landlord is also deductible and your financial advisors should be able to run some spread sheets showing the difference between owning and renting. Each case is different and a general statement about taxation cannot answer your specific questions.
Finally, you want to determine how title to the property should be held. Some people will create a limited liability company (LLC), and put the property in the name of that LLC. A limited liability company can provide protection for your other assets, should you (or your business) be sued. In general, only the assets of the LLC are at risk in the event there is a court judgment against the LLC which exceeds the amount of any insurance coverage. However, in order to obtain this protection, you have to play by the rules. You cannot commingle your assets with those of the LLC; you have to sign all documents in your capacity as “member” of the LLC and not in your individual name. And if you put another asset into the LLC, that asset will become at risk.
Despite the fact that limited liability companies have been around for over 20 years, some banks are reluctant to make loans to those companies. So you have to confirm this with your banker.
This is a good time to consider buying residential real estate, and your “pondering” makes good sense. But you have raised a number of questions – all of which must be answered to your satisfaction before you take the plunge.