That eureka moment when business owners realize value of their real estate

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Gavin Reiff sees it all the time: the moment when family business owners recognize that their real estate might be worth something.

“A lot of people are not attuned to it – they own land and it’s at the back of their mind,” says Reiff, vice-president, real estate advisory, at Richter in Toronto. Suddenly, they realize they could be sitting on a lot of money in the form of their incidental or ancillary real estate.

“Until that point, it’s an underutilized asset,” he says.

Their realization can open the door to frank discussions about a family business’s viability and future goals.

That’s because many have not thought about how to optimize or leverage the value of the real estate, says Colin Deeks, senior consultant with Prime Quadrant, a multi-family office in Toronto. “For many families that’s not their core expertise, and this can be a challenge to navigate the most efficient way to manage the real estate.”

And yet, with real estate values soaring over the past two decades, how real estate assets are handled and managed can have a big impact. In some cases, they can be developed, augmenting a family business’s profits.

Or their value can exceed the profits of the business, leading to difficult questions about where a family’s focus should be.

Finally, families have to think about what developing or selling an asset will mean to the operations of the business – what debt they’re prepared to take on, what that will mean to the primary business and whether this is an investment that will yield dividends in the short or long term.

The explosion in value of Canadian real estate has meant that many families find themselves in possession of one or more valuable properties. Some of these parcels may be used in the primary business while others might be ripe for development, lease or sale.

The optimization of a real estate asset shouldn’t be taken lightly, says Reiff. “It’s a treasure box. You can open it only once. And once you do, there’s no going back.”

This is because selling property brings with it tax, governance and future funding considerations, says Fred Cassano, national real estate tax leader at PwC.

This necessitates a careful review of the business’ priorities, a lot of troubleshooting and even succession planning. Here are the considerations.

Ask tough questions

Owning a business is one thing, but getting into the real estate business is another. Cassano says owners need to be made aware of what’s involved in partnering with other organizations, financing options, developing, leasing and/or selling a property, and that will require a new dynamic set of skills.

Plus, it requires a huge shift in mindset to enter a new sector, says Deeks. “You need to think of yourself as a real estate owner rather than an owner of a business. You can become a real estate family, but you have to start thinking like a landlord,” he says. If that’s not possible, signing a services agreement with someone to service it can be a great way of managing this challenge, says Reiff.

Determine the future of the business

Perhaps the patriarch wants to leave things as they are, but the younger generation will be taking over the reins in several years’ time. As a result, the following questions need to be asked, according to Deeks: Who will be running the business in 10 years’ time? Do they want to be in real estate?

“It’s really about what the long-term family businesses’ objectives are,” he says.

Determine best uses via analytics

Before deciding what to do with a property, perform a careful analysis of its location and the larger area that surrounds it, and examine the type of population in the area and the way that population might be changing, says Cassano. “You run predictive analytics on real estate,” he says. Algorithms can determine a building’s possible uses based on a set of data points, he says, and determine its viability in the long run.

Consider sustainability

With environmental, social and governance (ESG) issues at the forefront, a business might look into retrofitting buildings in a sustainable and eco-friendly way, says Cassano.

While these types of initiatives can provide a return on investment in the future, they can be expensive to undertake in the short term. For that reason, he suggests business owners — and future owners — discuss the pros and cons of an ESG-focused retrofitting.

Improve liquidity

If cash is a concern, separating the property from the operating business and raising debt on it can be an effective way to generate liquidity, says Deeks. That’s because borrowers can typically access more attractive terms secured against the real estate, and capital invested in the company’s primary business might provide a higher return on investment.

However, “when you’re taking out debt, you’re taking on liability,” says Reiff. And that could mean losing the property.

Determine which is more lucrative, the business or the real estate

Often, a primary business may be suffering. A business may be worth only the cash flow it generates, says Reiff, meaning it makes a profit but could never be sold for more than the value of the real estate. For example, that might be a firm that processes film or a manufacturing company that uses outdated machinery with little value.

Thus, owners have to weigh continuing their business versus selling the real estate assets used in the business. In cases where the family business is slowly declining, “selling the real estate can be an elegant way to exit it,” he says.

Other implications

One important factor to consider: What impact will the sale or development of a building have on the business? Will employees be working in a construction zone for weeks or months on end? How will that affect the transport of goods? Will it impact employee retention? Will the construction costs jeopardize the business?

Business owners also need to ask themselves: “Will I lose my building?” says Reiff. Or if they opt to sell and build somewhere else, will the new location be as attractive to clients? Will it be more costly to ship from that location?

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In the end, a business’s decisions about what to do with its incidental real estate will come down to soul-searching, a careful review with advisors, and communication with the next generation of owners.

“It’s entirely dependent on each situation and the quality of the underlying business,” says Deeks. “What is the best option for the family going forward?”

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