How to budget effectively before buying commercial real estate
With commercial real estate often being a company’s biggest purchase, budgeting effectively to avoid costly mistakes is crucial to your business’s profitability.
“It’s important to understand the full cost of buying to see how it will impact your bottom line,” explains BDC Business Centre Manager Brett Prikker, who has financed numerous commercial real estate transactions. “I’ve seen cases where a business had to sell a recently purchased building because costs were miscalculated.”
Follow these steps from Prikker to help you budget effectively for your current or potential commercial real estate acquisition.
Step 1: Understand your costs
One of the biggest budgeting mistakes many businesses make when evaluating their commercial real estate purchase is underestimating—or worse, entirely missing—major expenses associated with the transaction. To avoid this potentially costly budgeting pitfall, make sure you’re taking these factors into account.
Purchase costs include more than just the price of the property. For example, you may have to spend a significant sum on due diligence, such as environmental and structural assessments, an appraisal, and a title search.
Closing the deal also typically involves land transfer tax, legal fees, a realty commission and, in some cases, sales tax. If you have an existing mortgage, you may also have a prepayment penalty.
You should set aside an extra amount for unexpected contingencies. Ten to 15% of the purchase price is common. Many of these costs can be more fully determined when you’re negotiating a commercial real estate purchase.
Renovations and repairs:
Renovations may be needed to make the site suitable for your business. You may also need to do major repairs identified during due diligence. Big-ticket items can include the roof, windows, the foundation, siding, plumbing, electricity, heating, ventilation and air conditioning.
“Structural repairs are often the big surprise,” Prikker says. “Businesses often underestimate the cost of renovating a building.”
Tip: Before costing the work, review how you use your current space to see whether you can reorganize it more efficiently. Bring a contractor and key employees to the prospective property to discuss renovations. It’s a good idea to get several quotes for any major work.
It’s also important to consider the cost of moving furniture, equipment and inventory, setting up phones and Internet, making signs, marketing your new address, cleaning up any site contamination or hazardous building materials, and repairing your existing location to return it to its original state.
You could also face costs to resolve any permit and zoning issues, encroachments (structures that cross onto a neighbour’s property), and easements (a right to use part of a neighbour’s property) identified during due diligence.
Often overlooked is the cost of downtime during the move, so be sure to calculate the cost of any ramped-up production needed to build inventory to ensure uninterrupted supplies to customers. “Transitioning the business typically takes longer than expected,” Prikker says. “Businesses often don’t realize how much downtime there will be to production. Moving isn’t an overnight thing.”
Operating costs and increases:
You’ll also need to figure out your costs to operate the new property and any income it will generate. Costs generally include financing, utilities, property tax, insurance and maintenance, such as snow removal, janitorial services, landscaping and property management.
Ask the landlord for past bills. Take into account whether you will use the space differently than the previous occupant did. For example, if only part of the space was used before, your heating bill is likely to be higher. Your tax bill could also change if the property previously housed a different kind of business than yours.
Also research how much operating costs have gone up in recent years. That will help you make more accurate projections of cost increases in your forecasts.
Step 2: Prepare annual forecasts
Now plug the numbers you’ve pulled together into your annual income statement forecast. It’s helpful to break out each cost and income item (from sources such as tenant rent, parking fees, vending machine sales and exterior advertising) related to the purchase to get a good sense of the true cost. Then, evaluate whether you can manage the purchase based on projected revenues. Also, enter the numbers into your income statement from the previous year to check impacts on your profitability.
“The question is, Is this the best place for us?” Prikker says. “Budgeting properly will help you understand the benefit of owning that property.”
Step 3: Monitor the numbers
Keep track of your operating costs and capital expenditures on real estate in your annual budget for your company, along with any income from the property. Be sure to understand your costs so you can provide enough funds in your budget and constantly look for savings.