There are four common routes: buy the property inside the acquisition and pledge it to the senior lender; buy it in a separate property company with its own mortgage; leave it with the seller and sign a long lease at market rent; or buy it and sell it to a real estate investor at closing under a leaseback. Cash-flow lenders size the company's debt on EBITDA after a market rent, so an owner who paid little or no rent has overstated earnings. Real estate debt is sized on the property's appraised value, and it is usually cheaper and longer than the company's debt.
- Main choices
- Buy with the company, buy in a propco, lease from the seller, or sale-leaseback at closing
- What company debt is sized on
- EBITDA after a market rent, whoever owns the building
- What property debt is sized on
- The appraised value and the rent the property earns
- Diligence the property adds
- Appraisal, environmental review, title and survey
- The trade-off
- Capital tied up in property against rent paid out of cash flow
Four ways to structure it
Many founder-owned companies operate from buildings the founder owns personally or through a separate company, often rented to the business at whatever rent suited the family's taxes. When the business is sold, the buyer has to decide what happens to the property. The decision is usually made in the letter of intent, often without much thought, and it shapes the financing more than almost anything else in the deal.
| Structure | How it works | Best fit | Watch for |
|---|---|---|---|
| Buy it with the company | The property is bought as part of the acquisition and pledged to the senior lender | Banks lending on both cash flow and collateral; property that is essential to the operation | Cash-flow lenders and unitranche funds give the property little credit; equity is spent on bricks |
| Buy it in a propco with its own mortgage | A separate property company buys the building with a commercial mortgage and leases it to the operating company | Buyers who want to own the property but keep it out of the company's credit | Two lenders, a lease between affiliates at market rent, and cross-default terms |
| Leave it with the seller | The buyer buys only the company and signs a long lease with the seller as landlord | Buyers who want their equity in the business; sellers who want rental income | Rent at market, a term at least as long as the loan, and a landlord waiver for the lender |
| Sale-leaseback at closing | The buyer buys the property and sells it to a real estate investor, who leases it back to the company | Property worth more to an investor than to the company's lender | A long lease with fixed escalations becomes a permanent fixed charge |
Each can work. The right one depends on how much of the price is property, how essential the location is, how much equity the buyer has, and what the business needs after closing. The comparison in general is on buying the building vs leasing it from the seller.
Market rent: the adjustment that changes the loan
Whoever ends up owning the building, the company's lenders will size its debt on earnings after a market rent. If the founder owned the building and charged the company little or nothing, the historical EBITDA is higher than the business will produce once someone charges rent. If the founder charged more than market, the reverse. A quality of earnings review makes this adjustment, and lenders expect it.
A worked example in plain numbers. The company reports EBITDA of 3,000, and paid its owner no rent. A market rent for the building is 400 a year. Pro forma EBITDA is 2,600. Senior cash-flow lenders to lower-middle-market companies commonly lend 2x to 3.5x EBITDA, so the 400 of rent removes several times its own amount from the company's senior debt capacity: at 3.5x, the difference is 1,400 of debt. The building's value does not disappear, but it is financed separately, on its own terms, or it stays with the seller.
Rent is an operating cost to a cash-flow lender. Every unit of it comes off EBITDA before the leverage multiple is applied.
Lenders also look at rent as a fixed charge. A company with a large lease obligation has less room in a bad year than one that owns its buildings outright, and some lenders test fixed charge coverage with rent included; see DSCR vs FCCR.
Buying the property inside the acquisition
The simplest structure buys everything and pledges it all to one lender. Banks lending to the company on cash flow will often take the property as additional collateral and may provide a real estate term loan beside the acquisition term loan, with a longer amortization on the property piece. That can lower the annual payment compared with financing the same amount entirely on the company's cash flow.
Private credit funds and unitranche lenders are less interested. They lend on enterprise value and cash flow, and they rarely give the property much credit beyond what its rent-free use adds to EBITDA. A buyer whose senior lender will not value the building is often better off financing it separately, where a real estate lender will.
The cost of this structure is equity. The property adds to the price, and unless a lender finances most of its appraised value, the buyer's equity goes into bricks rather than the business. The first months after an acquisition are when the company most needs a cushion; working capital at close explains how to size it.
A propco with its own mortgage
Many buyers who want to own the real estate put it in a separate property company that leases it to the operating company: a propco-opco structure. The propco borrows on a commercial mortgage sized on the appraised value and the rent; the operating company borrows on its cash flow. Each lender looks at the collateral it understands.
Three points need settling. The lease between the two companies must be at a market rent and on terms the operating company's lender accepts, because that lender is underwriting the rent as a cost. Commercial mortgages usually amortize over a longer schedule than their term, leaving a balance due at maturity; the difference is explained in loan term vs amortization period. And the lenders will set out how a default at one company affects the other: cross-defaults, cross-guarantees, and the mortgage lender's rights if the tenant fails.
Leaving the building with the seller, or selling it at closing
Leaving the property with the seller is often the best answer for a buyer who wants every unit of equity working in the business. The seller becomes the landlord and keeps an income, which many retiring founders prefer. The lender's questions shift to the lease: it should run at least as long as the loan, with renewal options, at a market rent the business can pay, and the landlord should sign a landlord waiver so the lender can reach its collateral on the premises. A lease can also carry an option or a right of first refusal to buy the property later.
A sale-leaseback at closing turns the property into cash that funds part of the price. It works when a real estate investor will pay more for the building, on the strength of a long lease from the company, than the company's lender would lend against it. The trade-off is permanent: the company takes on a long lease with rent escalations, and its lenders count that rent in every coverage test for as long as the lease runs. How the two routes compare is on sale-leaseback of business real estate.
Appraisal, allocation and environmental review
The purchase agreement splits the price between the business and the property, a purchase price allocation that matters for tax and for financing. A property lender lends on the appraised value. If the seller allocated more to the building than it appraises for, the difference has to be financed as part of the business, on the company's cash flow, or covered with equity.
Commercial property also brings an environmental review, starting with a Phase I site assessment. For companies that handle fuel, solvents, coatings or chemicals, that review can decide whether a lender will take the property at all, and it should be ordered early. Title, survey and zoning follow the same logic: they are the property lender's conditions, and they run on third parties' schedules.
Choosing, and what lenders need to see
The way to choose is to model the deal each way before the letter of intent is signed: with the property bought, in a propco, leased from the seller, and sold and leased back. Compare the company's pro forma EBITDA after rent, the debt it supports, the equity required and the cash left in the business on day one. The right answer is usually obvious once all four are on one page.
For the lenders, a deal with real estate needs everything in the standard acquisition file plus the property's details: the allocation, any existing appraisal or survey, the environmental history, the market rent adjustment, and the draft lease where one is proposed. Midas Partners builds the alternatives into the financing model, and a senior banker sets out in the lender presentation why the structure chosen is the right one. The full package is built in a day once the documents are in; its contents are on the package.
Common questions
- Should I buy the building when I buy the company?
- It depends on how essential the location is, how much equity you have and what the property would cost as rent. Model the deal with and without it. Owning it saves rent but ties up equity; leasing it keeps equity in the business but adds a fixed charge.
- Why did the lender reduce the company's EBITDA for rent it never paid?
- Because the company will pay rent to someone once the founder is no longer both owner and landlord. Lenders size debt on earnings after a market rent, so a rent-free history overstates what the business will earn.
- Will a cash-flow lender count the real estate as collateral?
- Some banks will, and may add a real estate term loan with a longer amortization. Private credit and unitranche lenders usually give the property little credit and prefer it financed separately.
- What if the building appraises for less than the price in the purchase agreement?
- A property lender finances it on its appraised value. The excess has to be financed as part of the business, on its cash flow, or covered with more equity.
- Is a sale-leaseback a good way to fund the purchase?
- It can be, when an investor will pay more for the building than a lender would lend against it. The cost is a long lease whose rent the company's lenders count in coverage for as long as it runs.