Buying the building makes the deal larger: more capital at closing and a second financing, usually a real estate loan sized on the property's appraised value with a longer amortization than the acquisition term loan. Rent leaves the P&L and is replaced by mortgage payments. Leasing keeps the acquisition smaller and the capital focused on the business, but the lease becomes part of the credit: cash-flow lenders want a term, with renewals the tenant controls, that outlasts the loan, at a market rent, with the landlord's cooperation on collateral. Many buyers of companies this size lease, and buy the property later or through a separate entity.
- Capital needed
- Buying: larger, since the building needs its own equity. Leasing: smaller
- How the building is financed
- A real estate loan on appraised value, often in a separate property company
- Repayment shape
- The real estate loan usually amortizes more slowly than the acquisition term loan
- Lease if you don't buy
- Long enough, with renewals, to outlast the loan; market rent; lender access
- Seller's view
- Some want a clean exit; others want rent as retirement income
What changes when the building is in the deal
In a business acquisition that includes the real estate, the buyer pays for two assets: the operating business, much of whose value is usually goodwill, and a building with its own appraised value. Lenders treat them differently. The operating company is financed on its earnings: a senior cash-flow term loan and revolver, or unitranche, sized as a multiple of EBITDA. The building is financed on the property: a commercial real estate loan sized against the appraisal, with its own amortization and its own lender if need be.
That is why many buyers hold the building in a separate property company that leases it to the operating company, the propco and opco structure. It keeps the real estate debt apart from the acquisition debt, lets each be refinanced on its own schedule, and lets the property be sold or refinanced later without touching the operating company's credit agreement. It also means that, in the operating company's numbers, rent never really goes away: the operating company pays rent to its own property company, and the cash-flow lender underwrites that rent as a fixed charge.
Some buyers, particularly private equity funds and independent sponsors, prefer not to own real estate at all. Their equity is meant for the operating business, and a building ties it up in an asset that returns less. For them the question is not whether to buy the building but what lease to sign.
Side by side
| Buy the building | Lease from the seller | |
|---|---|---|
| Total capital at closing | Larger: business plus real estate | Smaller: business only |
| Debt | Acquisition debt on the business, plus a real estate loan on the property | Acquisition debt on the business only |
| Repayment shape | The real estate loan usually amortizes over a longer schedule | All on the acquisition loan's schedule |
| Rent | Replaced by mortgage payments, or paid to the buyer's own property company | Paid to the seller; a fixed charge in the lender's coverage test |
| Collateral | The building gives a lender hard collateral | The business's assets, plus lender rights under the lease |
| Third-party reports | Real estate appraisal and environmental review, plus the business diligence | Business diligence; the lender reviews the lease |
| Risk to the buyer | Owns the property risk and its upkeep | Depends on the seller as landlord and on renewing the lease |
| Seller outcome | Cash for the building at closing | Keeps the building and receives rent |
Why a bigger deal can mean an easier payment
Ignore interest for a moment and look only at principal. An acquisition term loan on a lower-middle-market company usually repays over a much shorter schedule than a loan against a building. Adding the building adds debt that pays down slowly, and takes rent off the income statement.
| Illustration | Business only | Business and building |
|---|---|---|
| Purchase price | 3,000 | 3,000 plus 1,000 for the building |
| Acquisition term loan | 2,000, repaying 200 a year | 2,000, repaying 200 a year |
| Real estate loan | None | 700, repaying 35 a year |
| Equity and other capital | 1,000 | 1,300 |
| Principal repaid in year one | 200 | 235 |
| Rent paid to the seller | 80 a year | None |
The combined debt is about a third larger, but the principal due in year one rises only from 200 to 235, and the 80 of rent disappears. Once interest on the extra 700 is counted, whether the company's fixed charge coverage improves depends on how the rent compares with the real estate loan's full payment. Where the seller has been charging the business a market rent, owning often looks similar or better; where the seller charged little or nothing, the lender will already have underwritten a market rent, and buying changes less than it seems.
The trade is capital: 1,300 against 1,000 in the illustration. A buyer whose equity is scarce will usually get more from putting it into the business than into the building. A buyer with capital to spare, a long hold in mind, and a property that the business genuinely depends on may prefer to own it.
If you lease: the lease becomes part of the credit
A lender financing a business it cannot move needs to know the business can stay where it is for as long as the loan is outstanding. When the seller keeps the building, the new lease is signed at closing, which is the buyer's best chance to get it right. Lenders commonly look for:
- Term: a remaining term, including renewal options the tenant controls, at least as long as the loan.
- Market rent: a rent the lender can defend. If the seller has been charging below-market rent or none, the lender underwrites the new rent, not the old one, and the earnings the loan is sized on fall accordingly.
- Lender rights: the landlord's consent to a collateral assignment of the lease, and notice and cure rights if the tenant defaults.
- Access to collateral: a landlord waiver letting the lender reach equipment and inventory on the premises. An asset-based lender often sets a reserve against its borrowing base where it lacks one.
- No termination on sale: the lease survives a sale of the building, so a new owner cannot end it.
- Purchase option or right of first refusal: not always required, but it lets the buyer acquire the building later, when financing it is easier.
A related-party lease also needs to look arm's-length. If the seller stays on as landlord and also holds a seller note or rollover equity, lenders will read the lease closely for terms that favor the seller over the business, and the intercreditor or subordination terms will cover what happens to rent if the loan goes into default.
What the seller usually wants
Sellers split into two camps. Some want a clean exit: all cash at closing, no ongoing relationship with the business, and no role as landlord to a buyer who may call about the roof. For them, selling the building with the business is the point, and a buyer who will not buy it may lose the deal.
Others see the building as retirement income. Rent from a tenant they know, secured by a long lease, can be worth more to them than a lump sum, and they may prefer to defer a sale of the property for their own tax reasons. For these sellers, a lease with a purchase option can bridge both sides: the buyer finances a smaller deal now and buys the building later. A retiring owner often falls into this camp.
There is a third route. The buyer can buy the building at closing and sell it at closing to a real estate investor under a long lease, a sale-leaseback. The seller gets a clean exit, the buyer's capital stays in the business, and the lender sees a long lease with an institutional landlord.
If you do not buy the building, a long lease with renewals is not a detail. It is part of what the lender is lending against.
Getting the numbers in front of lenders
- Both versions of the deal. Sources and uses, debt and coverage with the building and without it, so the choice is made on numbers rather than instinct. See sources and uses.
- Rent, normalized. What the business has been paying, what a market rent would be, and which one the earnings figure assumes.
- The target's latest full year of figures and the letter of intent, with the real estate terms stated in the letter of intent rather than left for later.
- For the property: the purchase terms, any leases to other tenants, and the appraisal and environmental review once ordered.
Midas Partners models both versions in the financing model, so buyer and seller can see the capital, payments and coverage each produces before the letter of intent is final. The file goes to lenders that finance each piece: of the 1,800+ lenders in the book, 1,148 write term and private credit for the operating company, and some also lend against the real estate or will work alongside a lender that does.
Common questions
- Can one lender finance both the business and the building?
- Sometimes. Banks often lend against both, with separate loans or tranches for the operating company and the property. Private credit funds lending on cash flow usually do not want the real estate, so the building goes to a separate real estate lender or stays out of the deal.
- Should the building sit in a separate company?
- Often, yes. A property company that leases to the operating company keeps the real estate loan apart from the acquisition debt and lets either be refinanced or sold on its own. The lease between them should be at market rent and on terms an independent landlord would sign.
- How long does my lease need to be if I don't buy the building?
- Lenders commonly want the remaining term, including renewal options you control, to run at least as long as the loan. A short lease on a location-dependent business can stop a loan from closing.
- Can the seller be my landlord?
- Yes, and it is common. The lease should be at market rent and on arm's-length terms, and the lender will want the seller's consent to its rights under the lease.
- Does buying the building improve my coverage?
- It can. Rent disappears and is replaced by payments on a loan that usually amortizes more slowly. Whether fixed charge coverage improves depends on how the rent compares with that payment, which the model should show.
- Can I buy the building later instead?
- Yes, if the lease gives you a purchase option or right of first refusal. Buying later is a separate real estate financing, once the business has a record under your ownership.