After months of searching and paying $10,000 for professional site selection assistance, Jack and Diane finally found a commercial site that meets the criteria set by their oil-change franchisor. Now they need to find a way to lock it in and finance it.
There's a little L-shaped piece of land in the Pacific Northwest that's a third of an acre and costs $225,000. Jack and Diane want to stake their claim. The adjacent use is a gas station and a car wash, and the neighbor is willing to grant an easement so the oil-change franchise can have access from two major streets.
The creation of these business synergies is important, and the franchisor's demographic studies have shown that the site exceeds their expectations, as there are plenty of cars and people in a three-mile radius. Although the site is narrow, the franchisor's architect is willing to change the plans a bit to make it work. Our intrepid couple's attempt to wedge their location into a tight spot follows a trend in the United States, as more and more franchisors are looking for ways to reduce overhead.
The question is, how do you pay for this new opportunity? Jack and Diane have saved about $100,000 from their professional careers and need to conserve their cash. The time has come to write an offer on the land, and they're going to need to structure their deal.
Spend Some, Save Some
Financing the purchase of land by using SBA financing is certainly an attractive option, as the banks that write loans with SBA underwriting can amortize the cost over a 25-year period. SBA rates usually float about 2.5 points above the prime rate. SBA lenders generally like to make loans that incorporate real estate because the land acts as a solid piece of security for the loan.
However, Jack and Diane know they won't reach their goals for financial independence with just one oil-change center, so they're looking for ways to conserve cash for future locations. Here are some of their options:
- Contract for deed: Attorneys like to refer to the contract for deed as the neutron bomb of real estate. That's because, in this arrangement, the seller holds title to the real estate until the buyer makes all the required installments. It can be very unnerving to be the buyer in this situation, since the more you end up paying, the more you will lose if the seller decides to keep you from receiving the benefit of the bargain. Often, a financially weak buyer will use seller financing under this arrangement, but it's a dangerous way to do business. Jack has agreed that this option is not for him.
- Build to suit: In build-to-suit leases, the owner of the land builds the improvements in accordance with the specific plans and specifications of the operator. This type of arrangement is a useful tool for a business operator/tenant to facilitate growth by saving capital and is also a beneficial way for a landowner/landlord to develop property. The resulting rent is usually calculated by amortizing the cost of developing, designing and constructing the project over the term of the lease at a predetermined interest rate. While subject to negotiation, a common approach is for the base rent to be calculated to bring the landlord a stated rate of return (usually 10 to 12 percent) based on an imputed land value, plus the hard cost of construction and the soft costs incurred by both landlord and tenant. The final rent is then based on the actual costs.
The documentation and terms between the parties depend on the parties' experience as well as the desire of each party to control the project. If structured correctly, the contentious issues that arise during a project of this nature can be minimized. In Jack's case, he has been approached by a developer who wants to be involved with the project. My concern for Jack is he doesn't have a binding offer on the property and doesn't have any control as a result. If the developer is unscrupulous, he could offer to buy the land and then deal with Jack harshly, since he knows how much Jack and Diane are depending on this site. Jack needs expert guidance. It's essential for the franchisee who contemplates a substantial build-to-suit project to hire a professional construction manager or development manager, the latter job title reflecting broader responsibilities in overseeing matters ranging from pre-development approvals (zoning, environmental and wetland remediation, traffic and road improvements, and the like) to design of the project.
- Sale leaseback: A sale-leaseback transaction occurs when the owner of the real estate sells it to a third party and then leases the property from the new owner. Companies looking to finance growth, make an acquisition, pay down debt or reallocate capital into more productive uses should consider sale-leaseback financing as a key capital-raising alternative. A form of off-balance-sheet financing, the major benefit of sale-leaseback financing is unlocking capital bound by real estate ownership and deploying it in more productive, higher-yielding uses. And, besides profiting from the real estate sale, the tenants retain full operating control of the property. At this point, this option is not particularly applicable to Jack and Diane, but it could work as a future strategy once their first franchised unit is open and they have an asset to sell.
Until now, Jack and Diane have been clinging dearly to their nest egg, minus the payment they made for the franchise rights. Each of the foregoing options has inherent risks and rewards that require expert assistance. At this critical juncture, I repeatedly see new franchisees wilt when it comes to hiring experts. Finalizing your land deal has huge risks, so I suggested that Jack contact a real estate attorney, lock down the land with a written offer and begin perusing the Net for a construction manager. Next month, we'll see if Jack takes this advice.
Todd D. Maddocks is a franchise attorney and small-business consultant who is founder of Franchisedecision.com. You can reach him at firstname.lastname@example.org.