9 Essentials to Successfully Diversify into Real Estate

To reduce risk, every business owner should strive to diversify his or her assets and investments. Real estate has compelling characteristics and is a must-have in every business owner's portfolio. Here are tips for making the most of your move into real estate.

1.    There's No Place Like Home: Everyone's #1 goal should be to own his or her own home and pay down debt so they'll have a substantial amount of equity. Philosophies differ on whether a completely paid-off home makes financial sense, but I'd argue that full payoff is a prudent goal for the business owner. Why? First, most business owners have debt against their business. Assuming the business is organized as a pass-through entity (basically, any legal entity type besides a C-corporation), you're getting an interest expense deduction - just as you would get for interest on home mortgage debt. Second, private business is a risky thing. You never know how the competitive or economic landscape could change in the future. Offsetting this risk with a paid-up home provides substantial comfort. Couple this with the fact that, legally, nobody can take your home away from you as long as you haven't pledged it as collateral for a loan. So, if you own your home outright, you could suffer total financial catastrophe and still keep your house. Let's never underestimate the comfort in that.

2.    Occupy Your Own Real Estate: If your business rents real estate and you have substantial equity in your home, it makes sense to set a goal of owning the property that your business occupies. In simple terms, if you are going to pay rent, why not pay it to yourself? If your business is site-specific, such as a restaurant, this might be tough to accomplish but not impossible. The only answer is to negotiate hard, be persistent, and use whatever leverage you have as a good tenant. If you can't get an outright purchase, go for an option and/or a lease-to-own agreement. If your business is not site-specific, you have the freedom to relocate. Find a great deal and make a move. It'll be a chore but will surely pay dividends over time.

3.    Set Clear Parameters: You know your usage needs. You also know your financial capabilities. Find a trusted real estate investor or broker and discuss your desires. Lay out details about the specific property that make sense for you. What geographic areas make sense? What characteristics must the site have? Do you want to be the sole occupant or lease to others? How many others? How much equity can you contribute? How much debt service can you and/or your business handle? Do you want a fixer-upper?

4.    Location, Location, Location. Municipalities have substantial influence on the path of future development - primarily in their ability to locate new roads and highways, expand and improve roads and intersections, locate schools, build bridges, etc. In your efforts to buy real estate in an "up and coming" area, find out what is planned in your community. Determine what organizations do your city and county planning. Go talk to them. Ask them where the growth is now and what capital projects can be expected to take place in the future.

5.    Deal Flow: The key to finding a good deal is finding lots of deals. Once you set your purchase parameters, get the word out. Tell every person and broker you know. Be willing to pay full commission. You might even consider hiring an exclusive broker-representative. Give them your parameters and tell them you want a good deal.

6.    Don't Overpay: With real estate, timing is everything. Another way to say it is: Patience pays. Your goal should be to find a really good deal. What's a good deal? You want to pay less than prevailing comparable sales in your area. Good deals are available. Always keep in mind that your desire for a good deal is not just a matter of greed or luxury; it's a matter of caution. Take your analysis with a grain of salt and a bit of humility. You could be a little off on your analysis - in the wrong direction. You or the property could suffer an unforeseen event. For all these reasons, you need a cushion. Buy right or don't buy at all.

7.    Due Diligence: As with most things, what you see may not be what you get. Before you buy, make sure you know what you're getting. Never agree to purchase before you are totally satisfied with conditions. Environmental issues are #1. NEVER buy a piece of property without thoroughly checking environmental conditions. Hire an expert to do a Phase I environmental review. If the auditor finds cause for concern, have the seller pay for a Phase II review. If he won't, walk away. And remember that commercial property is just like a house. Get an expert to check the structural, electrical, plumbing, etc. Fixer-uppers might offer the best opportunity for value appreciation, but be sure the only needs are cosmetic.

8.    Financing: Rule #1 is to make sure your risk of default is low. Don't buy if you don't have the financial wherewithal to withstand some bad luck, such as long-term vacancies. Rule #2 is to shop around. As with your home, you'll find many financing options when you buy commercial real estate. Study them carefully - assessing costs as well as appropriate amortization schedules. A quicker pay-down will reduce interest expense and build equity more rapidly, but you don't want to risk default.

9.    Own It Outside of Your Business: Don't purchase your real estate through your business. You'll lose much of the diversification benefit, because if your business fails, the real estate will go down with it. Buy it personally or through a separate legal entity. When the time comes to retire and/or sell your business, you'll be set to rent your real property to the new owner. Can you say, "Passive income?" It's a beautiful thing.

Real estate is an incredible thing to own. It has tremendous attributes, many of which beautifully complement ownership in a business. Of course, every investor should be leery of financial risk - risk that results from debt levels that could become difficult to maintain. So don't expand into real estate imprudently. But when times are good and your company is generating excess cash flow (or holding extra cash or low levels of debt), consider adding more real estate to your personal portfolio. Long-term odds are it'll pay big dividends.