Researching local ordinances and issues

Government officials like to regulate things and make rules. As a small business owner, it’s your responsibility to find out what rules may apply to your company and where you’re seeking to operate it.

(Now, I’m not suggesting that people don’t need rules and regulations. After all, would you like to buy a home and then find out next year that your neighbor is opening up a commercial chicken farm on his property or a junkyard that recycles and sells scrap metal?)

Check with the governing authorities of your town or city to find out what local regulations exist for home-based businesses. Here are some examples of good questions to ask:

• How many employees can you have working at your home?
• Can customers come to your home and, if so, what limits apply to how many people and/or vehicles are allowed?
• Must you file any paperwork or get any permits to operate a business out of your home?
• Will you owe any local tax because of your business operations and equipment?

How can you find answers to these types of questions? Pick up the phone or visit your local government offices, small business association, chamber of commerce, or another, similar local organization. Of course, you can also surf the Internet sites of such organizations.

In addition to researching what specific rules may apply to your business, do some basic research and use some good, old-fashioned common sense:

• What are the needs of your business and customers? If you don’t require fancy office space to impress others or to meet with clients, working from home may make more sense.
• If you operate a retail company that requires lots of customers to come to you, using outside space is probably the best (and legally correct) choice.

Controlling costs

The biggest potential appeal of running your business out of your home is to save money, or more specifically, to minimize your expenses. If you have space in your home that you can use, you’ve essentially found yourself a rent-free business office.

As I strongly advocate in my book Small Business For Dummies (John Wiley & Sons, Inc.), bootstrapping — keeping your expenses and overhead low so that you can largely self-finance your business — can make great financial and business sense. Having a home-based office can certainly be part of your bootstrapping strategy.

Another part of the low-cost appeal of a home-based office is the tax write-offs you may be eligible for by running a business out of your home. If you own your home and qualify for the home office deduction, you can take depreciation on your property as a business expense as well as operating expenses attributable to the portion of your home you use for business purposes. Renters can deduct their relevant expenses including a portion of the rent, utilities, Internet access, and so on. Chapter 9 covers the details for claiming the home office deduction on your income tax return.

Some seminar operators and other promoters talk up running a business out of your home just for the supposedly great tax deductions. They pitch that you can write off all sorts of homeownership and personal expenses. It sounds too good to be true because it is! Regardless of where you elect to operate your company, the reality is that you may only deduct expenses directly related to operating your business. Also, keep in mind that if you secure space outside of your home for your company, you may take the costs for that space as legitimate business expenses. Chapter 8 details the expenses you may take for office and other expenses.

Separating your work life from your personal life

One of the biggest challenges of running your small business out of your home is separating your work life from your personal life. Of course, some folks who work outside their home have trouble “getting away” from work when they’re at home, especially with all the increasingly invasive and addictive technologies in people’s lives.

But working at home presents unique challenges in compartmentalizing work and home lives:

• Discipline: At home, do you have the discipline to work the number of hours that you need to or will the kitchen goodies tempt you to make half a dozen snack trips? Can you refrain from turning on the TV every hour for late-breaking news or constantly surfing the Internet for stock quotes, personal research, and entertainment? The sometimes amorphous challenge of figuring out how to grow the business may cause you to focus your energies elsewhere.
• Shutting down: At the other “extreme” are folks who have workaholic tendencies and find it difficult to literally stop working. The close proximity of your office and associated working stuff can make it too easy to go back to work even after you’ve tried to leave it for the day.
• Privacy: When you work out of your home, others who come into your home — employees, service providers, and so on — will know much more about your personal life. This isn’t all bad or even a negative at all depending on how you feel about it and what’s going on in your life. But it’s definitely something to consider before you commit to running a business out of your home.

• Family matters: Last but not least, your home life should factor into where you decide to work. One advantage to working at home when you’re a parent is that you can be a more involved parent. If nothing else, you can spend the one to two hours per day with your kids that many people spend commuting! Just make sure you try to set aside work hours during which time your office is off-limits.

  Ask other family members how they feel about your working at home. Be specific about what you plan to do, where, when, and how. Will clients come over? What time of day and where in the home will you meet with them? You may not think that your home office is an imposition, but your spouse may. Home business problems come between many couples. If you’re single and living alone, home life is less of an issue.

Doing a cost comparison

While there are plenty of qualitative issues to weigh regarding working at home versus getting outside space, you should also crunch some numbers. Specifically, you should compare the costs, after factoring in taxes, of the alternatives. Those options include working out of your home, leasing a space somewhere, or buying an office or retail building, topics that I cover later in this chapter.

The Tax Cuts and Jobs Act that took effect in 2018 impacts the tax deductibility of some of the items real estate owners can claim on their tax returns. Of particular importance are the limitations on so-called SALT — state and local taxes. For your owner-occupied home, if you’re able to itemize your tax deductions on Schedule A, you’ll be limited to a $10,000 annual deduction for all state and local taxes and property taxes. For mortgages taken out after December 14, 2017, you may deduct interest on the first $750,000 of mortgage debt. With real estate used for business, you won’t face these SALT limitations.

When pricing out working from home (if that’s an option), be careful not to fall into the trap of assuming that using space in your home is “free.” Such space isn’t really free, especially if you’re considering buying or renting a larger home to have more space in part for your business.

Leaning toward leasing

Unless you can run your business from your home, you may be in the market for office or retail space. Finding good space and buying or leasing it both take tons of time if you do it right.

A lease is a contractual obligation between a lessor (landlord) and a lessee (tenant) to transfer the right to exclusive possession and use of certain real property for a defined time period for an agreed consideration (money). A verbal lease can be enforceable, but it’s much better for all parties involved to have a written lease that defines the rights and responsibilities of the landlord and the tenant.

In the early years of your business, buying, owning, and managing an office or a retail building generally doesn’t make sense. The down payment consumes important capital, and you may end up spending lots of time and money on a real estate transaction for a location that may not interest you in the long term. Buying this type of real estate rarely makes sense unless you plan to stay put for five or more years (I talk about buying business property in detail later in this chapter). Leasing a space for your business is far more practical.

Leasing burdens of retail businesses

Renting office space is simpler than renting retail space because a building owner worries less about your business and its financial health. Your company generally needs more credibility to rent a retail building because your retail business affects the nature of the strip mall or shopping center where you lease. Owners of such properties don’t want to move in a fledgling small business that quickly ends up failing or a business that’s run in an unprofessional, slipshod fashion.

If you and your business don’t have a track record with renting space, getting references is useful. These references can be folks you’ve interacted with over the years in the course of your work and can speak to your integrity, ethics, competence, and financial acumen. If you seek well-located retail space, you usually end up competing with national chain stores, so you better have a top-notch credit rating and track record. Consider subletting — circulate flyers to businesses that may have some extra space in the area you want to locate your company. Spending time in those business locations may help you identify businesses with excess space and a lack of customers. Also prepare financial statements that show your personal and business creditworthiness.

Negotiating a lease

Brokers list most spaces for lease. Working with a broker can be useful, but the same conflicts exist as with residential real estate brokers. Brokers are salespeople who get paid on commission, which doesn’t make them bad people but does create conflicts of interest that may be at odds with what’s in your best interests. That’s why you need to do your homework before hiring a broker to be sure you’re hiring someone who has expertise and ethics and is a good listener.

You may also consider examining spaces for lease without a broker and deal with the landlord directly. Such landlords may give you a better deal because they don’t have to pay a brokerage commission. It’s imperative if you go direct that you learn enough about leases and what to for and look out for. (Check out my book Real Estate Investing For Dummies, published by John Wiley & Sons, Inc., for more information.)

The biggest headaches with leasing space are understanding and negotiating the lease contract. Odds are that the lessor presents you with a standard, preprinted lease contract that she says is fair and is the same lease that everyone else signs. Don’t sign it! This contract is the lessor’s first offer. Have an expert review it and help you modify it. Find yourself an attorney who regularly deals with similar real estate lease contracts.

Office leases are usually simpler than retail leases. About the most complicated issue you face with office leases is that they can be full service, which includes janitorial services. Retail leases, however, are usually triple-net, which means that you as the tenant pay for maintenance (for example, resurfacing the parking lot, snow plowing, cleaning, and gardening), utilities, and property taxes. You’re correct to worry about these open-ended charges in a triple-net retail lease because you can’t control many of these expenses. And, if the property is sold, property taxes can jump.

Here are provisions to keep in mind when dealing with a triple-net lease:

• Compare your site’s costs to other sites to evaluate the deal that the lessor offers you.
• Your lease contract should include a cap for the triple-net costs at a specified limit per square foot.
• Try to make sure that the lease contract doesn’t make you responsible for removal costs for any toxic waste that may be discovered during your occupation of the space. Also exclude increased property taxes that the sale of the property may cause.
• If feasible, get your landlord to pay for remodeling. It’s cheaper for the landlord to do it and entails fewer hassles for you.
• With retail leases, get an option for renewal. This renewal option is critical in retail, where location is important. The option should specify the cost — for example, something like 5 percent below market, as determined by arbitration.
• Get an option that the lease can be transferred to a new owner if you sell the business. This protects you from getting booted out simply because ownership of the property changes hands.

If you really think you want to purchase (not lease) because you can see yourself staying in the same place for at least five years, see the next section.

Taking stock of your financial situation

If you can’t pay, you can’t play. Or, I should say, you want to be sure you can really afford a property purchase before you ever consider buying instead of leasing a business property.

As a small business owner, your priority is the financial health and success of your business. It makes no sense whatsoever to jeopardize your business’s health and possible survival by taking on excessive debt to buy a property. That said, buying a business property will never be a risk-free proposition, just like any other significant decision affecting your small business.

Here are critical issues to resolve regarding your financial situation before you contemplate looking for business property to buy:

• Do you have sufficient capital (cash)? Capital is a big barrier to most small business owners buying property for their business. The down payment and closing costs on a business property can easily take 30 percent or more of the sales price of a property. For example, if you’re considering a business property that costs $200,000, between the down payment and closing costs, you could easily need at least $60,000 in cold hard cash just to do the deal.
• Do you understand what improvements you need to make to a property and the cost of those improvements? It’s unlikely you’ll be able to jump right into a property you buy without making some modifications and changes to it to suit your business.
• Are you regularly producing financial statements for your business? In recent years and recent quarters, do you have an income statement or cash flow analysis? How about a recent balance sheet? If not (or even worse, if you don’t know what these are), don’t consider buying business property. Get yourself a copy of the latest edition of my book Small Business For Dummies (John Wiley & Sons, Inc.) which I co-authored with small business veteran and guru Jim Schell.
• Have you examined your personal finances and developed a personal financial plan? Do you know how much you should be saving toward your important goals such as retirement? Do you have proper personal insurance protection in place? Have you completed proper wills and other needed estate planning documents?

Doing a rent-versus-buy analysis

A rent-versus-buy analysis is the single most powerful piece of analysis you can do to assess whether buying or leasing makes more financial sense in your local area. You can lease (rent) property or you can buy property. If you can afford to buy a business property, it would be foolish to commit to buying (or renting) if you haven’t compared the two options financially.

A rent-versus-buy analysis is based on the prices for business property for sale and the cost for you to lease a similar or comparable property. Specifically, after identifying some business properties that would meet your requirements and that you can afford, you first need to calculate what it would cost you on a monthly basis, after factoring in tax benefits, to buy and own those properties.

Then, you need to determine what it would cost you on a monthly basis to lease those same or similar properties. For each property, what you’re trying to do is an apples-to-apples comparison of the monthly, after-tax cost of owning that property and the monthly cost of renting that same property.

After you have that information, how can it help you? You use it the same way to make a purchase decision for competing products or services. For example, if your analysis shows that leasing is far less costly than buying/owning, that may tip the scales of your decision toward leasing.

Evaluating leases as a real estate investor

If you’re interested in possibly buying a particular business property, it’s essential that you understand the lease terms that currently exist on the property. Why? For starters, the current lessee may have the right to continue leasing if the property is sold. Second, if the property is large enough for your business plus others, you may end up using the property yourself as well as leasing to others.

From an investment standpoint, owning a nice property with attractive and well-maintained buildings may give you a sense of pride of ownership, but you’re really investing in the leases. Successful real estate investors know that an excellent opportunity is to find properties with leases that offer upside potential in the form of higher income and/or stability of tenancy.

Regardless of the type of property you’re considering as an investment, make sure that the seller provides all the leases. And don’t accept just the first page or a summary of the salient points of the lease — insist on the full and complete lease document, along with any addendums or written modifications with the seller’s written certification that the document is accurate and valid. (Verbal modifications to the written lease aren’t generally enforceable.) Have your real estate legal advisor review the leases as well.

In the sections that follow, I discuss how to understand and evaluate leases.