Poll

 Buy small business or buy Rental Property? (please read below first)

Real Estate at 2% rule
10 (62.5%)
Small Business (Like a Subway franchise or gas station)
6 (37.5%)

Total Members Voted: 16

Author Topic: Buy small business or buy Rental Property? (Now with a poll for MMM Forum users)  (Read 4328 times)

CashFlowTurtle

  • 5 O'Clock Shadow
  • *
  • Posts: 19
Hello Mustachians!  My wife and I are long time readers, and are seeking advice.

We currently have about $100k in cash sitting around that we wish to invest. We disagree on which way to invest though, we've narrowed it down to 2 options, and want the MMM forum to help us decide (we have sufficient exposure to the stock market already).

Here are the two options (financing for both is already worked out)

1.  An 8-plex about 1,000 miles away - 500k with 100k down (minimal transaction costs in this state).
Earnings:
 - 19k/yr after debt  cashflow (after tax)
 - 11k/yr (65k in 5 years) of principal payments
Estimated 5 year return to equity: ~170k (cap reserve included as expense)
Estimated 5 year CAGR ROE (assuming 2% growth): 22%

2. Subway fast food franchise (or other similar small business) near where we live (NYC) - ~350k with 90k down
 - 50k/yr after debt cash flow (90k pre tax)
 - 19k/yr principal payments (108k in 5 years)
Estimated 5 year return to equity: ~320k (assuming 35k in capex)
Estimated 5 year CAGR ROE (assuming low growth): 33%
(15 year lease, good condition, currently run absentee, price includes fixtures and working capital)

Now, both options pose risks, a bad manager or local economic troubles, or unexpected capex, could really hurt returns on either option.  One of us prefers the safety of the real estate, as it's simple straight forward and has likely resale value (as long and interest rates/cap rates stay somewhat stable).  One of us prefers the small business, because the safety of the larger cash flows means that a small decline would still result in positive cashflow and the fact of it being physically near by (we are also both business savvy people and would hope to be able to add a little value to a franchise operation).

A few things to note - we also have the financial wherewithal to conjure 30-50k if anything happens if need be.  This investment is in addition to our house and 401k, and we view as part of a diversified portfolio.   This is also about the amount of cash we plan on saving in the next 12 months, so while it's large for us, it's not our life savings.

So, anyone have experience buying small businesses and rental property and can offer insight?  also, feel free to suggest other businesses with positive experience for 95% absentee owners (gas stations, restaurants, etc).

« Last Edit: February 10, 2015, 02:44:34 PM by Raggy »

Aphalite

  • Bristles
  • ***
  • Posts: 425
Re: Buy small business or buy Rental Property?
« Reply #1 on: February 10, 2015, 10:06:22 AM »
I would opt for the cash flow, which lets you reallocate your capital faster than residential investment - plus, food business keeps up with inflation better than real estate. There's no reason the resale value on the business should suffer if you maintain a reasonable capex/maintenance ratio

EDIT: It also seems to me the franchise is just a cheaper asset, you're buying at 7x estimated net earnings, which is a pretty good bargain
« Last Edit: February 10, 2015, 11:31:53 AM by aphalite »

Retire-Canada

  • Walrus Stache
  • *******
  • Posts: 7961
Re: Buy small business or buy Rental Property?
« Reply #2 on: February 10, 2015, 10:30:41 AM »
I'd go with real estate, but I'd only do that if I could have the property local to me. That's just my preference as I would want to manage it more actively than you would be able to do remotely. The management/maintenance end of rental properties is where I'd see the opportunity to improve the return on my investment.

I'd never buy into a Subway franchise. Having been involved in family retail small businesses the small value high volume transaction model hurts my brain. Plus I think the food is crap so I'd feel unethical selling it others.


CashFlowTurtle

  • 5 O'Clock Shadow
  • *
  • Posts: 19
Re: Buy small business or buy Rental Property?
« Reply #3 on: February 10, 2015, 02:40:09 PM »
Ok, I've added a poll at the top, please feel free to vote after you've read through the situation.

Also I'd ask that you please vote using your experience and thought to risk & reward, not how much you like 12" meatball heros ;)

We're really going to take MMM forum feedback very strongly into our decision (hopefully buy assets with both profiles a year or so though!)

health teacher

  • 5 O'Clock Shadow
  • *
  • Posts: 10
Ask this same question on the http://www.bogleheads.org forum. Specifically, the "Investments-Help With Personal Investments" forum.

You might get a better response on this particular question.




CashFlowTurtle

  • 5 O'Clock Shadow
  • *
  • Posts: 19
Thanks, I did try posting there too.

I'd still like some feedback from people that have bought (or looked into buying) franchises as a mostly passive owner if anyone has experience down that line.

AH013

  • Bristles
  • ***
  • Posts: 272
I'd advocate AGAINST owning either and thinking it's just going to be some passive income stream that you sit back and collect as investors.  Real estate & small businesses often pay great returns because they are essentially second jobs in addition to requiring a nice chunk of capital.

When you own real estate you're a landlord -- finding tenants, resolving disputes and complaints, collections work for tenants who pay late, handyman, organizing repairs, home services (depending on the unit type, you could be mowing yards, plowing snow, etc.), evictions, etc..  If you don't do this yourself, property managers & real estate agents eat a good chunk of the profit.  If you don't do this at all, you'll get sued and find yourself in foreclosure when nobody is paying rent and you can't cover the mortgage anymore.

When you own a small business you deal with staffing, theft, resolving disputes & complaints, overseeing operations, management of employees, etc..  If you don't do this yourself, store managers eat a good chunk of the profit.  If you don't do this at all, people rob you blind and/or create such a poor customer service experience you lose your customers and your business fails.

No offense, you're also a bit capital poor for either investment...a $30-50k cushion is nothing in running a small business...most chain franchises require at least $1M in excess capital on top of the purchase price to buy into a known chain so that you can stomach a bad business cycle.  A roof repair or the legal fees from a "I found a roach in my sub" lawsuit from a customer would wipe you out.  I see so many people near retirement who buy restaurants or other "fun" small businesses thinking it's a golden goose and then mortgage their home, etc to the max while asking their kids to work at the business (for free) until the credit lines run dry and they declare bankruptcy...please don't do this to yourself.

If you want passive income, continue investing in the stock market.

If you still won't listen, I'd advocate going with the business idea near you.  A property 1000 miles away reeks of disaster waiting to happen.  Do you plan to fly out there anytime there is a complaint?  What would you do if the property manager (assuming you have to get one...no way you're going to oversee the property yourself daily) quits on your?

CashFlowTurtle

  • 5 O'Clock Shadow
  • *
  • Posts: 19
Thanks for the commentary AH!  I appreciate the time and thoughtfulness.

I'd love to hear from people who have had experience either buying or considering buying a small business to run as an absentee owner.


3okirb

  • Stubble
  • **
  • Posts: 147
I have 5 Wendy's franchises.  There's no such thing as an absentee owner.  I have clients that own Subways.  When they say you need a new sign, you buy a new sign.  If they say you need new flooring, you get new flooring.  On your dime, through their connections.

I also own rental property, but (in my opinion) it's a REALLY BAD idea to have it 1000 miles away from you.  You need to be able to keep on top of things and SEE things that just won't work from that far away.  Some people are forced to do it because of moving, but I would never choose that right from the beginning.

Stash Engineer

  • Pencil Stache
  • ****
  • Posts: 518
I don't have any experience owning a small business franchise, but I do have rental property.  Investing in (and subsequently, managing a) rental property outside of your area would be a bad idea.

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28459
  • Age: -999
  • Location: Seattle, WA
Investing in (and subsequently, managing a) rental property outside of your area would be a bad idea.

I disagree with this, and have a whole thread about buying rental property you've never seen (though I do use a manager - long distance managing is possible, but not something I'm interested in right now).

http://forum.mrmoneymustache.com/real-estate-and-landlording/purchasing-real-estate-you%27ve-never-seen/
I am a former teacher who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and am now settled with three kids.
If you want to know more about me, this Business Insider profile tells the story pretty well.
I (rarely) blog at AdventuringAlong.com. Check out the Now page to see what I'm up to currently.