Two of the most popular options for aspiring entrepreneurs is investing in real estate or buying a business.
They both have their own relative strengths and weaknesses.
In general, owning a business requires less capital upfront – and there are several very attractive financing options, namely an SBA loan – but requires a good deal of your time. You can hire someone to manage the business but that will cut into your profits.
Real estate, on the other hand, requires much more upfront capital but less time to manage.
Buying a business is generally more risky(although both carry some degree of risk) but has a much higher potential for wealth building.
Let’s take a look at how buying a business compares with investing in real estate.
Criteria when buying a business
One of the most important criteria when buying a business is to make sure that you have a clearly defined investment thesis so you can quickly rule out businesses that just aren’t worth your energy.
Some things to consider include:
- What are your investment goals?
- What is your time horizon?
- How comfortable are you with short-term loss?
- Do you have non-invested savings?
- What is your risk tolerance?
You should also look for a business that has some obvious, easily implemented upsides. What ideas can you bring to the table that will improve sales very quickly?
The majority of small businesses in the U.S. are owned by baby boomers who have often not fully exploited the benefits of maximizing digital advertising, for example.
It might be relatively easy for you to fix these low-hanging opportunities to make your new business more profitable.
You should also consider whether you have particular skills that could help you run the business or whether you need to hire someone to manage the business as this will affect your bottom line.
Criteria when investing in property
The same mindset applies to assessing whether investing in property aligns with your financial goals.
A lot of what makes sense in real estate is intuitive. We’ve all lived in different places and can recognize the properties that will be most desirable compared to those that won’t.
There will be a lot more risk, for example, if you’re looking to buy a property that requires a lot more in the way of updates or renovations.
On the other hand, if you have a clear idea of how to improve a property you can maximize your return by grabbing these low-hanging opportunities.
Cash return on real estate vs small business
The return on investment in real estate vs buying a business are very different, as are the risks and time commitments.
Buying a business has more risk generally but also a much larger upside.
Many acquisitions entrepreneurs are looking to break even on a business in 2-3 years, meaning that they’ve earned back their original investment in that time period.
In real estate, many investors might be looking to earn a return of 8 to 20 percent, which is much lower.
On the other hand, investing in real estate is much more about the long term and you’ve always got the value of the property.
Investing in real estate is generally good over time but perhaps not as profitable as a business if things go well.
Financing options when investing in real estate
The capital required to invest in real estate is generally medium to high compared to buying a business. Let’s say you want to buy a $300,000 property with 25 percent down. That’s $75,000.
Most people don’t have this kind of money laying around in their savings accounts so will usually have to turn to traditional lending options like bank loans.
Securing these will depend on your own financial situation, lending environment and credit score, to a name a few factors.
Entrepreneurs will often look at reducing the down payment so they can own more properties.
One potential route into the real estate game is so-called “house hacking.”
This is where you move into a fourplex or duplex and then get an owner-occupant loan either subsidized or insured by the government so you could provide 5 percent down on a 3.5% 30-year loan.
Financing options when buying a small business
There are generally more favorable financing options available when buying a business and the upfront capital costs are generally lower.
One excellent option for buying a business is to use the SBA loan program, where the government insures the majority of loans between individuals and banks when buying a small business.
Seller financing is also much more popular when buying a business compared to real estate.
Let’s say you want to buy a $1 million business earning $350,000 in profit. A typical deal through the SBA might consist of 10 percent equity, 10 percent seller financing and the rest covered by the SBA loan.
That means you could purchase that business with $100,000 of your own money.
You can also use third-party investors to amass your 10 percent down payment.
Whether you choose to buy a business or investment is real estate is ultimately up to your personal financial situation and investment goals.
Do you have limited access to capital but a particular skillset you think could be used to maximize profitability in a particular industry? Buying a business is probably the path for you.
Do you have access to capital but don’t really have the time to oversee a business? You might consider investing in property instead.
Both are viable paths towards your financial future.
Think about both strategies and how they fit into your investment thesis.