Small Business Tip: When to Rent A Larger Space

by Dawn Fotopulos on January 20, 2012

Sharon, our dog groomer extraordinaire, is looking to expand her business AND work less hours. These articles on small business tips captures the advice we gave to Sharon.

For more on how to expand without going bankrupt, click here.

Sharon’s strategy is to buy a second home with a large garage to house her expanded dog grooming business.

Her plan is to rent the home to her part time worker, Emma and Emma’s mom,  and to renovate the garage for her dog grooming business.

The renovation would include full insulation, heating sources, running pipes to the garage for sinks and tubs as well as increasing the electrical capacity of the space.

Right now, her business is in the garage of the home she and her family live in. Her husband renovated their garage so while it’s small, she’s been able to grow her reputation and her business in that space.

Her maximum capacity is four dogs a day so unless she plans on hiring more full time people, her current space is really adequate for her client base.

So how did we assess Sharon’s plan to buy a new house?

The most important small business tip we can give Sharon is to recognize the assets she does have instead of reaching for what she thinks she needs.

Right now, her husband’s income is subsidizing the utilities, heating costs, and insurance expenses of operating out of her home’s garage. Her husband also did the build out of the garage to give her the plumbing and extra equipment the business required.

Sharon didn’t pay anything for all that work. If she buys the second home, it will be a different story. Her costs could easily reach in the thousands or tens of thousands depending on the condition of the place.

The other small business tip to remember is that you should always stay true to your core competency. Sharon is a great dog groomer. She’s never been a landlord. If she buys this second house, that’s exactly what she’ll become.

Anyone who’s ever been a landlord can tell (myself included) you WILL get those calls at 2AM when the heater isn’t working in the middle of the winter. And that’s just for starters.

What happens if Emma decides she doesn’t want to work in the business any more? Or worse, Sharon has to fire her due to poor performance. How much flexibility will Sharon have to do that if Emma and her mom represent key cash flow for this new piece of property?

Next, Sharon does not have the funds to put a down payment on any piece of property. She’d either have to borrow from the bank or from her relatives.

Given the small size of the cash flow generated from the business, the bank would probably not give her the money or it would ask for a personal guarantee. That could mean putting a lean on her family’s home. Marriages have broken up for less than that.

Last, now is NOT the time to purchase real estate unless you find a fire sale that’s a world-class value, and you will not need to sell it for at least ten years. No I’m not kidding.

As a former real estate investor, I can tell you interest rates run inverse to the value of any property. Interest rates are at their lowest in history.

That means property values are far higher than they probably should be. Despite the fact that we’re experiencing a recession, property values still have a very long way to drop.

Remember this article. Three years from now, everyone will think I’m a prophet.

When buying real estate, it’s better to pay 10% on a mortgage (as I did in 1990) and get the underlying property for a steal because you can always pay off the mortgage early. The total mortgage will be low because the property value is low.  You won’t have to borrow as much.

As an investor, it also means you have some downside protection in the value of the asset. As a small business tip, just ask yourelf which situation would you prefer;

  • Hold a mortgage at 10% on a $100,000 property that keeps its value or
  • Hold a 4% mortgage on a $240,000 property that loses 30%?

Property values are still inflated. I don’t care what anyone says, they are.

If Sharon borrows from relatives and banks to buy this second home and build it out, she is taking on business risk, personal risk,  and market risk.

If Sharon pursues this course, she will degrade her balance sheet, alienate her family members, possibly even lose the house she and her family live in.

(It’s a wonderful old farm house her great grandfather built. What a treasure to have and a tragedy to lose).

The likelihood she’ll lose money is extremely high if she buys the second piece of property;  far greater than she knows or is willing to accept.

We do not recommend expanding your physical plant and equipment when you want to reduce your working hours even under the most favorable real estate conditions.

In recessions, play a hard game of defense. Don’t think of  expansion unless you have the revenues in your hands. Don’t buy new plant and equipment unless it will increase revenues,  reduce expenses, or save time immediately.

Don’t invest in something expecting a three year return on investment. Not in today’s uncertain economy. If you purchase anything, you must get back at least four times your money in six months. If you can’t be sure you will, don’t make the investment.

If you don’t know how to measure revenues or expenses or return on investment, you must watch our Instant CFO Course. A $249 value for only $49.

Our next article will address what Sharon can and should do to increase her cash flow and ensure she’s not working crazy, high-pressured hours.

She can simplify her life AND make more money.  Stay tuned……..



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