Disqualified Entrepreneurship

My company is headquartered downtown in a largely depressed, somewhat industrial, Midwestern small city. According to Sperling's Best Places, Racine has a population of about 81,000, a median home price of $122,100, unemployment of 14.1%, and a cost of living about 11% below the US average. When my wife and I decided to relocate our family out of the Los Angeles area (neither of us were California natives), we had three main criteria in mind:

1. Affordability (we were tired of renting again, after having owned a house in Denver, then a condo in Santa Barbara, but not about to buy into the overpriced Southern California housing market).
2. Family (my family is scattered to the winds, but my inlaws are concentrated within a couple hours of here).
3. Water (we learned to sail when we lived in Santa Barbara; my office is adorned with pictures of beautiful sailboats as inspiration for the boat we plan to own someday).

Racine fit the bill. Housing is still depressed here. The value of our home (purchased in 2008) has dropped about 6% since we bought it, putting us about where we started in terms of equity. But then, it's a place to live not an investment, and it satisfies that requirement.

About three years ago, we bought a small building downtown (four blocks from Lake Michigan) as the company was expanding beyond me and a part-time assistant. The downtown area is perhaps half vacant. So much real estate on the market. I see these buildings and all the potential they represent. I think of all the businesses that could fill them.

I've started getting interested in alternative investments. I'd far rather invest in a business that I am committed to building, than buy some miniscule share of a public company, where the value of my investment is driven more by perception than by anything else. But the odd thing about tax regulations, and the focus of virtually all government incentives for building and growing companies is that they preference investment in someone else's business but not your own.

While the IRS allows an endless variety of investments to be held in one's retirement accounts, there is this unbending rule regarding disqualification, which prohibits a party from transacting with themselves. As Pensco's Top 50 Questions & Answers explains:

Generally speaking, it takes three elements to create a prohibited transaction for an IRA:

1. the IRA;
2. a disqualified person in relation to an IRA (e.g., the owner or owner’s spouse, ascendants, descendants, etc.)
3. a transaction between 1 and 2 above.

As I read it, that means, it's okay to invest in someone else's business, but not your own. Now, granted, it does appear there are convoluted ways to invest in a startup, or an existing company that you are a minority owner of, but as far as I can tell, the rules that prohibit self-transacting prevent such a business from being one's source of income.

In other words, if your IRA owns the company, you can't get paid by it. What's more, it would be forbidden for my IRA to buy a building that a business I own would rent, or for me to personally own a building that a business my IRA owns would rent. What an odd way to hinder entrepreneurship. Sure, your investment can grow in your retirement savings. But some of us still need to pay our bills today.

I look longingly at these vacant buildings, and glancingly at my retirement savings, invested in small stakes of large companies that I have little connection to, and I wonder just how much more I could accomplish, if I could take my own funds to invest in expanding my firm, or starting a new one.

Commercial Real Estate: expanding the office headquarters

Worthy of note:

"At the moment transactions have dried up in the commercial-property market as owners try to avoid selling at a loss. Those owners are implicitly assuming that a rebound is imminent, yet the downturn may be prolonged."

--"Commercial Property: A concrete problem," The Economist, August 1, 2009

This is of particular relevance to me today, as I'm looking to obtain a new headquarters for my company. I'm increasing staff and need a larger space. Lease vs. buy is a relevant consideration. Because prices are somewhat depressed, it would seem a reasonable time to buy. But as the article cited points out, low prices may be around for a while:

"In Japan land prices are still nearly 60% below the peak they reached in 1991."

Granted, I'm not in a market that was among those severely overheated. Cost of living here is about 15% below the U.S. average. Asking prices for small commercial office space (2000-5000 sq. ft.) are around $45-60/ sq. ft. That said, the general principle is to compare rent vs. buy on similar properties. There's little point in locking up cash in real estate equity if you can rent a comparable space for less. It's just finding comparables that's the trouble.

The jury's still out. I'm leaning toward putting down an offer to purchase, knowing full well that it might not become much of an investment. But I'm prepared to walk away if I can't transact on my terms. I'm counting on the prospect that I will be needing office space for my business for the long haul; I'm betting on the success of my company, and the assumption that it'd be better to own the space than rent from some unknown landlord. But leasing remains an option.

The advice I've been given, from attorney and accountant, is to establish a separate LLC as holding company for any real estate purchase, then lease back the property to the main business under a triple-net lease. The key is establishing a reasonable fix on going lease rates in the area so as to neither overcharge nor undercharge in rent. That separates the office property from the core business, and permits additional investors in the real estate to be distinct from the ownership of the core business.

We'll see how it goes.