Property and other Non-Current Assets
No matter how attractive property in the form of business premises may be, it's potential disadvantages outweigh its benefits by a considerable margin.
Expenditure and debt associated with physical non-current assets including property represent cash and / or financing resources that are no longer able to service a company's core trading operations and therefore unavailable to support further expansion..
Banks and other lenders are more concerned with risk, which is why, when assessing that they lump everything together, making no distinction between financing your trading and financing your property.
In any case, having less debt in the balance sheet is always very much better than having too much of it, especially when a large part of it is unconnected to financing operating cash-generating assets such as accounts receivable and stock on the shelves.
Do It Yourself
On the other hand if you want to eliminate rental inflation without affecting balance sheet liquidity, the smart way to do it is to acquire the property via your pension fund and become the company's landlord yourself.
Risks of Property in the Balance Sheet
A business investing in property is not a fail-safe investment either. In the event of an economic downturn, the value of property of all classes eventually suffer with commercial property usually the first to go and the last to recover.
Property and Secured Creditors
It is often argued that the presence of property in the balance sheet of any business can be reassuring to creditors. That can be so but not necessarily in a good way.
What is more likely is that if a company experiences problems that are likely to take time to satisfactorily resolve, secured creditors may use property as a get-out-of-jail card by forcing the business into administration and using its sale proceeds as a means to recover their debt, quickly and painlessly..
What if buying a business property instead of renting means that mortgage repayments are lower than rentals? That would mean more profit and better cash flow.
The answer to that is "liquidity." Providers of external finance do not separate long term debt from their exposure to a business when considering "risk."
If a business is expanding, increasing its borrowings (i.e. leverage) in the balance sheet to support an investment in an asset that reduces liquidity means that there is that much less cash and finance from trading facilities to support the much more important current assets such as stock / inventory and accounts receivable. These inevitably increase in line with expansion and that increase has to be funded somehow.
You're right about secured creditors and property. My brother's business had a freehold shop/office with a flat above and when things got tough in 2008, instead of helping him through that they put him into administration, flogged of the premises for a song and took the cash. They called it exercising their debenture. His accountant said that if he had been leasing the property instead this wouldn't have happened.
Property in the balance sheet is a rotten idea. Even if the mortgage to finance it is taken out with a different bank to the regular business bank the whole lot is banged together with the overdraft and any other facilities anyway. It may seem like an investment but to banks its just more debt and more risk regardless of its value, so if you need a bit of support for the business as we all do from time to time you could find the bank saying no.
This web site really has all the information and facts I wanted about this subject and didn't know who to ask.
One of the biggest problems with property in a balance sheet is that if a company with it runs into difficulty the bank or other secured creditor (but probably the bank) regards it as a quick and easy way to get its cash out. You've usually got a better chance of being allowed to trade your way out of trouble if your assets are all directly concerned with your business.