You’ve seen this headline in the news: local business closes after owner loses their property to a bigger, more powerful, and more importantly, cash-flush entity.
It’s a story that Withco founder Kevin Song knows all too well. The entrepreneur’s parents, who immigrated to the U.S. from South Korea, ran a neighborhood grocery store in Brooklyn for 20 years until they got a call that the landlord sold the property to a large developer.
“My parents were good, hardworking, earnest people, and they did a lot of work in the community, because they knew being a good business owner meant being good to the neighborhood as well,” Song said. “But a real estate analyst calls up my dad and says, ‘thanks for paying rent here for the last 20 years, but we’re doubling the rent next month. If you can’t pay it, that’s too bad.’"
They lost the business they had spent decades building within a month, and their home shortly thereafter. Song was 11 years old.
Those losses inspired Withco, a lease-to-own commercial property company founded by Song in 2019. The model puts small business owners on the path to property ownership and seeks to prevent his parents’ fate from becoming that of other small business owners across the country.
“On the real estate side, what happened was no one’s fault. The big problem is that this system has become misaligned, where ‘small business’ as a tenant group is seen as very risky, even if you're a fantastic small business owner with a healthy business,” he explained. “You might have to pay more for your space, or you’re not a landlord’s top choice in terms of who they can lease the property to, even though that business is creating real, tangible value in their neighborhood.”
Song’s partnership is straightforward — Withco purchases a building and becomes the business owner’s landlord. They structure a five-year lease agreement that siphons off a portion of the rent into a fund that will later serve as a down payment. At the end of the five-year term, Withco returns that accrued money to the tenant to use as a down payment for a loan to purchase the building from them for a predetermined price.
“We want to create as many ownership success stories as possible and make business owners commercial real estate investors, so that they can be rewarded for building and running a healthy business, instead of potentially just getting the short end of the stick one day.”
“Most mom-and-pop owners aren’t commercial real estate investors, and they may not have the commercial real estate expertise to get into the business of [property] ownership. So, we brought the lease-to-own model to the commercial market to empower them to become property owners, and give them the ability to turn their incredible cash-flowing businesses into generational wealth,” Song said. “We’re bringing sophistication and an institutional-grade process to this [segment of the] market.”
Path to Purchase
Even as the owner of a successful small business with positive cash flow, many independent operators with expenses struggle to save enough for a down payment to purchase their property. It’s ironic, considering one of their biggest monthly business expenses is usually the rent.
Additionally, leasing space is a short-term product, said Song, and can "oftentimes be counterproductive, where the best business owners end up displacing themselves,” he explained.
Here’s how a typical deal with Withco might play out:
Withco’s team identifies a small business or gets contacted by one that may be losing its space or looking to move. The company primarily works with retail and restaurant clients, neighborhood shops and franchises, and medical tenants, though any credit-worthy business that qualifies under the Small Business Administration definition (a business with a tangible net worth of less than $15 million and an average net income of less than $5 million after federal income taxes for the last two years) is eligible for a Withco partnership if they meet the company’s underwriting requirements for financial stability.
Then, Withco helps the business owner determine if they will stay in their space, move, or expand into a larger or second location. “We will make offers on buildings that are occupied by the small business already or underwrite both the business and a potential property to help them think about where they can move their business to next. So, we're very flexible in terms of who we work with and how.”
Most Withco buildings are free-standing, single-tenant properties that cost less than $5 million.
Withco purchases the building and commences a five-year lease with the business owner. Everything is transparent — business owners are given their monthly rental rates, a portion of which is isolated into a fund for the future down payment that tenants can access at the end of five years. By then, they will have accrued the 10% minimum down payment required for a commercial mortgage (2% per year over the five years) so they can purchase their property. In all, the average tenants ends up recouping about 30% of their rent paid over the course of the partnership. Withco suggests to clients that they secure financing through the Small Business Administration.
The sale price of the property is agreed to in advance, so the tenant knows exactly how much they’ll be spending on the building five years down the line. Withco’s upfront purchase price takes into account appreciation, so the sale price won’t change based on market fluctuations. Yearly rent increases, which are usually between 3% and 4% annually according to Withco’s website, are also communicated upfront.
The five-year lease operates on a triple net basis, where tenants are responsible for paying their operating expenses in addition to rent, covering costs related to taxes, utilities and maintenance. Additionally, they pay for the buildout and material improvements to the space. As this is a common type of commercial lease, the terms are likely not that different from the lease a business owner typically has in place with a current landlord.
With this arrangement to purchase a property, the physical improvements business owners make in their space are now true investments in their business, as opposed to sunk costs should they vacate the property.
Withco did not disclose the number of properties it has purchased or businesses it is currently partnered with, just that it was in the double digits. While the young company hasn’t yet reached the five-year sale mark, Song said the anecdotal evidence of its success can be seen in the small business partnerships they’ve already formed.
To name a few examples, Withco has partnered with Waiiti, the owner of a Florida auto dealership who had to move three times in just four years due to building sales where she was renting before she partnered with Withco to buy her current space. And Isela, who runs a family-owned Mexican restaurant in Albuquerque, New Mexico that started as a food truck thirty years ago, but didn’t qualify for financing to purchase the building they’d been renting for two years. And there’s Linda, who bought a Pennsylvania-based massage and spa business from its owners after working there for a decade, but couldn’t afford to buy both the property and the business at the same time.
“I don't think you can ever root against small businesses in America. There are 33 million of them, and the great ones are entrepreneurs. The incredible thing is that a small business is, in so many ways, a representation of someone; someone’s heart on their sleeve and their passions and ideas all brought together,” Song said. “These business owners are putting themselves out there, and the owners we work with are the ones behind their counters, interacting with their customers every day.”
Room for Growth
Song asserted that, beyond helping small business owners invest in their own space, Withco seeks to bring a higher level of sophistication to the mom-and-pop commercial real estate market and considers itself an institutional investor. In many situations, a landlord selling their building might offer first dibs on the property to the current tenant, especially if they’ve had a long-standing lease. But as much as the tenant would like to own, they might not have the funds ready, qualify for financing in time, or be able to close on the building as fast as an institutional buyer could.
“We come into those situations and work with landlords and brokers to give them the high-quality experience of working with an institutional buyer versus someone who might just be doing a one-off deal,” Song said. Withco works with all-cash offers and promises a fast closing process where they’ll go under contract within 10 days, have a 45-day due diligence period, and close within the next 15 days.
Additionally, Song said these types of neighborhood properties can often have “a lot of illiquidity on the sales side, and a lot of vacancy on the leasing side. So, we believe that our company can empower brokers with a new financial product they can offer to their customers. Whatever [a broker’s] motivation is — whether it’s earning a great commission or keeping a local business in the community around for the long run, we think we can be a great partner to all parties [in the transaction].”
At the crux of his business, Song believes that small business owners make the best commercial real estate investors. With their heart and soul invested in their business, they become stewards of their building and the neighborhood.
“They keep their sidewalks clean, and their windows and brass polished because they take so much pride in that ownership,” he said. “That’s why we want to create as many of these ownership success stories as possible, and make business owners commercial real estate investors, so that they can be rewarded for building and running a healthy business, instead of potentially just getting the short end of the stick one day.”
In 2022, Withco closed on a $32 million round of funding and is backed by venture capital investment firms such as Canaan and Founders Fund, among others. Additionally, celebrity angel investors include Venus Williams and Will Smith.
“It’s such a rewarding moment to see a small business owner transform into a commercial real estate investor,” said Song. “That lightbulb moment where they say, ‘it’s not just about generating cash flow for my business, it’s about the value I’m creating by having more control over my businesses’ future and therefore building generational wealth for my family or creating a legacy in my community.' We want to help as many business owners as possible do that.”
Source: Loop Net :https://www.loopnet.com/learn/this-startups-lease-to-own-model-empowers-small-businesses-to-buy-their-property/559705347/
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