When the family business and the real estate are the same risk
What happens to a family's real estate when it is intertwined with an operating business built by the same generation.
A founder builds a company, buys the building it operates from, and spends the next thirty years making both work. The business pays the rent. The rent pays down the mortgage. The property becomes part of the family's wealth and, eventually, part of what the founder intends to leave behind.
There is good reason to value that arrangement. Owning the premises can give a business control over its location, room to invest, and continuity that a lease with an unrelated landlord may not offer.
But the family may be counting two assets whose income depends on the same source.
If the operating company weakens, the property can lose its tenant at the same time the family loses business distributions. A separate deed, a separate entity, and a separate set of accounts do not, by themselves, create a separate economic risk.
The useful place to begin is with the money. Where does it come from, and which obligations depend on it continuing?
Federal banking guidance makes a relevant distinction between real estate loans supported by third-party rental income and loans supported by the ongoing operations of an owner or affiliated business. The distinction concerns the source of repayment. Applied to a family portfolio, it suggests a straightforward test: how much of the property's apparent stability rests on the company occupying it?[1]
Consider an illustrative family-owned distribution business. The company occupies a warehouse owned by another family entity. Its earnings support salaries, shareholder distributions, and rent to the property owners.
A loss of major customers could affect all three. The warehouse might still have substantial value, but replacing the tenant could require time, capital improvements, and a different rent. The property's value and its ability to provide immediate income are separate questions.
That dependence can remain manageable while the founder controls both sides. It becomes harder to administer when the next generation has different responsibilities.
Suppose one child takes over the business while both children inherit interests in the building. The operating sibling wants affordable occupancy costs and room to reinvest. The other wants reliable property distributions and adequate reserves. Both positions have an economic basis. A rent decision now determines how benefits and burdens are shared between owners.
A lease should make that relationship understandable. What supports the rent? Who funds major repairs? How are increases reviewed? What happens if the company needs less space, misses payments, or is sold? Where the same person represents both sides, the family also needs a process for reviewing decisions that affect owners differently.
The aim is to establish terms that the next generation can administer without having to reconstruct what the founder intended.
Succession also changes the assumptions behind the property's income. A 2007 study published in The Quarterly Journal of Economics found reduced operating profitability following family CEO successions in the Danish firms studied. Its findings are specific to that research setting. For a family property owner, they reinforce the need to examine future management and business performance rather than simply carry the founder's results into the next generation's forecast.[2]
The next leader may be capable and committed. The company may still need a different location, additional capital, or a smaller footprint. The real estate plan should allow those possibilities to be considered before occupancy becomes a family obligation that nobody can comfortably question.
Debt deserves the same attention.
The Office of the Comptroller of the Currency identifies weak financial performance, constrained liquidity, high leverage, and approaching maturities as factors that can increase refinancing risk. Its guidance also emphasizes considering other debt and testing whether a borrower can qualify under prevailing lending conditions.[3]
For a family enterprise, that means reviewing the business and property financing together. Which assets secure which loans? Who has given guarantees? Are there cross-default provisions? Does either borrower depend on the other for support? Those answers belong in a review of the actual documents with counsel and the lender.
A property that appears lightly leveraged on its own may sit inside a more demanding set of obligations.
There is a tax connection as well. IRS Publication 925 explains that net rental income from property rented to a trade or business in which the taxpayer materially participates is generally treated as nonpassive income, subject to stated exceptions. Calling an arrangement a rental does not settle its tax treatment. Changes in participation, ownership, or occupancy deserve review with the family's CPA.[4]
The property also needs to be understood outside its current use.
Would another tenant want it? What would adaptation cost? Are its layout, access, utilities, and permitted uses suitable for a wider market? Could the land support a different use, subject to approvals and a realistic development analysis?
Those questions help establish what options the family actually has. A building designed around one company's operations may require meaningful investment before it can serve another. A well-located parcel may offer flexibility that the current business has never needed to explore.
A useful assessment therefore looks at the company and property separately, then brings them back together. It examines sustainable business earnings, supportable rent, property expenses, capital needs, debt obligations, and ownership rights. It also tests a period of interrupted rent, a business sale, and a change of tenant.
Any proposal to support the business through reduced rent or additional property borrowing should state the amount, duration, expected benefit, and effect on each owner. The reasoning should be recorded while the decision is being made.
The right outcome may be to keep both assets, retain the building after selling the business, or change the property's use. What matters is whether the arrangement still serves the family's objectives and can be governed by the people who will inherit it.
The founder made the business and the building work together. The next generation needs to understand the terms on which they can continue to do so.
Before deciding what happens to the real estate, the family needs to know what happens to it if the business changes.
Sources
- Federal Reserve, OCC, and FDIC. “Interagency Guidance on Concentrations in Commercial Real Estate Lending; Sound Risk-Management Practices,” December 2006. The source is bank supervisory guidance; its distinction between repayment sources is applied here as a framework for family portfolio analysis. https://www.federalreserve.gov/frrs/guidance/interagency-guidance-on-concentrations-in-commercial-real-estate-lending-sound-risk-management-practices.htm
- Bennedsen, M., Nielsen, K. M., Pérez-González, F., and Wolfenzon, D. “Inside the Family Firm: The Role of Families in Succession Decisions and Performance.” The Quarterly Journal of Economics, 122(2), May 2007, pp. 647 to 691. Research findings checked against the journal abstract reproduced in HKUST's institutional research portal; the full article was not reviewed. https://researchportal.hkust.edu.hk/en/publications/inside-the-family-firm-the-role-of-families-in-succession-decisio/
- Office of the Comptroller of the Currency. “Commercial Lending: Refinance Risk,” Bulletin 2024-29. https://www.occ.gov/news-issuances/bulletins/2024/bulletin-2024-29.html
- Internal Revenue Service. Publication 925 (2025), “Passive Activity and At-Risk Rules,” section “Rental of Property to a Nonpassive Activity.” https://www.irs.gov/publications/p925