| April 29, 2015
It’s the burning question on the mind of many entrepreneurs – should I buy or lease a building for my business? Trulia recently ranked the top 10 U.S. cities where buying currently makes more financial sense than renting, and 9 of the top 10 were in the Midwest. The survey focused on residential property, but when the market is hot, the market is hot. Unfortunately, the choice is not always black and white and considering these important x-factors may help you see through the fog.
Do you have the cash to make a down payment? Do you have the credentials to qualify for financing? Lenders are increasingly making money available to finance commercial real estate acquisition and development, but not every business will qualify. Underwriting standards remain tight in our post-recession economy, and loan approval requires strong financials, a well-developed plan including a fully pre-leased building (whether 100 percent owner-occupied or multi-tenant) and at least 30 percent down (unless you qualify for an SBA program). Renting space requires significantly less upfront cost and hassle, and will still cost your company less on a monthly basis despite increasing rental rates and stabilizing vacancy figures across property types. On the downside, rented space may require certain improvements or other investments, which your business may not recoup at the end of the lease term. Tax is an important consideration as well – rent and interest is deductible in the year it’s paid, but the cost of the building must be amortized over a long period of time (don’t rely on me to tell you how long – consult your accountant or tax attorney!).
Despite the barriers to entry, becoming an owner of commercial real estate today, with values on the rise but still well below pre-recession levels, may prove to be a fruitful investment for your business down the road. But, perhaps, an investment is exactly what your business hopes to avoid – in that case, today’s rental market remains ripe with good deals for tenants.
Depending on the nature of your business, the amount of time spent in your chosen location may or may not be an important consideration. Purchasing space obviously provides the opportunity to stay in one spot indefinitely, while leasing space is most often for a definite term. Certain types of businesses, like retail, may derive certain goodwill with their customers due to maintaining a consistent business location. Other types of businesses, like certain service firms, may actually achieve a different type of goodwill with their customers by relocating from time to time to “hot” neighborhoods or locations. The costs of acquiring new or different space, along with the costs of moving, are also serious considerations.
It’s also important to consider the ability or inability to project and manage monthly expenses. If space is purchased, the monthly loan payment will likely be fixed. However, other expenses, like utilities, maintenance and other incidental items will be in flux. If you lease, the monthly rent may be subject to increase, but other expenses will be easier to predict because they are typically charged to tenants at a fixed monthly rate. Can your business model absorb these kinds of fluctuation?
Not surprisingly, there are different risks inherent in owning versus leasing space. Owning property carries with it the risk of liability for a variety of things, including injury, property damage or environmental issues. Most businesses choose to form a new entity to own the real estate (known as a holding company) to segregate such risks from their business operations. New tax regulations have complicated this common structure, so businesses should consult a commercial real estate attorney or tax attorney before taking this step. Renting space also comes with some risk, including damage resulting from the activities of other tenants and the landlord. Planning and tough negotiation in the early stages of either decision is essential to managing these risks and the myriad of others which exist.
Pondering these x-factors should help with your decision to buy or rent. In either case, a commercial real estate attorney can provide deeper insight into the legal and financial considerations of both leasing and buying. As a start, check out this “Is it Better to Buy or Rent” calculator from the New York Times. The tool pulls from many variables, particularly how fast prices and rents rise and how long you stay in your property. There is no perfect algorithm, but careful consideration will ensure you make the best decision for your business.
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