Are you wondering if it would be more favorable to purchase or lease a facility for your business? If not, are you just interested to know how these two methods of acquiring commercial real estate differ? What are the merits and drawbacks of each? Is now a good time to purchase commercial space? Should you focus on historic low interest rates that drive more favorable monthly costs, or global economic fragility & geopolitical market forces that may undermine overall value? A good place to start is with basic empirical considerations.
For starters, two companies of the same size in the same industry may have very different answers. Leasing may make more sense to a rapidly growing start-up company that is burning through cash for their expansion. Flexibility to adapt to changing needs and a need to re-invest profits make this decision simpler. In contrast, a mature business may prefer to control their location and will have stable space needs, and a long term view toward appreciation, plus a desire to control costs. As such, this company may be a candidate to purchase.
Between these two extremes are many companies that must assign value to different considerations to determine whether to buy or lease.
Some reasons cited by businesses to buy their commercial space include:
- Investment (equity growth)
- Personal control of domain (no dependance on landlord to modify or improve the space, or need of landlord consent to do so)
- Business continuity (no threat of costly business disruption based on landlord’s decision to not renew lease)
- Tax benefits (the ability to write off financing interest payments and depreciate the building, as well as defer payment of capital gains taxes through IRS Sec. 1031 exchanges)
Some drawbacks to purchasing commercial space include:
- Investment commitments of typically at least 20% of the purchase price (which is often difficult to free up and make liquid quickly)
- Potentially much higher monthly costs than leasing (especially if considerable debt is leveraged against the property, and equity build-up could be very slow)
- Depreciation in sluggish or depressed economies (a large portion of the value of the asset, or lender’s collateral, can evaporate based on market forces beyond your control)
Some benefits cited by businesses to lease include:
- Flexibility to address changes in the company (because some firms cannot forecast their needs beyond 3-5 years, or fewer)
- Savings in capital (other investments may be more profitable)
- Less risk and obligation (because the landlord is responsible for repairs and maintenance of the property)
- Tax benefits (that allow a company to deduct rent and general operating expenses associated with their office space)
Some drawbacks to leasing commercial space include:
- Reduced ability to expand premises at will (many landlords do not grant sweeping expansion rights because of their responsibilities for notices, and some landlords breach these rights inadvertently)
- Absence of control over the environment that one has under lease agreement
- The proverbial stack of rent receipts (as opposed to equity build-up often inherent in ownership)
While there is no sweeping rule for deciding whether to lease or own your business’ commercial space, the pivotal question is: Based on a carefully prepared and analyzed cost comparison between similar space for lease and purchase, do the rewards justify or outweigh the risks?
Fortunately, you are not alone. An exclusive tenant/buyer representative will take the time to understand your company’s industry, history and anticipated future. They will know your investment position and objectives and work with your expert tax and legal counsel to to help you make the most informed decision.