Ah, the age old question…Should I Lease or should I Buy? In dealing with entrepreneurs everyday, I hear it often.
There are definite advantages and disadvantages to both.
First let’s consider the purchase of real estate.
In buying a commercial building you are acquiring an asset that adds substance to the balance sheet. It builds equity over time as the mortgage gets paid off and as the value of the real estate goes up. It is an asset than can be borrowed against in the future or rented for income.
It gives the company a tangible asset which often times ends up being one of the company’s largest assets. It can become a large part of a business owner’s wealth building and/or retirement strategies.
A nice building can provide the owners of a company with other intangible benefits such as a feeling of stability, control and pride of ownership. A company’s building can also be their largest billboard and advertising vehicle. There are no rent increases to be concerned about or any risk of eviction or non-renewal of your lease by the Landlord.
A piece of property strategically acquired can also be a great way to income split with a spouse or children. The building is purchased by the spouse and kids and then rented to the company at a hefty rate, thus creating a way to legally split income with a spouse or kids who may be in a lower marginal tax bracket.
Also with a purchase you have potential tax advantages through interest deductions & facility and equipment depreciation. If your company is large enough in size there can be local tax implications as well, as we have all seen over recent years with local state and provincial governments competing with each other to offer tax holidays to corporations to move their company to their respective jurisdictions.
Ownership in a good quality piece of property can also offer the corporation the possibility of a future sale-leaseback. This type of deal is typically only done by larger, well established, good credit risk type corporations. The sale-leaseback is a transaction where a company owns a piece of property but wants to free up some capital for whatever reason. The company sells the property to a non-related third party and then leases the property back for
10 or 20 years. The sale-leaseback can be a strategic move to free up capital that is tied up in real estate and provide a form of off balance sheet financing for specific projects or corporate objectives. It also frees up lines of credit and other financing channels that corporations use.
As with all things in life there is a price to pay for these benefits.
First of all there is the sizable chunk of equity that is required to purchase a commercial property. There are, from time to time, government backed programs that enable you to get into a property with as little as 10% down but for the majority of the time the minimum investment required is in the 25 % to 35 % of purchase price range.
Secondly this is typically a long term investment and it is not the most liquid of investments. If the use or design of a property is very specific in nature due to the type of business that you have, it may be very difficult to sell the property when it comes time to get out. (Like my old boss used to say… be careful what you own because it ends up owning you.)
Of course as owner you are the go to guy when it comes to maintenance and repairs as well. Make sure you have funds set aside for emergencies and budget for long term capital items that wear out over time like furnaces, roofs, parking lots, sidewalk paving, etc.
Now let’s look at Leasing.
Leasing commercial real estate can be attractive for many reasons.
First of all, leasing commercial real estate is the ultimate leverage for a business owner. Think of it this way, if you have little money to invest it allows you to get a PREMIUM location for an easy monthly payment instead of the sizable investment that would be required to otherwise secure the very same location through a purchase. (If you could even buy it, as the most desirable locations are often NEVER for sale) Even if you do have a large chunk of
cash you may still want to lease because the location that you can secure through leasing is still more desirable business wise than one you could secure through a purchase. This is why you see huge companies like Burger King, Wal-Mart, Sears, IKEA, etc. leasing space instead of buying. They have the cash to buy but it makes more business sense to lease in a better location.
You can also gain leverage through being able to find a location that was previously built out by someone else whose improvements to the space are still suitable for your needs. If you find a location that was fixed up by a previous Tenant and those improvements to the space still work for you with minimal change, you can save ten of thousands of dollars. Sometimes a Landlord would be willing to finish the space the way you need it and then amortize the costs of the improvements into the rent. Anytime you can get what you need for your business and
not have to spend the money to get it that is a big benefit to your company.
Leasing is a an absolute boon to anybody looking to expand their business to multiple locations in a short time frame or anybody whose company is going through rapid growth. It can also allow you to keep the money in your business where it may be earning a higher rate of return than it could earn if it was invested in a piece of real estate.
Leasing provides flexibility to move with minimal time and expense at the end of a lease and depending on the Lease you sign, the ability to expand to adjacent space (if it is available) or shrink through sub-leasing as your company changes in size.
There are tax implications to leasing as well. You can deduct the full amount of the rent from your taxable income. Leasehold Improvements are capitalized and expensed over the life of the lease and the first two renewal options.
Some of the downsides to consider in leasing are as follows:
1. You future is affected by the decisions of others. If your Landlord wants to raise your rents or not renew your lease it can have an immense impact on your business.
2. The money you spend each month does not create any long term wealth or asset value for you or your company.
3. Often the lease has clauses regarding the sale of your business to another person and the Landlord may have the right to reject any person whom you may be trying to sell your business to. Some leases even give the Landlord the right to terminate your lease if you try to sell your business or assign the lease to a new party. Read Your Lease Carefully and know how it will impact you!
So now that I have laid out the pros and cons to either option, here is the world as I see it. If your company is just starting out, is cash poor or is going through rapid changes in size due to growth or downsizing…Lease. If your company is mature, stable, experiencing slower growth patterns and is cash rich…Buy.
This is not intended to be Legal or Tax advice. Please discuss these ideas with a competent advisor.
About the Author:
Harry Logan is a Commercial Realtor with RE/MAX executives realty in Winnipeg, Manitoba, Canada. Harry represents Buyer’s & Seller’s and Landlord’s & Tenant’s in all aspects of Commercial Real Estate including the Leasing and Sales of Retail Shopping Centers, Apartment Blocks, Investment & Income Producing Property, Industrial & Warehouse Space, Office Leasing and the Sale of Businesses.
Harry can be reached at 204-667-SOLD (7653) or through his website at http://www.WinnipegCommercial.com