Whether you have a law firm, dental office, retail store, nonprofit, manufacturing firm or art studio, there comes a point where every organization must weigh whether to lease or buy commercial space. The decision hinges on factors such as the type of business enterprise, available capital and the local commercial real estate market.
Consult with the company’s financial advisor and a commercial real estate broker to learn other perspectives to make a final decision.
Here are some metrics to consider and help make a preliminary decision.
Compare the Cash Outlay
Most commercial leases do not require a large amount of upfront money compared to purchasing a commercial property. For example, a commercial property may be listed on the market for $750,000. A buyer would need to have as much as a 30% down payment of around $225,000. The transaction costs include an appraisal, property inspection, loan fees, charges and other expenses. Conversely, a commercial tenant may pay a base rent of $5,000 a month for the property.
Fixed vs. Variable Cost Factor
If you purchase a commercial property, business owners can do a good job of estimating the costs year after year, such as the monthly payment on the loan and certain operating expenses.
Most commercial leases contain a clause that allows an annual base rent adjustment tied to the Consumer Price Index or other benchmark. When a lease term expires, the tenant becomes subjected to the whims and uncertainties of the local commercial real estate market.
Business Expansion
Make an accurate estimate of the company’s growth and space requirements over the next few years. A company that expects to outgrow the space in a few years may choose to lease space with a strategy that calls for them to buy after three years or at end of the lease term.
When making a decision to buy commercial space for your business, consider the costs of moving out of a building you own and the consequences of selling or leasing your current space.
Tax Consequences
The IRS Code affects commercial property tenants and landlords differently. For example, rules allow businesses to deduct the full amount paid as rent. Rental property owners can write off repairs. However, improvements must be deducted over a 39-year period.
Regulations also allow commercial property owners to depreciate property over 39 years. Property owners can also deduct interest payment on the mortgage. Both tenant and landlords have a list of qualifying expenses which they can deduct.
Appreciation Factor
Becoming a property owner puts the company in the real estate investment business. Owners with more space than currently needed for their operation can become landlords and lease space to other businesses. Commercial property purchased in an excellent location that has a history of appreciating land value opens opportunity for the property to be sold for a profit at a later time.
Making the Final Decision
It might make financial sense for established business owners who have the finances and plan to stay in one location for the near future to buy commercial space and build equity, instead of making monthly lease payments. Management must add into the equation ordinary costs of operating a property, as well as irregular expenses and “surprises” awaiting any commercial property owner.
Business owners who are undecided about making a large upfront payment, unsure about future space requirements of the company or unmotivated about the prospects of commercial property ownership will find leasing far more appealing.
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