Should Your Business Lease or Purchase Commercial Space?
To Lease Space or Buy Space? Which Is Best for Your Business?
If your business is successful and your current lease is about to expire you may want to consider buying commercial space or industrial space rather than continue leasing space for your small business. In this article we will explore the pros and cons of leasing a business versus buying commercial space.
Location, Location, Location
When thinking of buying your own building to house your business remember that location is just as important with commercial space as it is with your own home. If your customer base is primarily in a particular part of town you will likely need to continue operating close to your current location and if the market is tight it may be difficult to find space to purchase in the same area. A different location may not appeal to your customers.
Advantages of Buying a Business Property:
- Low financing costs - With current interest rates at historic lows you can take advantage of low mortgage rates to own your own premises, thereby building ownership equity rather than paying a landlord.
- Fixed overhead - Owning your own premises means that you know what your future costs will be – mortgage rates have been declining for decades and do not fluctuate like lease costs sometimes do. By owning the property the real estate component of your business overhead is fixed for the mortgage period. On the other hand, lease costs are affected by improvements to the building, changing real estate values, demand, and other factors. When leasing a business, there is no guarantee that at the end of a lease period you will be able to renew your lease under similar terms. Recently, for instance, I spoke with the previous owner of a local retail business who when faced with an unaffordable 30 percent increase in lease costs decided to close his business.
- Stability - If your business uses specialized equipment, machinery, or fixtures that are difficult and/or expensive to move, or if the business requires extensive renovations, ownership of the premises may be preferable. Otherwise, if the landlord does not renew your lease when it expires you could be facing extensive costs, particularly if the lease stipulates that you must return the premises to the original condition when you leave.
- Potential appreciation in value - If you are fortunate enough to purchase a building in an upcoming area and/or at the bottom of a real estate cycle, the property may greatly increase in value in future.
- Collateral - Premises owned by the business are an asset that can be used as collateral for debt or equity financing.
- Freedom from landlords - Not all landlords are created equal, and some landlords are prone to cutting costs by neglecting maintenance, security, and capital improvements.
- Subletting for additional revenue - If you buy a business property and there is extra space on the premises you may be to bring in additional revenue by subletting (See 5 Ways Your Business Can Make More Money.) This can be lucrative provided there is a steady demand for space in your location and a good supply of quality tenants. However, as anyone who has ever been a landlord can tell you, dealing with tenants can be very frustrating and time consuming, and in a slowing economy this tends to be more of a problem.
Disadvantages of Buying a Business Property:
- Possible decline in property value - If after a number of years in a particular location it becomes necessary to move, owning your own commercial space can be a major drawback. Deteriorating business conditions, changes in the neighborhood, or local tax increases may cause a decline in value and make selling your business property very difficult.
- Tying up capital - If your business is in a startup or growth phase you may prefer to invest capital in the business rather than buying commercial space.
- Fluctuating interest rates - With interest rates at historic lows an eventual rise is likely, meaning your mortgage costs may increase in future.
- Cost savings may be negligible - When leasing a business, the costs of property taxes, maintenance and repairs, security, parking, insurance, etc. are mostly included in a lease agreement. If you purchase a property these expenses become your responsibility. Any decision to buy or rent should include a side by side comparison of the cost of renting versus owning. If you intend to purchase you should have an annual maintenance budget that includes money set aside for major repairs such as roof replacement, building envelope refurbishing, etc. The renewal of an existing lease can actually work in your favor in periods of slow demand and low occupancy rates. In such an environment if you have a good relationship with the landlord you may be able to negotiate better lease terms such as a lower rate, a longer lease period, or improvements to the premises.
- Do you really want to be an owner/landlord? Your accountant can analyze your operating budgets, investigate tax issues and advise on the pros and cons of buying versus renting from a financial perspective, but when making the decision to buy you should also take into consideration how much extra time will be taken up by being an owner/landlord. Dealing with maintenance issues and tenants (if subletting) can consume a great deal of time that may be better spent focusing on your own business activities.
- Is your business growing or declining? Owning a business property can be problematic if your business is in a growth (or downsize) phase where you may need to sell the existing premises to either acquire additional space or reduce your space requirements. Renegotiating a lease is much less difficult.
Have You Considered a Home-Based Business?
If your business is suitable there are a great many advantages to operating a home-based business. Aside from not having to commute to work, home business owners typically have a better work life balance, and the expenses related to the portion of the home used for business are fully tax-deductible. If you're interested in starting a home business see:
Consult the Experts
In any decision to purchase commercial space make sure you have the right people on your side and involve them at all stages of the decision. This includes:
- An experienced realtor with expertise in commercial real estate
- A lawyer who specializes in the conveyancing of commercial property
- A mortgage adviser
- Your accountant