The uncertain future of commercial property values in south central Pennsylvania makes the decision to buy or lease commercial real estate a difficult one. Some business owners want to buy, but are left with questions about when and how to buy commercial property in order to make the most of the real estate market. Meanwhile, others contemplate whether to purchase at all, or whether it is more beneficial to continue leasing their commercial space. This article highlights some advantages and disadvantages to both buying and leasing in order to assist business owners in making this difficult decision.
Buying commercial real estate to house one’s company offers many advantages to business owners. Purchase of real estate allows a business to avoid the inevitability of rising rents and improves the owner’s ability to forecast operating expenses. It affords the owner the ability to control costs and avoid the possibility of a change in ownership or management that is unsatisfactory. This allows a business to maintain a competitive edge over rivals who, because of rising rents, are forced to raise prices to meet expenses. Furthermore, purchasing real estate can produce both short term and long term sources of revenue for the company. In the short term, leasing or renting the property can provide an immediate stream of rental income. In the long term, the sale of the property can generate revenue because real estate usually appreciates in value over time.
Another thing to remember is that a rent payment and a mortgage obligation for the same amount are anything but equal; rent is consideration for the use of another’s property, while a mortgage payment is a financial obligation that accumulates equity (ownership) as it is repaid. In short, one who pays off a mortgage typically owns a property free and clear, not so for the tenant whose lease expires.
An additionally powerful, yet often overlooked benefit of owning the real estate upon which the business is located is that the business likely will be easier to sell if accompanied by the real estate. That is, prospective buyers will find it easier to get financing when they are buying both your business and the real estate, and an increase in interested buyers usually results in increased selling prices.
Buying commercial real estate, however, is not for every business. Some companies prefer the flexibility that leasing offers. This holds especially true for companies that are experiencing rapid growth and need to upsize their commercial space frequently. Moreover, if buying commercial property puts a strain on working capital or wipes out capital reserves, it could put a company in a very vulnerable position. For this reason, buying commercial property is out of the question if it could limit a business’s ability to take advantage of new opportunities for lack of liquidity. In these scenarios, the flexibility and limited upfront expense of a lease makes leasing the smart choice.
Some other advantages of leasing include:
- No down payment is required. Avoiding a down payment frees capital for expansion that would have otherwise been expended on a down payment— while keeping the option to purchase open until finances are more stable.
- Avoid property upkeep and maintenance. When the air conditioner breaks (as it eventually will), a lessee business owner need only call the property manager and wait for the repair person to arrive. Alternatively, if that same space was owned by the business, all similar repair and maintenance expenses would have to be paid by the business.
- Leasing provides short-term flexibility. As a business expands, it may outgrow its space. By signing a lease for one to five years, a business retains the option to move to a new location better-suited to its changing needs. Leasing also gives business owners the opportunity to try different locations to determine which one(s) are better for customers, employees and the overall business model.
- Finally, there are tax benefits of leasing. While businesses can routinely deduct the full amount of the rental payment , commercial real estate owners are limited as to what expenditures they can write off and when. A property owner can write off repairs immediately, but deductions for improvements to and depreciation of commercial real estate are taken over time. Property owners also can deduct interest paid on the purchase loan, property taxes and certain other expenses.
The bottom line: if a business can rent for considerably less than buying and can lock into a favorable lease, in a building and location that accommodates the organization’s needs for the next five to ten years, then renting may be the wisest choice. Before doing so, however, make sure that the prospective landlord is reputable and financially stable so that utilities, property taxes, building maintenance and security do not become issues. Other business owners, opting instead to purchase commercial property, will find ample opportunities in today’s current market.
Is Now a Good Time to Buy Commercial Property?
Despite an ongoing debate about the direction of the commercial property market, good deals on commercial real estate are available. While commercial landlords may be currently offering leases at competitive prices with months of free rent and other sign-on perks, purchasing outright is similarly appealing. Struggling businesses and strategic defaulters who have witnessed property investments slip “underwater” present excellent opportunities for savvy potential buyers. Additionally, the current buyers’ market coupled with low interest rates puts potential buyers in a position to command favorable terms.
Despite the possibility of small market fluctuations in the near future, the bottom line is this: buying property under ideal market conditions that has great appreciation potential presents an excellent financial opportunity for business owners. If an owner is not planning to sell or relocate the business anytime soon, then he or she really has nothing to lose in purchasing, especially because many commercial mortgage loans do not require personal guarantees.
What to Look for When Buying Commercial Property
Keep these important factors in mind during your search for an appropriate business space to purchase:
- Does the location’s zoning accommodate your business?
- Is there ample space to expand your business?
- Is the location growing economically or experiencing population growth?
- Is there high traffic in the area (upon which your business, like most, depends)?
- Are there physical “red flags” that maintenance has been deferred?
Perhaps most importantly, a business should consider a commercial property that already has other tenants. Although becoming a landlord may create additional headaches, the revenue stream created from the rents may allow the property to pay for itself. If you plan on renting space, consider creating a business entity such as a limited liability company (LLC) to hold the property; the LLC would then lease the space to other businesses including the business of the owner. One main reason for this ownership structure has to do with the limited liability of an LLC; however, there are many other reasons beyond the scope of this article.
Finally, during your deliberations on whether to lease or buy a property, consult with a real estate attorney and tax professional about the legal and financial ramifications of both arrangements. This will ensure that both short and long-term business goals are realized.