Buy or Lease?
Next time you're writing a check for the rent, ask yourself "Would I be better off owning my business location?" With interest rates at near historic lows, the answer for a sizable number of entrepreneurs is: probably so. "If you have the opportunity to either rent or buy, absolutely buy," says Scott Crossman, president of Orlando, Florida, commercial real estate brokerage Crossman & Co. "This is a great time in the market when you can borrow money on very aggressive terms. In the majority of instances, that makes great sense."
Owning does offer many benefits. With each mortgage payment, you'll build equity in the property instead of just lining the landlord's pockets. That equity may be enhanced if the property value appreciates. And as the landlord, you control the space, deciding everything from what color to paint the building to which tenants--if any--to lease unused space to. You also control costs, since you can decide on financing and maintenance and upgrade schedules. And you won't be subject to rent hikes.
Buying a commercial property generally requires a cash down payment of 20 percent of the value. If your property has other tenants, you'll need signed leases to show your lender. You'll also have to arrange for the property to be insured against damage or loss. Terms of the loan will normally be 15 years, with the interest rate pegged to a benchmark, such as the rate being paid by U.S. Treasury securities. Buying commercial property is a serious commitment that typically costs a lot of money, so you'll want expert legal, financial and real estate advice at every step.
Do Your Homework
Before making the decision to buy, consider several factors. The first is your cash situation. If making the down payment consumes cash needed to expand your young business, buying now may be unwise. Also consider that you'll need reserve funds or credit for unexpected repairs. These can be large expenses in the case of air conditioning systems, roofs, foundations, etc.
Carefully examine the tax consequences of becoming a landlord. Most are positive. Owners are typically able to deduct a portion of the value of the building and improvements each year as depreciation, a noncash expense that can reduce taxes on business profits. If the entrepreneur purchases the property in his or her own name, the business can pay rent to the owner, which generates income to the entrepreneur without incurring double taxation.
"Another thing to look at is your business's future," says Bert Mathews, president of The Mathews Company, a Nashville, Tennessee, commercial real estate company. "How much space are you going to need 10 years from now? If your business is growing quickly, owning your own space is probably not that good an idea if you're going to buy a building and occupy it all by yourself." Having tenants, he adds, will give you more flexibility, as you may be able to take over their areas as needed.
Finally, consider your exit strategy. Try to pick a building that fits with the rest of the properties in your area, so when the time comes to move, you'll have less trouble selling. Remember that real estate is naturally illiquid. It can take months or years to sell a property, especially if prices have declined. "If your business strategy calls for you to someday be on the other side of town, it can slow you down," Mathews says.
If you purchase, you need to figure out how much you'll pay on the mortgage vs. how much you'll pay in rent, as well as the effects of appreciation, amortization, taxes and repairs. Coming up with a positive figure when you calculate the rate of return is no guarantee you'll like being a landlord instead of a tenant. But it can be a good way to lock up a desirable location, avoid future rent hikes and get a good grip on controlling your own future--all while making a potentially profitable investment.
Mark Henricks writes about business and technology for leading publications and is the author of Not Just a Living.