Let’s face it; it’s a crazy time to be a business owner. You’ve probably already had to pivot more than you thought possible this year, so whether to buy or lease commercial space for your company might seem like a low priority. But over time, the decision to rent or own can have a significant impact on your bottom line. Let’s take a look at some questions that can help get you thinking about which decision might best serve your organization.
How long do you plan on being at the location?
The old question, “Where do you see yourself in seven years?” seems cliché in an interview but when it comes to commercial real estate, longevity matters. Generally speaking, if you plan to occupy the same location for seven years or more, buying the property is less expensive than leasing—plus, interest rates are low right now.
However, you need to consider how the space will fit your business: is there a possibility that you might need to expand the flex space for added inventory? What about downsizing to accommodate a shift in working from home? If the space won’t suit your business plan for the long-term (or at least the next seven years), leasing may make more sense. But did I mention that cost shouldn’t be the only consideration?
How much cash are you willing to tie up?
Even though real estate is typically one of the best investments you can make, buying a building does cost more up-front than leasing. The question then becomes, do you have the money to put toward a mortgage down payment and if so, can you afford to spend that cash? Do you want to?
Let’s say that money invested in the business earns 10 percent per year over a period of time and that the property appreciates by 2.5 percent per year—this would mean a 7.5 percent increase on return had the money been invested in the business instead. In this instance, leasing may be more beneficial, even though real estate can be a great way to generate wealth.
What tax implications should be considered?
When deciding whether to lease or buy, it’s important to evaluate deductions for expenses and associated tax implications. Calculating the tax savings involved with leasing is fairly straightforward: Generally, you can deduct all associated costs.
The tax consequences of buying are less clear-cut. Property is a capital asset, which means it’s not deductible as a business expense. Property is depreciated over a 39-year period, with the cost of the capital asset recovered over the life of the asset. At the time a building is sold, both capital gains taxes and depreciation recapture must be accounted for in the calculation.
Also important to note is that buying a commercial property through a separate legal entity can provide additional tax and liability advantages. For example, utilizing a separate corporation to buy a property enables that property to be rented to the main business. If the rent is set at the mortgage payment plus depreciation, it could create a tax-deferred stream of income. Such a scenario would shield the property from liability associated with the primary business (or vice-versa).
Creating a separate legal entity also provides for flexibility if the decision is made to sell the business—the business could then be sold without losing the property. This would allow an owner to potentially continue to earn rent on the property, even after the business is sold. Conversely, if there is a need to raise money for the business, the property could be sold without selling the business itself.
Which option will earn the most money?
Given the option of buying, eventually a mortgage will be paid off completely —meaning the building will be owned outright. Assuming yearly appreciation of just two percent on the building, within a 15- year period the building will be valued at 35 percent more than the purchase price. Over a longer period of time, the potential appreciation in the building substantially increases the cost advantages of buying over leasing. As mentioned earlier, if a business intends to occupy a building for more than seven years, it is generally better to purchase than lease the property (from a purely monetary standpoint). The longer a company stays in the facility, the more the cost advantage increases for buying. But it also bears repeating: monetary cost should not be the only consideration.
If the extra up-front cash invested in buying the building impacts the ability to grow the business, then leasing is probably the better option. And don’t forget that owning and managing a building comes with its own set of challenges. Instead, many owners may prefer to invest the extra time and money it takes to manage a building into focusing on the business itself.
What do I need to make the right decision?
The factors that determine whether to lease or buy aren’t always self-evident. The decision you make has to be based on your own circumstances. (And I didn’t even cover the choice to buy land and build to suit, which also might be a great move for your business.)
Basically, as an owner, you need to have a good idea of your long-term view and the numbers that can support a grounded choice. What are your space needs and how will they evolve over a period of time? What’s your working capital position, and what will it look like in the long-term? What is your expected return on capital invested in the business? If you lease, what should you look for in a contract? If you buy, which credits and tax incentives are applicable? Have you met with a site selection consultant?
The good news is that you don’t have to come up with all the answers yourself when you have a solid accounting and business advisory team working for you. A strong team will discuss all your options and analyze the data that drives a prudent decision—MarksNelson specializes in it. I hope you’ll contact us if you’re ready to rethink your lease and make the best choice for your organization.