Here, we explore options for whether to purchase or lease a commercial property. There are many factors to consider in order to make the correct choice. Ultimately, it depends on your business model as a business owner or an investor and whether you want to create a real estate portfolio to support, add to or be independent of your model.
Consider the following to assist in making the right choice on whether to purchase or lease commercial property.
PROS OF BUYING
Build Equity
Equity is the difference between the present value of a property and its existing debt. Your wealth can be created from the equity that you have in your properties by leaving it in those properties allowing for benefits such as appreciation or converting it into cash to acquire other real estate assets.
Asset Appreciates
Property owners benefit from the increase in value of their real estate. Some of the factors that may contribute to your property’s appreciation are inflation and rental income, tax benefits, supply and demand in your market and interest rates.
Inflation and Rental Income
We see inflation when the prices of goods and services rise and the value of the dollar decreases. Your money does not go as far as it does when inflation is low. With inflation, housing prices increase, including rents, which you collect from your tenants. You control the rate of the annual increases and to hedge the rent against inflation, you can set the increases by a rate at or higher than inflation, potentially increasing the value of your investment.
Tax Benefits
There are many tax benefits to owning commercial real estate. They include but are not limited to depreciation, interest expense and capital gains tax. Since the IRS allows you to depreciate commercial properties over 39 years, the tax liability on that property’s depreciation decreases over time. The yearly interest expense on the mortgage of your property is deductible and if you were to sell your commercial property, capital gains tax is generally lower than that of retirement funds.
Supply and Demand in the Market
It is most beneficial as a real estate investor to have property in a market where the supply is less than the demand, especially if it seems that the market will continue along the same path through many factors such as a steady increase in population. Short supply and high demand force prices up, including rent, increasing the value of your asset.
Interest Rates
It is a benefit to a commercial investor when the interest rates are low, which is evidenced by a limited supply of and a high demand for money. Lower interest rates stimulate investors to purchase commercial properties, or land to build on.
CONS OF BUYING
Upfront Costs
Generally, the down payment and closing costs associated with purchasing a commercial property are higher than those for a space that you may rent (security deposit) which may put an avoidable strain on your business.
Responsible for Management
With property ownership, there is the responsibility of managing the property. Management includes but isn’t limited to rent and tenant management, repairs and maintenance. These tasks can be difficult and expensive, whether you manage yourself or hire a management company to do the work for you.
Liability Insurance
As a commercial property owner, you’ll have to pay for a liability insurance policy to protect from accidents and lawsuits. Additionally, if you have tenants, you are subject to property manager liability insurance. Insurance premiums may be high depending on the market, which would decrease the income produced on the property, decreasing its value.
Loss of Capital
Depending on where your commercial property is located, it’s possible that over time, its value will decrease, creating a loss if you decide to sell.
PROS OF LEASING
No Down Payment
The down payment generally required to purchase a commercial property may be significantly higher than a security deposit that is required when a lease is signed. If your business does not have the funds for a down payment, the option to lease may be the best option.
Maintenance
Depending on the structure of your lease, the landlord maintains much of the property. Although in most cases you, as a tenant, are responsible for the maintenance of the interior of your space, the Landlord is generally responsible for the maintenance of the exterior of the space, building (outside of your space) and property.
Liquidity
The market determines the liquidity of commercial property. Liquidity is the rate at which a property can be bought or sold on the market at a price that reflects its current market value, which in essence is turning the asset into cash. In the right market, the property can be sold quickly, but the opposite is true for a weak market. If your commercial property and business are in a weak market, the asset can be more of a liability.
Tax Benefits
There are many tax benefits to leasing a property. As a lessee, these are some of the items that you can deduct from when filing taxes, lease payments, property insurance tax, property taxes, utilities and maintenance costs.
CONS OF LEASING
No Equity or Appreciation
Like renting an apartment versus owning a home, you do not accumulate equity in leasing a commercial space/building versus owning. You can’t benefit from the appreciation of owning the building.
Added Stream(s) of Income
Commercial properties can provide another stream of income for you or your business. With other commercial spaces, rent can be collected to provide you with added personal or business income. If you only leased space, you could not collect from those potential rents.
High Rent and Rent Increases
Rents are determined by the market and the desirability of a market area. The stronger the real estate market and more desirable an area, the higher the rent will be. It may make sense for the potential revenue of your business, but the higher rents could decrease the bottom line. Also, most commercial leases contain automatic annual increases that could be higher than or connected to the inflation rate. If inflation is high, the increase also negatively affects your bottom line.
Potentially Costly Improvements
As a lessee, you may need to make improvements to the space to make it work for your business. Any improvements that aren’t use-specific (and even some that are – for example an added shampoo bowl for a salon) such as plumbing, electrical, mechanical or structural stay with the space after you, the tenant, leave. Your share of that cost is lost, if you must vacate for any reason.
Less Control
Lessees have less control if their business declines or must be closed, as they still must fulfill the terms of the lease, which includes paying rent. Unless the lessee can make arrangements with the owner/landlord, they are still responsible.
Consult the Barkett Team to Learn More About Your Options
For business owners, the choice to own or lease is a complex one and a decision to consider thoughtfully. The Barkett Realty team is here to assist you in making the best decision for you and your business. We are diligent in our endeavor to provide the highest quality service and in creating long-term relationships with our customers and clients.
Consult with our team to meet with one of our expert agents who can explore your options with you!
