Original article posted in Inside Tucson Business here.
You may have reached a point in which you are considering buying a building rather than continuing to lease commercial real estate space.
While every business is different, there are a few common factors that you should consider when evaluating this situation.
Pros and Cons
Cash Outlay. You can expect to make a down payment of between 10 percent and 25 percent of the purchase price, depending on the lender and your credit.
In a lease, you won’t put down nearly as much. With good credit, the typical outlay is the first and last month’s rents.
Opportunity Cost. Money tied up in buying a building might be better invested elsewhere.
Consider what return you could expect to receive on that money compared to the return you would expect if you invested the money into your business operations or other investments.
Fixed vs. Variable Cost. When you buy a building, you have a good idea what your costs will be over the long term, especially if you have a long-term fixed-rate mortgage.
If you lease space, the market will dictate what you will end up paying for rent over the long run.
Growth Considerations. If your company is relatively new or in a high-growth mode, leasing allows more flexibility and fewer growth constraints.
If your company is mature and stable, buying space is a way to meet your needs.
Property Management. You need to manage your own building, even areas you may not be using. Many businesses with long-term growth plans buy a building that’s larger than they need and rent out the expansion space. That increases the need for good property management.
Appreciation. One of the primary goals of buying a building is to generate a long-term increase in value through market appreciation. This is a good idea in a healthy market and usually successful over the long term. Consider how long you want to keep a building to benefit from selling in a healthy market.
Tax Factors. Lease payments usually are fully deductible.
Many expenses of owning space must be written off over longer periods of time. You get to take depreciation on the improvement portion of the property and usually can deduct all of your interest payments.
When considering tax factors, it is always very important to consult with your attorney and tax professional about the legal and financial considerations to owning space.
Cash Flow Analysis
Only a detailed analysis will give you a true picture of whether buying a building is better than leasing one. You need to prepare a comparative net present value cash flow analysis. This should include your predictions on the future
- Holding period
- Anticipated appreciation vs. rental increase
- Interest rates
- Cost of expenses increases.
It is a good idea to do different analyses, each based on optimistic assumptions, realistic ones and pessimistic predictions.
This exercise helps determine your margin of error. It seems like a daunting task, but there are some good programs available to help you do this analysis.
Brokers such as Commercial Real Estate Group of Tucson can significantly improve the accuracy of any analysis and simplify the process. Contact us to get started.