When to Lease and When to Buy

When looking for a location for their business, most business owners struggle with the question of leasing verses owning. The answer to this question is different for everyone, but there are some guidelines and common factors to consider when determining which is best for you.

Type of Business. Often times the question of lease verses buy is easily answered by the type of business you run. For example, if you are a retailer or restaurant dependent on a high traffic/convenient location, leasing is most likely your better option. Real estate in these valued areas tends to be cost prohibitive for many small business owners. This may be true especially for restaurants, whose start-up costs tend to be very high already. More affordable properties will have a less desirable location which can be the difference between the success and failure.

Real Estate Verses Business Value. While owning real estate can look good on your asset sheet, what is most important for the success of your business is cash flow. Let’s say, for example, you owned two properties of equal value with a business on each. On property A, the business has revenues of $1 million, and on property B, the revenues are $1.5 million. The value of property B is substantially higher than of A, despite the equal value of the real estate. Thus the value created by the operation of business B outweighs the potential appreciation of the value of the real estate.

Potential Business Growth. If you envision a need for expansion in the next 3-5 years, having flexibility is in your best interest. Some properties may be suited for expansion, but most are not. Having the option to move to facilities that suit your expanding business at the expiration of a lease is a better choice.

However, if you have a stable business or one which would not require more space, investing in property has advantages. Having a consistent location is also a key to many businesses’ success.

Fixed Costs. Knowing what’s ahead can help you plan and allow you to save money to re-invest. As a property owner, your fixed costs stay constant and are not subject to market fluctuations. You won’t have to worry about your rent increasing and cutting into cash flow.

Opportunity Costs. Owning property requires a large initial outlay and maintenance costs over time. The cash invested in real estate will no longer be available to invest into the operations of the business. Time spent on property management can also decrease the time you spend running your business. Making comparisons between the future real estate value verses the value your business would gain by investing directly into your operations will help you determine which is more advantageous.

Market Conditions. When property is undervalued and interest rates are low, investing in real estate can have substantial long term advantages. As market conditions improve your real estate appreciates, making it less expensive to own and more expensive to lease. If your business conditions change, you have the advantage of owning commercial real estate at a low rate, with the ability to lease part or all of your space at a substantially higher rate.

Tax Savings Opportunities. Here is where your accountant is worth their weight in gold. Owning real estate can offer many tax advantages with deprecation costs and deductible interest. Financing options are more readily available for real estate verses any other fixed cost your business has. Working with a commercial real estate professional and with your accountant, you have the ability to craft a financing package that will both maximize your short-term cash flow and minimize your annual tax bill.

Looking Long-Term. Many business owners use their investment in real estate to help fund retirement. Using the appreciated value of their property over time can result in either a large gain when selling, or steady income through leasing the space to other businesses. Money used to pay off the principle comes back to the owner when sold, compared to leasing where rent is lost as an expense over the life of business.

Seek advice when deciding whether to lease or own. Knowledge of your business plans and goals, tax savings opportunities and the benefits verses risks of real estate investment for your particular endeavor will allow you to make the best decision about what will help your business reach its highest potential.