Whether your business should own or lease its real estate is a simple question with a more complicated answer. There are multiple factors to consider including your business cycles, the long term growth potential of your business, husbanding of capital, and the current markets.
If your businesses’ space needs are not cyclical, a purchase is often an attractive option. Ownership can be optimal for sustained, core space needs, but will not benefit your business for variable or cyclical real estate needs. For example, the potential transaction costs of shedding unwanted property, even in a generally rising market, make sale a potentially costly matter. These costs can include brokerage fees, carrying vacant space (maintenance, taxes, insurance and the mortgage), and, in many jurisdictions, transfer taxes.
Businesses with variable or cyclical space needs support the lease model. Short term leases can offer a business great flexibility. The proliferation of pop-up stores for Halloween goods and other seasonal rental spaces attest to the growing popularity of short term leases. Short term leases exist although they might not fit with the exact timeframe your business is looking for.
An additional potential benefit of leasing is the absence of a maintenance burden on the business owner. If your business is renting a property there may be an interior maintenance component and exterior maintenance may not be the tenant’s burden at all. Further, many accountants describe balance sheet treatment of owned real estate as less favorable than rental obligations of the same magnitude.
If your business is in rapid growth mode, factors to consider are how rapidly the additional space will be needed and what your business can afford to lock up, even if it is not yet fully productive until you grow into it. This approach worked well for one of the Firm’s clients who needed more space to operate their business right away. The client found a perfect location that would accommodate their planned growth and bought the space even though it was larger than their current operating needs required. The excess space was leasable and attractive to potential tenants which allowed the client the ability to grow into the space and offset the cost of the purchase with the leasing option.
Growth concerns are the same for businesses whether they own or rent their space, but the solution may be different. A large enough tenant, or a tenant in a tenant-favorable market, can often enter into a lease for the space it needs in the short run, with an option to lease more space periodically. That flexibility does not usually arise in purchases and sales.
Buying means tying up 20% or more of the purchase price of the building. It may also mean personal guarantees from the principals and financial reporting to the lender. Loans often have prepayment penalties if the loan is paid off early, and the fact that your business is growing and you need a larger space is not a reason for the lender to waive the prepayment fee.
Our real estate attorneys have negotiated the waiver of the prepayment fee with lenders when the borrower’s replacement building will result in a loan from that same lender, but that is not a universally available solution.
The purchase and leasing markets are not always easy to navigate. Each varies by location and each has recovered from the recession at different paces in different places. The purchase market may not be going up at the same rate as the leasing market. Certainly there can be good deals, that would tip the balance in favor of a purchase or a lease, but determining what is a good deal brings you back to the evaluation of the several factors discussed above – your business’ cycles, projected long term growth, and capital needs.