Buying Vs Leasing
Commercial Real Estate
Ask any entrepreneur whether they would prefer to buy or lease a building and 9 of 10 will answer buy. But is buying always the better alternative? When does leasing a building make more sense than owning? In this part one of a three part series we will cover buying Commercial Real Estate along with the benefits associated with ownership. Part two of the series will cover leasing. Part three will compare Buying Vs Leasing Commercial Real Estate.
There are many variables for a small business owner to consider when analyzing whether to buy or lease real estate. Among them are the right property, purchase price, interest rates, etc. Here are two additional considerations, in my opinion, that should be placed at the top of the list:
- What are the businesses growth goals?
- Will the use of capital for a down payment impede business growth?
According to this Small Business Administration report 2/3rd’s of businesses survive at least two years and 1/2 survive at least five years. Its also reported the number one reason for small business failure is a lack of capital. For most small business owners thinking about failure is not a comfortable subject. However, with knowledge comes wisdom and knowing this information may allow them to make educated business decisions.
Buying and owning real estate used in a business usually makes long term sense for a small business owner. The caveat here though is that property ownership doesn’t usurp capital needed to continue operating and growing the business.
Having reviewed financial statements of hundreds of businesses along with the personal financial statements of the business owners I can attest the greatest wealth driver for a small business owner tends to come in the form of real estate ownership.
Property Owner Benefits
When a business owner owns and uses real estate to operate its business there are three primary benefits received from ownership.
When a mortgage payment is made a part of the payment is applied towards the principal balance of the loan. Over time the loan amortization reduces the mortgage principal balance and this reduction increases equity build up in the property.
An income tax accounting mechanism that allows a property owner to receive a tax deduction on prorated value of the improved portion of the real estate. The depreciation schedule in place as of this writing is 39 years. There are options to accelerate the depreciation, but that discussion is best left to the accountants. The depreciation deduction can be used by business owners to offset other income sources thereby further benefiting the property ownership.
The buildup of equity based on the increased value of the real estate due to market forces. Typically this type of equity increase occurs over a number of years. And due to the cyclical nature of real estate appreciation is not guaranteed. Appreciation may accumulate slower or faster in various points in the real estate cycle.
It’s worthy of mention there are two other intangible benefits of owning business real estate. When a business owns its real estate its likely not to experience a disruption to its business and not have to move from one location to another every several years. In addition, its customers will experience the convenience and consistency of patronizing a single location. The other is the ability to lease out all or a part of the real estate when times get tough or after the businesses use for the property ceases.
In summary, an owner of real estate must carefully consider the question of buying Vs leasing commercial real estate. The wrong decision either affects business growth and thus profitability. The right decision can pay rewards through the immediate income tax reduction benefit of lowering income taxes (offsetting other income when structured appropriately) and the longer term benefits of loan amortization and property appreciation. The latter two have the potential to be the driver for real wealth creation. Look for Part Two of this series in a future blog post where we will discuss leasing. Part three will follow with a comparison of Buying Vs Leasing Commercial Real Estate.