Should Small Businesses Buy Or Lease Commercial Real Estate?

It seems like yesterday that buying your business location was a pipedream for most folks. Thanks to the Great Recession average Americans stopped spending, small business income and stability plummeted along with commercial real estate occupancy levels and rent rolls and, along with it, commercial real estate values which depend on the property’s income.

…IN THE WORLD OF COMMERCIAL REAL ESTATE, THE WORST OF THE STORM HAS PASSED…

As a result, not only could many small businesses not afford or risk investing in owning their business location, but most lenders would not consider loaning to them!  But, in the world of commercial real estate, the worst of the storm has passed. Consumers are spending, commercial real estate values are stabilizing, loans are once again becoming available, and buying, rather than renting, your business location is a viable option most small business owners might be wise to at least consider. The best news is that you can easily do this in three simple steps:

STEP ONE: EVALUATING YOUR BUSINESS

• SPECIAL FEATURES.  Are there extensive interior or exterior building features your small business requires which you will need to invest in?  If those features require landlord approval or if the costs are significant, it may make more sense for you to own and control the building and invest in your own asset rather than your landlord’s.
• SPACE REQUIREMENTS. How much do you anticipate your space requirements will change?   Some small businesses have relatively static space requirements while others expand or contract significantly over time.
• LOCATION STABILITY.  How important is it that you be able to keep your business in the same location for the long-term?   For some small businesses, such as certain types of retail or services businesses, location is everything.  For other types of business, not so much so.
• “ON PAPER.”   How does your small business look on paper?  Chapter 1 in my new book “Financial Fresh Start: Your Five Step Plan For ADAPTING and PROSPERING in the New Economy” breaks down what it takes to insure that your small business looks good on paper, see things from your bank’s perspective and win that all important loan approval.

STEP TWO: EVALUATING THE DOLLARS

• CASH FLOW.  As much as we all like to say we think in the long-term, many small business owners – and particularly owners of new small business – simply don’t have that luxury.  If cash flow is vital to your small business, as it typically is in the earlier years, the upfront outlays associated with leasing, as opposed to buying, may be necessary.    Your primary initial cash outlay will in most cases be limited to your security deposit and first and last month’s rent.  In comparison, purchasing requires a significant down payment and other closing costs.
• OVERHEAD STABILITY. On the other hand, if you’ve got the ability to make decisions based on the long term, from a purely financial standpoint, owning enables you to better predict stable overhead costs – no need to worry about a landlord building in his own profit at your expense and raising your rent – oftentimes trumping renting.
• TAX BENEFITS.  Unlike rent, the money you use for a down payment and the principal portion of your mortgage payments is not immediately deductible.   Instead, these sums are recovered over time by annual depreciation deductions.  Repairs and maintenance are also treated differently depending upon whether you rent or own.  On the other hand, as an owner you are able to deduct interest, real estate taxes and certain other expenses.
• RETURN ON INVESTMENT.  Clearly there is no ROI on money paid as rent.   Conversely, owning lends the added benefit of property appreciation.    To that end, buying in an area where you expect land values will increase makes sense.

STEP THREE:  EVALUATING YOURSELF

• REPAIRS AND MAINTENANCE.  Although many leases place at least some repair and maintenance responsibility on you as a tenant, all of these responsibilities fall on you when you choose to buy.  If you’re not keen about having this on your plate and have no one to delegate it to, buying may not be for you.
• BECOMING AN INVESTOR.  Buying essentially places you in a second, entirely different business, namely real estate investing.  It’s more work, but also more potential reward.   In fact, some small business owners decide to buy more real estate than their own small business needs and elect to lease out the balance to other tenants for a profit.
• THE LEGALEZE.  Gaining the necessary knowledge to succeed as a commercial real estate owner often times requires becoming familiar with local building and zoning rules, as well as landlord-tenant statutes and other legal aspects including, deciding whether you want to own the property in your small business’ name or establish a separate “holding company” to own and lease the building to your small business.

With the economy on the road to recovery, commercial real estate stabilizing and lenders ready to loan again, there’s no time like the present to consider buying your small business location!

Shari Olfeson is the author of the book Financial Fresh Start: Your Five Step Plan For ADAPTING and PROSPERING in the New Economy. You can connect with her on Twitter or Facebook.