Posted on June 10, 2016
Small businesses grow in stages. What was appropriate office space for a company’s first growth phase may not be suitable for a growing team of 50 employees. Eventually, many businesses reach a point when they become curious as to whether it would be beneficial for them to purchase office space rather than continue to lease .
Of course, every business and situation is unique. However, there are a few common factors that should be taken into consideration when evaluating whether to buy or continue leasing.
1. Cash Outlay – Typically if you are planning to purchase an office, you can expect to make a down payment of between 10% and 25% of the purchase price, depending on the lender and your credit. When you lease you won’t need to put down nearly as much. With good credit, the typical outlay is the first and last months rent, which is only about 10% to 15% of the cash outlay required when buying.
2. Fixed vs. Variable Cost – When you buy, you have a good idea what your costs will be over the long term. This is especially true if you have a long-term fixed-rate mortgage. If you lease, the market will dictate what you will end up paying for rent over the long run.
3. Growth Considerations – The specific growth phase of your business should be a major consideration in making the lease vs. buy decision. If your company is relatively new and/or in a high growth mode, leasing would allow more flexibility and fewer constraints to that growth. On the other hand, if your company is mature and stable, buying is great way to meet your future needs.
4. Property Management – You’ve heard the expression, time is money. If you own office space, it needs to be managed. You can either hire out the function or do it yourself. Many businesses with long-term growth plans buy more space than they need and rent out the expansion space. All the more need for good property management. And remember, when leasing, repairs are handled by the property management. When you lease space, if the air conditioner breaks (as it eventually will), all you’ll have to do is call the property manager and wait for someone to show up and fix it. If you own that same space, you’ll be forking over thousands of dollars on repairs every time something major fails.
5. Appreciation – One of the primary goals of buying is to generate long-term increase in value through market appreciation. A good idea in a healthy market and usually successful over the long term.
6. Tax Factors – Lease payments are usually fully deductible, but many expenses of owning office space must be written off over longer periods of time of up to 39 years. The good news if you buy is that you get to take depreciation on the improvement portion of the property and can usually deduct all of your interest payments. When considering the tax factors it is always very important to consult with your attorney and tax professional about the legal and financial considerations to owning office space.
7. Cash Flow Analysis – In order to really understand the financial aspect of purchasing office space, you need to prepare a detailed comparative net present value cashflow analysis, which takes into consideration your predictions on the future: including holding period, anticipated appreciation vs. rental increase, interest rates, and cost of expenses increases. It is a good idea to do three different analyses, optimistic, realistic and pessimistic, to help determine your margin of error.
The buy versus lease decision has a myriad of financial and operational factors that extend beyond the real estate asset and its projected occupancy cost. There should be equally as much consideration given to business needs and expectations when considering this crucial decision.
If you or your company are looking to expand in or enter the Utah market and need to lease or purchase commercial retail, office or industrial space, contact me today for expert advice and access to some of the hottest listings along the Wasatch Front.