Location is a vital component of any business. However, once you have determined the area where you want to set up shop, one of the key decisions you will face next is whether to buy or lease the property. Here are some key factors to consider when deciding which option is right for you.
Buying vs. leasing
The main advantages of buying a property are the ability to control the costs as well as the financial benefits that may possibly accrue including the potential appreciation of the asset and the depreciation for tax purposes.
Furthermore, in some circumstances, you could even end up paying out less to buy the property than you would pay to lease a similar property.
“Over the long-term, owning may be cheaper than leasing because you’re cutting out the rental property investor’s profit margin,” says Gadi Meir, Vice President of Business Real Estate Financing for Wells Fargo.
You should also consider if you’ve been in business for a number of years, and your location is especially valuable to you because you’ve established a presence in the neighborhood and have regular customers, then owning a property for the long term may be beneficial.
“However, if you need flexibility in your business and you don’t want to use your credit or available cash for real estate, then leasing may be preferable,” Meir added.
This is especially true if your business is still growing. That is because leases typically only lock you into a location for two to five years, making it easier to pick up and move if, for example, your business is expanding rapidly and has outgrown your current space. Or you may negotiate a long-term lease with favorable rates that could allow you to use the capital for another business opportunity.
The bottom line is: If you qualify for a loan, your cash flow is stable, you can afford the upfront downpayment, you want to secure your current location, and are willing to take the real estate risk, then you may decide that owning a business property makes the most sense.
How much money do you need for upfront costs?
When buying commercial real estate, you’ll need to come up with a down payment. That’s a large upfront cost that doesn’t apply if you lease, Meir says. For standard commercial real estate purchases — office or retail space — you can expect to pay upfront a minimum down payment of 20% – 25% of the purchase price. For “special purpose” properties — restaurants, auto repair shops, etc. — it can be as high as 40%.
Also, keep in mind that if you do decide to buy commercial real estate, your credit profile will need to be analyzed. And if you’re opening a brand new business, a solid business credit history can be difficult to prove. “When we look at an applicant, we’re looking to see that they have two years of positive business cash flow — sometimes even three years,” Meir says. Documents such as tax returns will be requested. “Lenders want to see that a business has sufficient cash flow to manage the new commercial real estate mortgage payments, plus a buffer.”
Since leasing requires less cash upfront — usually just first and last month’s rent and a security deposit — this could leave you with more cash for other business needs.
What are your credit needs?
If you’re planning on using credit to grow your business through equipment purchases or other investments, leasing may be a good choice because a large mortgage will tie up your available credit and possibly prevent you from borrowing for other purposes. However, if you have enough borrowing power to take on the mortgage as well as other investments, buying might be the right move for you.
Clearly, it is a complex decision whether to buy or lease, and so it makes great sense to consult with a team including a real estate expert, lawyer, accountant, and banker as you investigate your options.
Business Real Estate Financing offers loans up to $750,000 for small business owners and real estate investors. Click here to learn more.