One of the classic questions in commercial real estate is whether it's best to lease or buy space. Every time the question gets asked, the answer is always the same: it depends. Here are four ways to dig deeper and find out which strategy is right for your business.
Up front, the rule of thumb it is usually less expensive to lease commercial real estate than to buy it. Security deposits are usually less expensive than down payments and loan fees. However, in certain instances, this rule won't hold true. For instance, if you need extensive tenant improvements and can build them into your loan when you purchase, you could end up spending less up front to buy. Creative financing with little or no down payment can also help to lower the initial cost of buying.
The prevalence of lease structures that tie rental costs to operating costs has removed some of the safety from leasing. When you have to pay the same expenses as a tenant that you would as an owner, you're taking the same risks of having to pay for repairs or of having energy costs spike. Over the very long term, owning can also turn out to be less expensive. While lease payments typically escalate with interest, loan payments are fixed for as long as you have your loan at a fixed interest rate. With self-liquidating debt, you could even end up owning the property free and clear.
Owning and renting commercial real estate offer different types of flexibility. If you own a building and don't have onerous prepayment penalties in your loan, you can sell it whenever you want, although you could end up losing money on it depending on your timing. On the other hand, if you rent, you are usually locked in during your lease term, but can move out at essentially no cost to your landlord whenever the lease expires.
The flexibility of leasing makes it especially suitable when you aren't sure about a space's long-term prospects. On the other hand, if you have the opportunity to take down a commercial real estate property that you plan to occupy for decades to come, buying could end up being the least expensive option.
Income Statement vs. Balance Sheet
Leasing and buying commercial real estate are fundamentally different from an accounting perspective. Under the accounting standards in place as of 2014, leased property usually don't exist on your balance sheet. All that you will do is record the expense of your operating leases on your income statement. On the other hand, when you own a building, you report it as an asset and depreciate it while reporting the mortgage as a liability. Many companies choose to lease simply to keep their real estate obligations and the concomitant debts off of their financial reports.
The Bottom Line
Deciding whether to lease or buy might seem complicated, but, in a way, your business has already made the decision for you. It isn't about making the best real estate decision. Ultimately, it's about making the best business decision. The commercial real estate strategy that generates the best business results is the right one.
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