The decision for a business to own or lease real estate is a large financial decision that comes down to two key factors: (i) operations and (ii) long-term goals. Unlike purchasing a home, the objective for purchasing real estate is (or should be) for investment purposes. Amazon has been purchasing property over the last few years, including their warehouse distribution centers. Public Storage’s long-term strategy is building or owning property in prime locations. However, 75% of commercial real estate is corporately owned (Brueggeman, 2015). Most businesses therefore tend to lease their space. Even Starbucks leases. In our latest lease v. buy article series, we want to take you through some of the important factors before determining which solution is best for your business.
When the size of the space is smaller, then it maybe more optimal to lease given the capital requirements to purchase a property is larger. A start-up or new business is less likely to purchase a property as it is more focused on obtaining capital to ramp-up. Therefore, it would be more beneficial is this situation to lease space when sales and profit margins are unknown. In fact, for most of our startup clients, we recommend leasing. A tenant representative can also help negotiate leasing concessions such as free rent or improvement allowances as part of the transaction.
When leasing a property, much like a car or renting an apartment, at the end of the lease there is nothing gained: other than paying rent. When deciding to purchase real estate, the business is also making an investment in the property and may benefit from residual value. If property values increase, the business can benefit from selling the property at a higher price than when it was purchased. If rental rates also increase, then the business has created a shelter against such risks whereas if faced with leasing, may be subject to market rents and vacancies. For instance, as of the time of this article, industrial spaces have been at historical low vacancy rates enabling owners to increase pricing as supply is much lower than demand. As an owner, the business controls its rent and can also lease out unused space to other tenants becoming both a business and investor.
It is important to consider the appetite for risk. As with all investments, real estate values increase and decrease. If a business is concerned about its long-term position, then leasing is the better option. Lease terms are negotiable and give businesses, especially new or growing businesses, options and flexibility. A more seasoned company may look at purchasing property.
A large consideration is the tax impact. A lease is generally an operating cost and can be deducted as an expense, thereby lowering the company’s taxable income. However, depreciation is a consideration that can be a benefit to the owners as it may decrease their individual taxable income. Many businesses opt to take advantage of the various tax implications by owning real estate under one entity and then lease-back space to the business entity. Therefore, the company doesn’t have to show real estate on the financial statements, which may have negative impacts. As each business’ situation is different and the tax code often changes, it is important to reach out to financial advisors.
Access to Capital
The Small Business Administration (SBA) provides loan options for small businesses to borrow funds for purposes of purchasing real estate. Such SBA loans can require as little as 10%, meaning the lender will provide a loan for 90% of the property value, with the business occupying at least 50% of the property. However, lenders will look at business cash flow, history, credit, among other items. For start-up and newer businesses, they may not have enough credit history. Leasing maybe the only option.
While both options are considered financing options, the ultimate decision is specific to each business. At Estate Match Realty, we can walk you through the different advantages and disadvantages of leasing v. owning property based on your goals. We also work with your financial and tax advisors or can refer you to professionals.
Brueggeman, W. & Fisher, J. D., Real Estate Finance and Investments, 15th ed., McGraw-Hill, New York, NY, 2015 (ISBN 978-0073377353).
“Starbucks Company Profile.” Starbucks Coffee Company, Starbucks Corporation, www.starbucks.com/about-us/company-information/starbucks-company-profile.
Starbucks Corporation. (2016). Form 10-K. Retrieved from www.sec.gov.