Most companies lease the office and warehouse space they occupy. There are many reasons for that: don’t want to be a landlord; don’t have the down payment; want to keep the money in the business where it will earn a higher return than in a real estate investment; don’t want to be stuck owning a building; don’t know how large the company will get…and the list goes on.
But there are some compelling reasons why buying a building should be given serious consideration.
Reason #1 Long-term cost may be less
This will vary by location to some extent, but when you evaluate the cost of owning or leasing the same or comparable building, buying is almost always less expensive over a 10-year period. More on this later.
Reason #2 Customize for the long-term
Some companies need to customize their space for their specific needs which may have no value to the next occupant. In those cases, landlords often refuse to pay the cost of those improvements and even require that the improvements be removed at the end of the lease term. That results in a double-whammy expense to the tenant. Buying a building allows the company to customize the building and continue to occupy it and get the benefit of those improvements over a longer period of time.
Reason #3 Equity build-up
When you buy a building, you pay a small amount of principal with every monthly payment. While it’s very small in the beginning it increases with every payment and becomes a steam roller in future years. Every payment adds equity to your balance sheet.
Reason #4 Appreciation
There is never a guaranty that a property will appreciate during the time you own it. I’ve been in the commercial real estate business for 35+ years and have gone through 3 separate business cycles.
The downturn of the 1980s saw commercial property values plummet precipitously and many owners lost their property to foreclosure. The downturns of 2001 and 2008 had far smaller impacts on values. Part of that was because there were many “vulture” funds ready to pounce on suffering owners who couldn’t hold on any longer.
But there was so much money chasing those deals that the supply of money and the demand for deals kept prices higher than expected which lessened the potential damage. My advice to clients is to ignore potential appreciation when evaluating a purchase in lieu of leasing. Just evaluate the two cash-flows. How much money is spent leasing over 10 years? How much money is spent buying a building over 10 years? Whichever is less wins.
I certainly advocate for counting the purchase cash-flow net of equity build-up as that is real value to the owner.
Reason #5 Low-interest rates
Interest rates are generally lower to buy owner-occupied commercial real estate than general business financing. This low cost gives owning an advantage. If your company borrows money to operate, you can easily figure out what a bank is willing to lend for general business operations including lease payments versus buying a property.
This makes sense because the bank has tangible collateral when loaning on a building purchase. If the payments stop, they can foreclose on the building and sell it to pay off the loan. They usually don’t have collateral for general business lending that is as solid.
Reason #6 Flexibility
Most people think that when you buy a building, you are “stuck” with it and argue they want to continue leasing to maintain flexibility.
I argue the reverse.
When you sign a lease, you are stuck with the lease for the lease term. But when you own a building, you can sell it any time you like. If you decide you no longer need your leased space, the primary solution is to sublease it. In most cases, it takes several months to years to find a suitable subtenant and the rental rate is usually less than the primary lease requires. In addition, you will likely have to pay commissions and possibly improvements required for the subtenant. And you will remain fully liable on the lease so if the subtenant bails, you have to continue paying the full rent again.
If you want to dispose of owned space, market conditions will dictate the price. Sure, it may take a while to find the right buyer and there will likely be commissions to pay and maybe even some repairs, but hopefully the property has appreciated or at least held its value. Who knows if the difference in subleasing or selling earlier than planned will be lower, but the point is that you can sell anytime which provides greater flexibility than leasing does.
Reason #7 Multiple Assets
In most cases, the owner of the business buys the building through another entity she owns and then the business leases from that entity. This gives the owner the option to sell the business and the property separately.
If you sell the business, you may do so subject to a long-term lease on the property which leaves you with a cash flowing asset – the building. Or you can sell the building while still owning the business. Or you can sell the building and move the business. Hmmm, sounds like this could have been in the flexibility section.
Reason #8 Accounting Treatment
Some people will argue that by owning the building, you don’t have to put the lease on your balance sheet as the new GAAP standards require.
That’s not exactly true.
If you buy the building through the company, the building will be an asset on the balance sheet and the mortgage will be shown as a liability. If you buy the building through another entity and lease it to the business, the business should then have it on the balance sheet. Those that argue for leaving it off the balance sheet must be advocating that you not charge rent to the business.
If you do that, you probably aren’t subject to GAAP compliance and don’t have to show leases on the balance sheet anyway.
Buying is usually the lower long-term cost, but it may still not be the best solution for your company depending on your unique circumstances and objectives. We would be happy to talk with you about the options and show you the analysis comparing the two so you can make an informed decision.
Bob Gibbons is a Real Estate Advisor & Tenant Advocate (also known as a tenant rep) with REATA Commercial Realty, Inc. which is a tenant advisory firm based in Plano, Texas. Bob serves companies in Plano, Frisco, McKinney, Allen, Richardson, Addison, Dallas, and the surrounding areas and specializes in companies that lease or buy office and warehouse properties.