Many business owners find themselves wanting a physical space to operate out of. Whether you’re looking for a customer-facing location or some type of back office, you should consider the pros and cons of buying versus leasing. Ultimately, the decision to buy or lease commercial property will come down to your financial situation and your unique business needs.
What to Consider
- Your business goals
- Any plans you currently have for expansion
- Your ability to qualify for financing and your current equity position
- The current value of the property you’re considering
- The potential costs and tax implications involved with buying or leasing the property
Pros and Cons of Buying Commercial Real Estate
In some cases, it can make sense to purchase a property for your business. Some reasons you might consider buying include:
- You have enough cash for a down payment and at least six months of mortgage payments
- You have unique building configuration requirements
- The property looks promising as an investment
- You’re looking to rent part of the space out to other tenants in order to create passive income
When considering a commercial real estate purchase, it’s important to weigh the potential pros and cons:
Pros of Buying a Commercial Property:
- Allows you to build equity. Your balance sheet will grow stronger as you pay down your mortgage and the property appreciates.
- Potential for passive income. If your business occupies less than 100% of the building, you could rent out the remaining space or units.
- Tax deductions. There are multiple tax benefits available with a commercial mortgage including deductions for interest and depreciation expenses.
- Flexibility to change the space. When you own the property, you don’t need a landlord’s permission to knock out a wall or otherwise reconfigure the space. You’ll still need to abide by local zoning regulations, but you’ll have a much greater ability to customize the space than you would if you were renting.
Cons of Buying a Commercial Property:
- Large initial cash outlay. When buying a commercial property, you’ll typically need to put down between 15% and 35% of the purchase price. You’ll also need cash on hand for closing costs.
- Liability. You will need to carry additional liability insurance as the property owner in case of injuries on the premises. This will likely include coverage of employees, and customers if your location will be customer-facing.
- Risk of loss. While the value of commercial real estate tends to rise year-over-year, your property isn’t guaranteed to appreciate. It’s possible for the value of commercial property to decline, so you should consider current market trends and forecasts before purchasing.
Pros and Cons of Leasing Commercial Real Estate
When you lease a commercial property, you do not own it. Rather, you use the property for the term outlined in your commercial lease. Common reasons you might decide to lease a commercial property rather than buy include:
- You don’t have enough money up-front for a down payment and/or closing costs, or you prefer to use your available cash flow for another purpose
- There is no commercial property currently for sale in your target location
- You’re not ready to commit to a location for the long-term
- You need space urgently and don’t have time for a lengthy commercial real estate sale
Here are some pros and cons of leasing a commercial property:
Pros of Leasing Commercial Space:
- More liquidity. When you lease, there is no need for a large down payment. Those funds, which would otherwise be tied up in the property, are free to be used for other business purposes.
- Flexibility. You’re obligated to stay in the space only until the end of your lease. So, if you decide you don’t like the location, or find yourself needing more or less space, you can walk away when your lease is up. That’s much easier than having to go through the process of selling or renting out the property.
- Less likely to have to pay for property repairs. You’ll be responsible for your monthly lease payments, and may have fluctuating costs for equipment repairs or minor wear and tear on the property, but typically your landlord will cover any necessary major or structural repairs. Just be sure to review the terms of your lease closely before signing to ensure that’s the case.
- Tax benefits. In most cases, the rent that you pay toward a commercial lease is tax deductible.
Cons of Leasing Commercial Space:
- Possibility your rent could increase. Many commercial leases include a rent escalation clause, which allows the landlord to adjust your rent payment during the lease term in order to account for changes in the real estate market or overall economy. Also, at the end of your lease term you will need to negotiate a lease renewal with the landlord if you would like to remain in the property. It’s possible that your rent could increase during this negotiation as well.
- Potential for more expenses. If you are responsible for insurance, property taxes, utilities and maintenance (a common arrangement in a triple net lease), your monthly costs may exceed what you would pay if you owned the property outright.
- Not as much flexibility to change the property. You will typically need permission from the landlord in order to make any changes to the property.
- Not guaranteed to occupy the property long-term. When you lease a commercial property, there’s always a risk that your landlord might not renew your lease when the agreement is up. This can result in having to relocate your business, which can be especially challenging if you’ve been in the same location for years and have an established customer base.
Final Thoughts
Deciding whether to purchase or rent a commercial property is not an easy decision. You should be sure to thoroughly weigh all of the pros and cons associated with each option. It’s also a good idea to meet with an accountant or tax advisor to ensure you understand all of the tax implications involved with buying or leasing a space for your business. You should also consider meeting with a business lender to see if a commercial mortgage is a viable option for you. If it’s not, renting might be your only option until you can further grow your business.
If you are a business owner in MA or RI who would like to talk through your financing options or explore cash management solutions, don’t hesitate to contact us today.