Commercial Real Estate - Should you Purchase or Lease?

By Dave Moore of The Get Moore Results Team - RE/MAX CHAY Realty inc., Brokerage (Copyright - Do not reproduce without permission) The Commercial Real Estate Transaction: Should you Purchase or Lease? In business, likely the 1st key to your success is the right location. If customers can easily find you, the work you have to put into driving traffic to your doors becomes less of a task. You have to develop a plan with your customers’ demographic clearly identified. Where do they live, work, and typically go to find your product or service offering(s)? Once you have a handle on the best location, you need to decide between leasing or buying a Commercial space. Here is where there is not necessarily a right nor wrong answer. The decision making process depends on a variety of factors: cash flow, the projected and / or historical growth of the business, taxation considerations, as well as future plans (both business and personal). If you are in business in a big city, you will have a lot more options available when it comes to locations. In Barrie, Innisfil and the Simcoe County area, the options become a bit more limited simply because of the actual number of locations that are available. Recently Commercial space has probably become in shorter supply in our area than it was even 2 years ago. This can sometimes limit your options. The decision to Purchase or Lease requires input from a variety of sources and advisors. A realtor can help you find what is available out there, but the ultimate choice for one option or the other definitely requires consultation with your Accountant and possibly your Financial Advisor. Why don’t we first look at some of the main reasons that tell you that leasing might be your best option: Is your business still fairly new? If so typically you do not enjoy a comparable level of fiscal certainty, nor the same level of available capital as a longer standing business might. In the earlier stages as your business grows and develops you may not be able to really pinpoint your growth rate, space requirements, or your profitability. Leasing might be in your better interest due to the fact it provides the financial flexibility allowing you to adjust more quickly to a moving target of business demands. Would you rather keep your cash in the business than Real Estate? There may be more value through investing money back or directly into your company. Again here is a place your advisors can help. Leasing might be your best option. Capital that is readily available can put you in a stronger position to grow and expand your business. Buying Real estate can lock capital into a single asset. The other thing to consider is that Buying almost always costs more than leasing. In turn, this creates lower cash flow. Are you seeing rapid expansion or possibly contraction of business?? Are you are seeing rapid growth, or possibly worse, reverse growth patterns in your business? No sign of either pattern slowing or changing soon? Leasing offers more flexibility to move in order to accommodate a need for more or less space. Does your business require or involve Warehousing?? Sadly we cannot snap our fingers or wiggle our nose to create more space. If you find you need more space than your current location can accommodate, leasing makes it easier to move at the end of your term. If you own you may need to sell to accommodate the move. Is your business Contract based? If you deal in client contracts with set end dates, leasing can allow you to match your lease terms to your contracts. If the proper terms are built into the lease this may allow you the flexibility to extend or shorten the lease if your contract is shortened, extended, or withdrawn. Mortgages may require personal guarantees. Naturally the banks want to protect their equity position. Think carefully before using your personal assets or your home to guarantee the mortgage on your businesses’ building. The risk to your family and credit rating should be considered. Leasing offers no such personal risk. Renting provides an easier out! Overall leasing is an option that provides a lot more flexibility should your business have to relocate quickly. A lease can usually be broken for a fee if nothing else. Where do you go quickly if your building does not sell for some reason? Now let’s look at some of the factors and reasons that make purchasing your best or better option: You require a custom space, or a permanent one When you own the building you can custom tailor it to your needs and equipment requirement. No need to worry about restorations when the lease expires, or worse still having to leave behind capital improvements (as some leases may require). Though you have to follow local by-laws, you can make changes as you see fit. Asset Ownership Building equity can help to strengthen your balance sheet. There can be a definite upside with the flexibility purchasing gives you, to become a landlord and generate rental income from tenants. If a financial setback happens, you may be able to use your equity as leverage. If you do buy ,strongly consider creating a holding company, a separate legal entity apart from your main business. This has a lot of implications such as helping to protect the building from creditors in tough times. It may also create a better tax platform position if your company leases it back. This is where a good Accountant comes in for advice. Personal Investment Owing commercial real estate may create opportunities for income splitting, or even estate planning. Shares can be owned by a spouse, or kept inside of a family trust. However you do this, you need a good Accountant to structure things in order to avoid tax problems and implications. A good Financial Advisor is also key here. When it’s time to sell the business Owning the building can be very advantageous. You can sell the business and retain the building; the purchaser can then lease the facility from you. You the seller, retain the hard asset that is the building. This leaves you the option to hold on, or sell it at some future point that may prove to be more beneficial. You don’t like rent increases? Well, as a tenant you will be subject to the whims of your Landlord and face higher rental fees. As an owner, dependant upon your mortgage terms, you can better predict, and plan your monthly facility expenditures. This helps create more reliable financial predictions and promotes more sound, longer-term decision-making. Has Your business already reached it’s likely maximum growth potential? Once you think you have arrived at your peak growth potential for your business, you may be very well positioned to step up and purchase your permanent business location. Inside this scenario, you are fairly confident your requirements will remain fairly static: no hiring spurts, not additional equipment required, your space requirements are in line. This alone may make buying a building a very viable option. What if you expect growth in the short to medium term? You may wish to consider buying bigger than your current needs, then lease out the extra space to help balance out and offset the additional carrying costs. Sign tenants only to short term to medium term leases to allow you the flexibility to assume the space when you need it. A secondary approach is to do both, purchase and lease. Buy your primary location and lease appropriate satellite space. Another approach is to lease with an option to purchase. This can be more expensive but it’s a growing trend. The advantage it gives, is you have a say regarding the building you are in as well as having potential to earn income from other tenants. Upsizing Eventually if you should outgrow the space you purchase, capital gains and capital cost re-capture could be triggered. If you re-purchase, replacement property rules can enable you to defer taxes on the sale. There are time requirements to qualify and so again a good Accountant is your best asset at this time. Any transactions with tax implications can become very complicated so the professional Accountant is your best asset. In Summary: A lot of variables determine Buying vs. Leasing. Good forecasting, business certainty, and solid cash flow pay key roles in the decision process. How well you are able to predict growth, stability, cash flow, and your needs are all part of the equation. The longer-term owner with a reasonable history and a good succession plan are best positioned to make the call, but this does not preclude newer businesses from making the same decision. Ultimately the process, which includes your advisers, will help you to reach a path that best works for your business and personal situation. It should fit with your overall goals Ask yourself these questions when finalizing your decision to purchase or lease: Have the costs of each option been considered and taken under advisement? Make sure to include the taxation implications and current rules. If I am Purchasing, will this option help my business grow and prosper in the longer term? Can my business afford the cash flow implication in order to make a down payment on purchase?