Five Considerations When Deciding to Lease or Purchase Commercial Real Estate

Have you been running your business from your garage, kitchen table or a co-working space, and decided you’re ready to upgrade your space?

The decision to commit to a new space to support your business is cause for celebration, but can also be overwhelming for those who are diving into commercial real estate for the first time. One of the initial decisions you need to make is whether it makes more sense for your business to lease or purchase. Here are five things to consider:

 

A space that meets your unique needs

If you’re thinking about commercial real estate, there’s a good chance your current space isn’t fitting your business needs. Whether you’re just outgrowing your current space or need a more strategic location, close your eyes for a moment and visualize what exactly your business needs.

It’s helpful to pinpoint the interior and exterior features that you want your future space to have – high foot traffic, accessible parking, nice views, natural light, etc. – to narrow down your options. Finding the prime location at the right price can be a challenge, so it’s important to be clear on what you’re looking for in case a property that meets the bill becomes available.

To the extent that it’s possible, consider your business's long-term goals. Hoping to expand someday? Buy new equipment? Hire more staff? Think through how the move to a new location might impact your business and aim to invest in a property that suits your needs for the long haul.

 

                                                               Creating a Growth Plan For Your Business

 

PRO TIP: Do your research on the historical use of the property and surrounding properties! Knowledge of the zoning of the property, previous owners, age of the building and more is not only fascinating but can also provide you with leverage to negotiate and a better overall understanding of what you’re getting into. Also, look at which businesses and resources are nearby and the local demographics.

 

Upfront and monthly costs 

Next, it’s time to look at your budget for this move. This step is where your business’s capital, cash flow, flexibility and stability will all come into play.

Down payments are required for buyers – typically between 10-40% of the property’s value. Businesses that aren’t able to afford this upfront payment are better off leasing, in which case a more affordable security deposit is needed instead. Some properties, like gas stations, bowling alleys, movie theaters, etc., are considered “special use” and usually require larger down payments, although there are some creative exceptions. This is also true of investment properties since these properties come with greater risk and liability.

After the initial payment is handled, mortgage costs are the next potential strain for buyers. But fixed-rate mortgages can typically be negotiated to longer terms than leases, meaning smaller payments over a longer period of time. These arrangements allow buyers to access a more flexible stream of cash flow. Commercial mortgage terms tend to fall between five and ten years (with up to 25-year amortization periods).

Leases are less of a commitment than mortgages and offer greater flexibility, but can be unpredictable at times. Unexpected rent or ownership changes can be frustrating and disruptive to business often causing an untimely need to relocate.

Finally, consider the tax benefits that come with commercial real estate purchases. Buyers can take advantage of deductions on mortgage interest, depreciation, insurance and more to reduce the amount they're required to pay in income and capital gains taxes.

 

                                                                 Managing Business Cash Flow

 

Control and flexibility

Another part of the equation is how much control you would like to have over your business’s property decisions. Not restricted by lease terms, commercial property owners have more creative control over changes to the physical space and can renovate to their heart’s desire.

While this flexibility is appealing, control comes with responsibility – the buck stops at owners for repairs and maintenance, which are costly and can take time. This means things like trash and recycling, HVAC and plumbing. It is possible for owners to hire property managers to take some of the burden, but this is an expensive investment.

 

Equity

The opportunity to build equity is reserved for property owners, and refers to the difference between the amount owed on the mortgage and the value of the property.

Equity can rise or fall based on the property’s value in the market and the amount of the mortgage paid off over time, and can be tapped by owners to grow their business and improve their space. These improvements increase the future sale value for owners, while renovations to a leased space or expensive build-outs benefit the landlord or property owner in the long-term – not the tenant.

 

Tenants

Speaking of tenants… If you decide to buy commercial property, you could eventually consider having tenants of your own to help cover some operating costs, like property taxes and insurance, but you’ll be legally responsible for taking care of their requests in a timely manner.

If you decide to lease, you’ll be the tenant and can be affected by your landlord's stability. However, having a landlord can also be a perk when you have routine property requests that can be handled by someone else.

There’s a lot to consider when deciding whether to lease or purchase property for your business. Rockland Trust’s team of community bankers is well-versed in local commercial real estate and can help you weigh your business’s options. Check out the other resources on our Learning Center or if you have questions, reach out to our Business Banking team.