LEASE vs PURCHASE

Choosing the option to best fit your company’s needs

Business owners are often faced with the decision to either lease space or purchase a property for their business operations. Market conditions, will dictate the price and available selections of properties for sale or lease. The business owner should evaluate the pros and cons of either alternative. Below are some points to consider when evaluating a lease or purchase:

LEASE

Flexibility

Shorter lease terms allow for greater flexibility if a tenant is anticipating growth or a change in business climate. Longer lease terms allow some control over market rental rate fluctuations. Leases offer tenants with flexibility, as the tenant can determine the length of term they want and do not have the hassle of having to sell their building. In addition, leases can be structured with additional built-in flexibility; Tenants can negotiate termination options, expansion options, renewal options and the right to sublease if they outgrow the space or need to relocate for whatever reason.

Rental Rates

Rental rates are determined by market conditions, however, there is some predictability built into a lease contract. The rental rates are typically set for the term. Increases are those of operating expenses (property taxes, insurance, utilities, etc.) that can increase with inflation.

Low to No Cash Outlay

If the Tenant has good credit, in most cases, the Landlord will fund the up-front costs of any required tenant improvements. With rising construction costs, tenant improvements can exceed $20/square foot, this can be a significant outlay. Tenants typically provide the landlord with a security deposit at lease execution. This amount can vary, but it typically is equal to one (1) month of rent, again, based on the tenant’s credit. In some cases, Landlords will waive the security deposit.

Lease Payments - Tax Considerations

In most cases Tenant’s can expense the cost of their monthly lease payments reducing their tax bill.

Many Options

Tenants have the ability to pick and choose the best location based on their need to be in proximity to clients and employees. In addition, tenants can select from a variety of rental price points based on the class, age, location and building amenities.

No Maintenance & Property Management Responsibility

With most leases, tenants are not responsible for the maintenance and repair of their buildings in addition to managing vendors. Maintenance and management are in most cases the Landlord’ responsibility.

Other Things to Consider

Relocation costs can be high if a tenant decides to move to another property. The cost of new telephones, data cabling and other telecom costs top the list of major relocation expenses. Tenants should weigh these costs into their overall occupancy cost over the lease term.

Market conditions will have a great impact on rental rates. In a Landlord’s market rates can be high and landlords can be inflexible with lease concessions. On the other hand, if your timing is right, you may secure a great deal during a tenant’s market, when landlords are competing with each other for your business.

PURCHASE

Build Equity

Building equity is one of the main reasons purchasing is of interest to many business owners. Since real estate cycles usually come in 10-year waves, buyers will typically see better appreciation if they hold the property for a long period and, time their sale when the market working in their favor. If you buy low and sell high, you could make a tidy profit.

Tax Considerations . Interest & Depreciation

Property owners can expense deprecation and interest payments (if they have a loan on the property).

Cash Outlay

A building purchase involves a substantial up front cash outlay on the part of the buyer. If a business owner elects to leverage the property, they will be required by their lender to place approximately 20% to 25% of the purchase price of the building as a down payment. There are, however, some lenders that provide 100% financing. In addition, with a purchase, buyers will have up-front due diligence costs and closing costs. Lastly, there may be improvements that need to be made to a building after a purchase, such as repairs, new carpet, paint, office reconfiguration, etc. These are all costs that are in addition to the purchase price, and should be quantified as early as possible.

Control

If you own your building, you can control the use of the property, subject to zoning and other municipal restrictions. Owners also control the maintenance and repairs that are made to the property and can have direct impact on their operating expenses, based on how the property is managed.

Exit Strategy & Liquidity

If a business owner must relocate, sell their business or exit the property for any reason, they can always chose to lease their building to another user and collect rental income,or sell the property outright. However, business owners must keep in mind that the sale of a building could take a while, especially in a soft market or if they have a highly unique or special use property.

Market Risk

Market conditions will dictate the number of buyers in the market and the price they are willing to pay for your property. If a business owner must sell in a hurry, then they may be subject to selling in a buyer’s market, where property values are low. Naturally, in a Sellers market buildings are fetch a better price, fewer options are available, and there are more buyers. Clearly, timing is critical when selling your property.

Other Things to Consider

Buyers are encouraged to weigh their opportunity cost of investing in real estate, as market risk can be significant. Can you get a better rate of return in an alternative investment? Is asset liquidity important to you in your business? Will you be able to sell your building at a good price and achieve the equity build-up you were planning?

In addition, it is critical for a buyer to carefully evaluate the cost of owning a building over time. Due diligence during the initial phases of a purchase is very important to flush out any latent defects in the building’s structure and mechanical systems. The costs of maintenance and repairs are important to note, as they are an on-going cost associated with any real estate purchase.

In an effort to make the best decision for your company, it is advisable to have a qualified commercial real estate specialist, a real estate tax attorney, or your CPA, help you evaluate the decision to lease or purchase. Ultimately the decision to lease or purchase lies with you, the business owner, however, an experienced professional can provide you with a comparative analysis so you can determine the most cost effective strategy for your business, based on market conditions and your business goals.

 

Jo Thompson, CCIM
Transwestern
5001 Spring Valley Road
Suite 600W
Dallas, Texas 75244
214-446-4535 .Office
214-446-2570 . Fax
jo.thompson@transwestern.net

Transwestern is one of the largest privately held, full-service commercial real estate firms in the U.S. On average, each member of our senior leadership team exceeds 20 years of commercial real estate experience. It is this experience, along with intense market knowledge, that forms the foundation for providing clients with tailor-made solutions for their real estate needs. Transwestern Dallas strives to be the number one value-creator for commercial real estate throughout the DFW Metroplex.