Guest post by Jarrod Hunt, Senior Vice President of Industrial Services, Coldwell Banker Commercial Intermountain
Unlike residential real estate, particularly the homes we raise our families in, buying commercial real estate should not be an emotional decision, but rather a means to execute a business strategy. There are several things to consider when evaluating whether you should buy or lease space for your business. I will focus on the assumption that the evaluation is based on your own company occupying the space rather than buying it as an investment to be leased to another party. Investing in commercial real estate with the intention of leasing it to another party is a different decision-making process.
ADVANTAGES OF OWNING:
Appreciation– Generally speaking, well-located and constructed commercial buildings gain value over a period of time. It is common to assume that well-located and constructed properties will appreciate at similar rates to the Consumer Price Index. This helps keep your monetary value consistent over long periods of time in terms of buying power.
Equity Increase– As a mortgage is paid down, the owners’ equity, in turn, increases. Be careful to understand that a considerable portion of each monthly payment goes towards interest in the early years of the loan. This equity increase grows faster the longer you pay on the loan. Ask your lender to provide a full amortization schedule so you can see how that works.
Control- Many business owners need specialized improvements within buildings for their unique operations. If this is the case, buying may be a good fit. Often the high cost of those specialized improvements may be included in your mortgage loan so they can be paid off over a longer period of time. Additionally, you may not want a landlord telling what you can or can’t do within the space.
Tax Advantages- In certain cases, the depreciation of certain aspects of the property along with the direct write-off of mortgage interest can benefit an owner in ways paying rent doesn’t. True, rental payments can be deducted as a business expense, but perhaps not to the same level as the depreciation and interest. Consult your tax advisor for a more detailed analysis of your situation.
The real tax advantage comes at the time when you sell the asset. Any profits made on sale of a property held for a period of time are taxed as capital gains, which is generally at a lower marginal rate than ordinary income. There are also opportunities to defer the tax obligations on capital gains by using the proceeds to buy another “like-kind” property in a tax-deferred, Section 1031 exchange. This strategy keeps money working for you that otherwise would have been paid in taxes until the time you ultimately exit the real-estate market, which may be upon death and transfer to your heirs. Again, consult a competent tax advisor on your individual situation and how this can help with retirement or estate planning.
ADVANTAGES OF LEASING:
Location- Leasing may be the only option when location is important and the preferred location is limited to leasing, such as a shopping center or premier office/business park. It is often much more cost effective to occupy space as a tenant in a project that took considerable capital to establish. The project landlord can spread out that large capital outlay more efficiently than a single smaller-property owner. There are also significant cost savings when constructing a single larger building than many smaller buildings with an equal aggregate square footage, which translates into lower lease rates.
Flexibility & Mobility- Leasing can provide significant flexibility if a business is new, growing or uncertain about its future. Lease commitments can be measured in terms of months, where mortgages are much longer and a significant commitment often involves personal guarantees from the borrowers. Leasing also allows a business to keep its space needs in line with its growth or customer needs. If your business is stable and can be predicted for several years down the road, then this advantage is less valuable.
Financing & Leverage- This is a big one! Leasing requires a modest deposit, usually 1-3 months of rent based on your credit scores, business profitability and balance sheet. Many new businesses simply can’t qualify for a mortgage loan, so leasing is their only option. Also, a growing business may not want to tie up needed capital in real estate if those funds can be used to expand the business or replace more expensive capital being borrowed at a higher interest rate than a mortgage allows for.
To summarize, the decision to buy commercial real estate should be analyzed from a variety of perspectives. There are many good reasons to own real estate and many good reasons not to own. Engaging a competent commercial real-estate agent, lender and tax advisor will help you compile the information needed for this decision and help you keep your emotion in check.
Jarrod Hunt brings many years of business management and financial analysis experience to Coldwell Banker Commercial Intermountain. His 16 years as a real estate advisor coupled with a broad spectrum of experience managing his own company, he has a proven track record of providing solutions for a myriad of real estate and business challenges. His expertise includes market demand and feasibility analysis, investment structure and analysis, and organized property disposition.
Jarrod provides analysis and strategy for lease and sale negotiations, cash flow and investment analysis, organized and accelerated disposition for excess properties, and valuation/feasibility consulting.
Coupled with the technical expertise of how to structure the deal, Jarrod also adds a personal touch to the equation. With demonstrated ability to fully understand the end goal of the client and resolve off sheet issues involved with the transaction, Jarrod is truly the next generation of real estate advisors.