When your business needs more space, should you buy it or lease it? Property expert Nita Arora-Parkes explains the upside and downside of each approach.
Most businesses, at some point, are faced with the question of whether to lease or purchase their business space. To help you make an informed decision, below is a list of both the advantages and disadvantages of leasing versus purchasing. As there is no 'right' answer, each business needs to consider its own specific needs before making a decision. Careful thought should be given to financial, tax, and business-specific elements. Part of this decision would be to choose the option that will provide the required space at the least net cost. Some believe that leasing is cheaper than purchasing, but this is not always the case, as the obligations on a lease can sometimes be similar to those when you are buying
In addition to this guide, you should seek out the advice of a solicitor and accountant to advise you on what is best for your particular business.
Use the following points to help weigh up your options.
Purchasing business space
The advantages of purchasing business property include:
- Fixed costs: Having a fixed long term commercial mortgage can give your business clear, fixed costs.
- Tax advantages and deductions: As an owner you can claim tax deductions for all costs associated with owning, running and maintaining business space, including interest on the mortgage and property taxes. There are some depreciation differences which you will need to check with your accountant.
- Financing: A mortgage loan can be used to finance your purchase, so that the actual monthly amount required may end up being similar to that of a lease.
- Access to equity: You may be able to use the property as a guarantee in business dealings with your clients, suppliers or partners.
- Additional income: If you have additional space, you have the opportunity of renting out a portion of it to another tenant to generate some additional income. If you completely outgrow your premises, you have an option to rent out the entire space while moving into larger premises yourself, or to sell.
- Capital growth: If the building/space you own is in an area of appreciating land values, the prospect of selling it for a profit eventually is a positive one. However this now puts you in the property investment business, which can be profitable depending on the market. In times of inflation, real estate is a good investment. Rising rents suddenly become an asset as an owner.
- Control: Owning your business property gives you more control. Having your own premises can give you increased security and freedom in which to run your business. Whereas lease agreements may have restraining features that give you limited control over the property. In addition, any improvements to the premises become the owner's property, and add to the value of the owner's investment.
There are also some disadvantages, namely:
- Lack of flexibility: Most businesses especially new, do not know what the future holds: If your business continues growing, your owned office space may become inadequate, forcing a premature sale of the property. But if your circumstances change, so too can the level of income your business generates.
- Upfront costs: Buying business space will initially cost far more upfront. There are property, appraisal and maintenance costs as well as a deposit and potentially property improvement costs.
- Agility: If your requirements change, or the area changes then you may find that you are not able to move quickly and easily, especially if the demand in that area is low when you are looking to sell. The average time on the market for a commercial property for sale in Sydney is between 9 -18 months. The average time on the market for commercial property for lease is 6-12 months.
- Capital required: A significant amount of capital is tied up in upfront costs and maintenance, this deprives you from making better use of that money for other parts of the business and may impact cash flow.
- Capital loss: If you have to prematurely sell the property and it is sold for less than what it you purchased it for originally, this will mean a capital loss for the business.
- Maintenance and improvements: As the owner, you are solely responsible for maintaining the property and making any improvements.
Leasing business space
Here are the upsides of leasing business property:
- Prime Location and Property: The option to lease provides a business with the opportunity to rent a greater choice of properties with a good location and create a better image, which you may not otherwise be able to afford to do if you buy. If like a retailer your business is dependent on location and image,, the leasing option provides a more affordable solution.
- Available Capital: If your capital is not tied up in real estate, you could use that money elsewhere in the business, this would allow you to respond to opportunities in the market faster. The deposit for a commercial property investment loan is usually 30% of the purchase price (unlike residential, where you can sometimes loan 100%).
- More Time: Leasing provides you with the ability to focus fully on running your business not managing your commercial investment
- Faster response to business needs: If the business grows quicker than you expected, a decision to move to larger premises can be executed faster if you do not have to worry about selling first, which can take time. If on the other hand, the business is terminated, the ability to sublet may minimize the financial loss.
- Risk: Leasing is not necessarily a long-term financial commitment, which is beneficial if you are just starting out. Whilst you are entering into a lease agreement which will have a fixed time frame, once the lease expires you can leave the property.
Of course there are some disadvantages too:
- Variable Costs: With a leasing option you are usually subject to annual rent increases (generally in line with the Consumer Price Index, etc.) and increased costs when you renew the lease.
- Limited Control: You have little or limited control over what the owner of the property decides to do. If he/she sells you may have to relocate, which causes disruption as well as being an expensive exercise. This can result in a loss of “goodwill” that has been gained and potentially a loss customer base..
- Lack of Equity: If the business has no equity in the property, the lease repayments essentially build the property owners equity.
- Obligations: There can be many obligations and hidden costs in a lease which can be onerous on the tenant if they are not aware of them and can leave them out of pocket
If you can get the property at a below-market price, it may be worth buying. If you are well established and looking to stay in the same location for over 10 years, and have the financial resources to make a real estate investment, it is worth considering buying the property. Additionally, if you are a specialised industry like manufacturing, which has unique fit-out and machinery requirements, you may want to own those improvements to the premises.
If however you are using general warehousing and distribution facilities, which are easy to replace, then leasing may be a more cost-effective solution. Generally, leasing will be preferable to businesses that do not want to use their capital on real estate investment, and those who are not quite sure yet how much space they will eventually need especially new businesses.
As you can see above, the answer to lease or buy a business space is not a simple one. Your decision will depend on financial, tax, legal and business-specific situations. Before you decide which way you should go, make sure you consult with your solicitor and accountant about the legal and financial considerations of your decision.
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