Commercial Real Estate to Lease Vs Own

In my daily dealings with small business owners I see entrepreneurs struggle with the question of whether to lease or own consistently. The idea of owning can be very appealing, especially now as interest rates are still low (historically), new loan programs are popping up like 90% non SBA financing and 30 year fixed programs. And, building bargains seem abundant.

This question is certainly not new. Businesses have struggled with this for years – in good times and bad. The decision can become complicated quickly as objective (financial, space needs, etc.) and subjective factors (business image, growth plans, pride of ownership, etc.) combine. Forces outside of the business owner’s control, such as the general economy, interest rates, future real estate values, further obscure the issue.

The most thought of advantage of ownership is the potential appreciation. However as we are seeing now, appreciation is not always guaranteed.

Historically, financial experts have broken down the question by quantifying the factors such as the difference between the down payment/monthly mortgage vs. lease payments (among many others factors such as tax rate, tax benefits, interest rate, inflation, depreciation, expected holding period, expenses, etc). The point is to come up with an estimate of the buyers Internal Rate of Return on the down payment injected into the purchase.

Internal Rate of Return is commonly discussed, analyzed and dissected. Many factors can be manipulated, such as the anticipated appreciation rate inflation rate etc, to come up with different projections. Some of the major pros and cons of ownership include:

Pros

o The creation of equity
o Monthly mortgage payment is usually lower than comparable lease payment
o Potential future rental income
o Assisting owners with wealth/retirement
o Building an asset that will assist in securing business lines of credit and other forms of loans
o Pride of ownership
o Stability
o Control
o Business image
o Not being exposed to increases in rental market
o Not being exposed to whims of landlords
o Dramatic tax benefits

Cons

o Property management responsibilities
o Interest rate exposure on adjustable mortgages and/or if mortgage balloons
o Opportunity costs of down payment not being in a more liquid asset, or being used for business operations
o Decrease in functionality of building
o Building value subject to market conditions
o Length of time in selling building
o Decrease in space flexibility

These types of analysis can be very useful and give a clear perspective on a complicated issue. But, for most small business owners in general and in our Michigan economy, the question really boils down to money, and long term plans.

First of all, can the business really afford to inject 10% or 20% into a facility? Equity is hard to “tap” in commercial real estate. Many businesses need that capital for daily operations. Secondly, what is the difference in the potential mortgage payment vs. lease payments? Is owning going to increase cash-flow for the business (as it commonly does)?

Long term plans. Owning can be the wrong strategy for companies with strong growth potential/ expansion plans as selling on the short term can be expensive and difficult. Also, companies seeking venture capital may want to shy away due to how real estate ownership affects their books.

So, without overly simplifying the issue, the economy seems to be making purchasers think more of “now”, how holding real estate affects their business immediately vs. traditional long term hold IRR type mentality. Many buyers are discovering that despite concerns over the market, ownership still makes a lot of sense for their business and personal wealth.