One of the trickier decisions many business owners face is whether they should lease or buy commercial space. It’s easy to default to the “buy” side of the debate because it seems like you’ll be better off building equity in an appreciating asset rather than paying rent to a landlord every month.
But it’s not that simple.
Benefits of Buying
No one will argue that equity is a good thing. If you buy, then your ownership stake in the property will grow a little every month as you pay down the loan principal and interest — and as the property (hopefully) appreciates.
There are also some tax advantages to owning commercial real estate, and the potential to earn passive income by renting out part of your space to other tenants.
However, the advantages come at a cost, because putting together a real estate deal and then managing your property can be a more significant burden than most people bargain for.
Why Renting Rules
The No. 1 reason to rent is that it doesn’t require extensive knowledge of real estate transactions and property management. Something we’ve noticed at Leasecake is that multi-location tenants don’t always have the time or inclination to concern themselves with becoming a commercial landlord.
There’s also the matter of the high upfront costs that go along with buying real estate.
One of our co-founders, Jim Bankston, has developed, owned, and managed commercial property for more than 30 years. In his experience, many businesses lease space with the thought that it’ll be a short-term thing for a few years until they buy a building. But for them to find an existing building and come up with the down payment — well that’s just about impossible when all the cash is tied up in inventory.
As a matter of fact, after all these years, and with a current portfolio of 50 tenants across nine buildings, he’s only seen it happen once.
“If someone is good at manufacturing widgets, making pizzas, or operating a pest control company, then they want to focus on that thing,” Jim said. “Buying and managing buildings is a whole different skill set.”
Jim also points out that it can be difficult for business owners to qualify for financing on a commercial building.
Typically, the down payment on commercial real estate is 20 percent to 40 percent of the property’s value. You’ll also have to pay for closing costs and due diligence fees. For example, on a $1 million property, you can expect to pay anywhere from $100,000 to $400,000 out of pocket for the down payment and other fees.
When your cash is tied up in inventory and operating expenses, it’s much easier to come up with a deposit that typically equals one month’s rent. Leasing allows you to use your remaining available cash for working capital or expansion.
There is no single answer to whether you should lease or buy — you should make the decision based on your circumstances. However, our observation is that leasing has the lowest barrier to entry for most business owners and offers the flexibility you need to grow efficiently.
If you lease multiple locations, it’s essential to stay on top of all your lease renewal dates, rent escalations, location notes, and critical clauses buried inside paper leases. The best way to keep track of all those lease events and minimize your risk is with commercial real estate lease management software.
To learn more about how Leasecake can help, schedule a demo today.