As you grow your business, you face the question of whether it makes more sense to buy or lease space to operate your business.
The right choice will depend on your current situation and finances combined with your plans for the future. Consider these pros and cons as you make your decision.
Benefits of buying
Build equity. When you buy, part of each monthly loan payment goes toward paying down your principal. As you pay down the balance, you build equity.
When you eventually sell or refinance your property, you can extract that equity to use
however you like.
Gain rental income. Many commercial property owners don’t occupy all the space they purchase.
The space you don’t need can be rented out to tenants to provide rental income.
Upside: If you need to expand in the future, you can terminate tenants’ leases and take over the space yourself. Downside: You have to act as a landlord or hire a property management company for the job.
Keep costs constant. While lease payments may increase over time depending on conditions in your local real estate market, you can lock in fixed costs over the long term with a commercial real estate loan.
Drawbacks of buying
Tie up capital. Your loan may require at least 10 to 20 percent of the purchase price as a down payment. Other upfront costs are greater, too. For example, you’ll have closing costs and due diligence fees.
Increase liability. You’ll be responsible for repairs to the property and maintaining it as a safe environment for the people who use it. If you rent out a portion of the property, you’ll have to meet more stringent legal requirements and purchase additional insurance.
Limit flexibility. Commercial real estate is an illiquid investment, so it’s harder to move to a new location or expand your current space when you own rather than lease — unless you buy a larger space than you need and rent out a portion of it. Lease terms may be as short as three years, while commercial real estate loans may have terms of 15 to 30 years. In addition, with capital tied up for such a long time, you should consider the opportunity costs. What will you not be able to do as a result of paying the upfront costs?
Benefits of leasing
Free up working capital. Upfront costs to lease are much lower than those to buy. With less capital tied up in a long-term asset, you have more liquidity.
This can enable you to take advantage of opportunities as they arise.
Increase flexibility. When your lease expires, you have the freedom to move to a new location. If your business is heavily location-dependent, as many retailers and restaurants are, this can be an important consideration if your current location loses its vivacity.
Maintain focus. Without any of the distractions of managing maintenance or repairs to your space, you’ll have more time to focus on your top priorities.
Drawbacks of leasing
In contrast to buying, you don’t build equity when you lease. Instead, 100 percent of your monthly payment goes to the landlord and you never end up owning the property. You won’t benefit from any price appreciation on the property.
Pay higher and rising costs. Amounts depend on the individual property and lease, but monthly payments on a lease are often higher than monthly loan payments on a comparable property. Also, they may increase annually or at each lease renewal.
Lose control. With many leases, you have little or no control over maintenance or renovation of the property. And, when your lease expires, your landlord may decide not to renew it, forcing you to move.