Should You Buy or Lease Your Business Facility?
It’s a question every business owner will eventually have to answer: Should you buy or lease your business facility? As with most things, there are pros and cons to each option.
The main benefit of buying your facility is that it becomes an asset you own -- and one that ideally will increase in value over the long term. Your monthly mortgage payments go toward building equity in your property, while rent or lease payments simply go toward paying the mortgage for your landlord.
However, leasing offers more flexibility than owning. This is an important consideration for many businesses, especially fast-growing and cyclical companies for which it’s difficult to forecast space needs.
On the financial side, both lease payments and mortgage interest are fully deductible as a business expense. But if you own your property, you can also take deductions for depreciation. Plus, ownership of commercial real estate can be another way to build wealth over the long term and further enhance the value of your business.
In addition to building equity, the biggest advantage to owning facilities is fixing your cost of occupancy, since a long-term fixed-rate mortgage will lock in your monthly payment for many years. Keep in mind, however, that there are potential balance sheet implications of ownership.
Ownership (assuming the property is financed) involves taking on debt, which must be disclosed on your company’s balance sheet. This can have an adverse impact on your company’s ability to obtain other types of business financing. An operating lease, however, does not impact the balance sheet, since no debt or equity is created. This kind of off-balance-sheet financing can optimize your company’s financial leverage and make its balance sheet more attractive to creditors.
Another issue to consider is the potential return on your company’s assets: Should cash and retained earnings be invested in real estate or back into your core business? Growth companies usually prefer to invest available cash back into their core business operations to help fuel further growth. Buying a building, however, typically requires a large cash outlay for a down payment -- cash that could produce a higher return if reinvested back in the business.
A common strategy among small business owners is for the owner to buy the property personally and then lease it back to the business, using the tax benefits personally. This is another way for business owners to get money out of the business pre-tax and further build personal wealth. It also provides long-term financial flexibility: The business owner can hold on to the property when selling the business at retirement and lease it to the new owner. This can be a great way to generate retirement income.
Often, the best candidates for owning their facilities are mature companies in mature industries that can take a long-term perspective (e.g., 20 years or longer), because real estate is still a relatively safe long-term investment. Restaurants and retail storefronts are good examples: Many have been in the same locations for decades, and they can boost profits due to an occupancy cost set many years ago that’s lower than current rent rates.
Don Sadler is a freelance writer specializing in business and finance. Reach him at don@donsadlerwriter.com.
