Although the decision to rent or buy
has some connection to real estate
market trends, a company’s stage in its business life cycle should have the
largest impact on the answer to this question. Executives need to evaluate their
organization’s current position and short-and long-term goals before making this
choice.
“If company leaders are having difficulty
making a decision on leasing versus buying, they can consult with a real estate professional who can lend a hand in providing
the financial implications of each alternative,” says Douglas LeClair, director of the
Financial Consulting Group at CB Richard
Ellis in Atlanta.
While all companies have unique situations that require careful analysis, some
general principles apply to all organizations as they compare their options.
Smart Business learned from LeClair
some of the significant opportunities and
challenges with leasing and buying.
What are the advantages and disadvantages
of leasing real estate?
Leasing real estate makes sense for many
companies, particularly when they find
themselves in growth or decline stages.
During these times, leasing offers businesses the flexibility to grow and to contract
without major financial consequences.
Some other advantages of leasing include:
- Monthly rent can be written off as a
business expense. - Credit ratings don’t play as crucial a
role in completing a deal. - Businesses can sublet or move at lease
expiration with no risk of loss in property
value from a poor market.
Leasing also has disadvantages, such as:
- Rental rates typically have annual
increases. - There is no built-up equity or residual
value at the end of the lease term. - Landlords can force tenants to move at
the end of their lease terms.
What are the pros and cons of owning?
Many companies find owning facilities an
attractive option, particularly when they sit
in the mature stage of their life cycle. These businesses tend to have capital available
for investment and typically desire a stable
occupancy situation. Knowing these fixed
costs can help them perform meaningful
long-term strategic planning. Other positives of buying include:
- Businesses can make changes to suit
their operations. - Mortgage interest is tax deductible.
- Annual depreciation also decreases tax
liability. - Open space can be leased.
- There’s buildup in equity and possible
appreciation in value during ownership.
Some potential negatives of purchasing
real estate also exist:
- Initial cash outlay required to secure
financing - Inefficient property management by
companies who don’t specialize in real
estate - Time and energy diverted from core
competencies - Delayed relocation due to an inability
to sell property
What questions should decision-makers
answer during this process?
When evaluating whether to own or to
lease, several questions come to mind.
Thoughtfully responding to these questions will help executives determine which
alternative makes the most business sense
for their company right now:
- Does your business have the cash to
make a down payment? Purchasing real
estate will have a significant effect on the
liquidity of business assets. - What is the opportunity cost associated with that investment? Locking financial
resources into a property comes with the
opportunity cost of not having the ability to
put it back into the business or into other
higher yielding investments. - Where is your business in terms of the
growth cycle? If a company currently operates in the new or high-growth mode, leasing might make more sense. A mature company might want to buy to provide assurance of stable, long-term occupancy and
diversification of assets to hedge against
inflation. - Do you have the time, resources and
the desire to properly manage the property? Many times businesses will buy more
office space than they currently need so
they have room for growth or expansion.
This not only requires taking on responsibility for day-to-day issues that come with
property management, but it also presents
the issue of leasing additional space. - What are your tax implications? Lease
payments are usually fully deductible on
the lease side. On the ownership side, business can deduct mortgage interest payments and depreciation on improvements.
Discuss which side offers the largest benefits with financial advisers.
What other factors are there to consider?
The emerging cost segregation method of
depreciation may make purchasing real
estate more attractive to many companies.
Instead of subtracting the land cost from
the value of the building and depreciating
that total over 39 years, businesses can
front-load depreciation and realize all of it
over a very compressed period of time.
These cost segregation calculations come
from a detailed analysis of companies’
improvements. This accelerated depreciation has potentially enormous tax benefits
for businesses.
DOUGLAS LECLAIR is director of the Financial Consulting
Group at CB Richard Ellis in Atlanta. Reach him at (404) 504-7903 or [email protected].