With interest rates still hovering near historical lows, it could be an opportune time for businesses to purchase the space they occupy. Not only does owner-occupied commercial real estate safeguard against dramatic rent increases, but it also provides a tax advantage.
“The key benefit is the depreciation. That’s the depreciation you don’t get when you lease, but you do receive when you buy,” explains Joe Yurosek, senior vice president and regional group manager at Comerica Bank.
Yurosek spoke to Smart Business about commonly overlooked real estate financing options, the pros and cons of fixed and variable rates, and why a business that already owns property might want to consider refinancing.
What factors should a CEO or business owner consider when looking at commercial real estate?
No. 1, does the CEO or business owner want to participate in any appreciation of a building which they wouldn’t participate in if they leased it? That’s a principal advantage that should be taken into consideration when deciding whether to lease or buy.
The second consideration is there are some tax advantages, as the building itself is depreciable over the useful life of the asset. The owner gets to depreciate the building and the improvements over the useful life of the building, but they don’t get to depreciate the land. Sometimes it’s critical for an owner to make sure that they secure a location.
When you own a property, you guarantee yourself the security of long-time location. This can be important in certain industries if you are near a port or close to a freeway. Or you might have [invested] excessive costs into a building so you would rather own where you already are than lease somewhere else.
On the other side of that there is the possibility, although in California it hasn’t been too prevalent lately, of price depreciation.
What are some methods that businesses can use to finance real estate?
The most active method used today is where the buyer is required to put down up to 25 percent and then they retain long-term financing for the remaining 75 percent. An alternative product that is really attractive when it comes to current interest rates would be industrial revenue bond financing.
There are also Small Business Administration products that offer benefits as well, including programs that require as little as 10 percent down. Also, everyone should contact their local municipalities, because often they have economic development programs and are willing to pass on financing support by way of low-cost money or loan-guarantee programs.
You mentioned industrial development revenue bonds. What types of businesses can benefit from this financing method?
There are some limitations on eligibility. Usually you have to be a manufacturer, but you can also be a nonprofit organization.
The buyer will be utilizing the credit strength of the bank or financial institution that issues the letter of credit support for the bonds. The bank then takes a deed of trust of the subject real property.
What are some factors that a business should consider when deciding whether to use a fixed or variable rate?
The buyer’s tolerance for risk is the key. When you choose a fixed rate versus a variable rate, you are hedging against increasing rates. If they don’t go up, you may be better off with a variable rate.
If you are inclined not to take risks, or if your business doesn’t support potential interest rate risk in the future, most people choose to lock in and know what their rates are.
Alternatively, variable rates allow for repayment flexibility. Some people like to pay off their loans early. By not locking in, it gives you flexibility to make early repayments.
What advice would you give to a business that wants to refinance the property that it already owns?
Today’s rates are at historically low levels, so a business with a variable rate might want to lock in and reduce future interest rate risks. It’s a very good time to lock in and move from variable to fixed.
Some owners are looking for additional funds. If they already own the property, this could be a good time to cash out by refinancing the building and using the cash proceeds to reinvest in the business. Refinancing is an alternative to selling a building if you need capital.
Joe Yurosek is a senior vice president and regional group manager at Comerica Bank. For more information, visit www.comerica.com.
