When it comes to your business's workspace, the rules of homeownership versus renting don't always apply. Learn to determine the right move for your business operation.
By Chad Preston
Conventional wisdom for the question of owning a home versus renting usually is a no-brainer: You buy. But it doesn’t necessarily apply to small businesses, because both options can be advantageous. There are a number of factors to examine to determine the right move for a small business. Learn how to weigh your options, and ultimately make the most lucrative decision.
The decision to buy or lease is not an easy one. Each has its pros and cons, says Darrell Zahorsky, About.com guide to small business information and president of Profit Innovators, Inc. in Durham, Ontario, Canada. Owning your office or retail space has several advantages, he says. One of them is the fixed cost. When you buy your workspace, you can lock in costs with a long-term mortgage.
“In the event of changing market conditions, you’re more or less immune to the rising mortgage interest rates and added costs of leasing spaces,” he says.
Another benefit is the tax savings you receive from deducting your mortgage interest and property taxes, Zahorsky says. “It’s important when you consider to rent or own that you talk to your accountant and play with the figures to see how you come ahead and what those tax savings are,” he says. You also have the potential to add revenue when you own by renting any unused space.
Buying can also be attractive for building or supplementing a retirement nest egg, Zahorsky says. Because real estate generally appreciates over time, and if you plan to be at a location for the long term — say at least five to 10 years — having bought property can help fund your retirement, he says. During the next 10 years there will be an increase in the number of businesses being sold, which may outstrip demand for businesses on the market, he says. When that time comes, your business may get a lower valuation and your sale of real estate can be used to offset that cost, he says. It’s important to note that selling both the business and real estate could be very lucrative when it does come time to sell.
“For most small businesses, owning their own space is generally not a good option,” says Jeff Landers, founder and president of Offices2Share.com. “Most small businesses don’t know where they’re going to be in three or four or five years from now. If you’re growing quickly, you don’t want to be buying your space and putting your capital into the real estate instead of putting it into your business. You could find out a year or 18 months later, that one, your business has grown much more quickly than you anticipated and you’ve outgrown the space. Or two, you run into financial difficulty, and the money you invested in that space is no longer available to fund your business.”
Generally speaking, shorter-term leases are better, Landers says, adding that he advocates as short a lease as possible for startups or quick-growing companies. This provides flexibility to move easily, he says. If a company needs to double or triple in size it is not locked into a lease and could move quickly. In addition, if a business runs into difficulty, it could more easily get out of that lease.
“We’ve all heard the adage ‘location, location, location,’” Zahorsky says. “Well, often that prime location has a high price tag to buy, but can definitely be more affordable if you lease. This is especially important for businesses that need high traffic. That high-traffic area can generate greater business revenues in your lease situation as opposed to buying a low-traffic location.”
Because leasing is often less costly than buying, you are better able to take advantage of opportunities as they arise, Zahorsky says. Another benefit of leasing, he says, is you’re not becoming a property manager, so you can focus on your business. “You’re not running a commercial real estate company so you’re going to have fewer headaches, less maintenance and you can focus on your business first,” he says.
Mortgage costs for commercial space are higher than residential rates, so it’s possible to spend more than you would if you leased, Zahorsky says. “There are more costs involved in owning, not just maintenance, but building improvement costs, as well as initial appraisals and other fees associated with it,” he says. “So the cons of owning can prohibit a lot of businesses from taking that route.”
Consider All Factors
A fairly well established business that has had a number of years to anticipate growth knows whether it’s growing or not growing, so owning the real estate could be advantageous, Landers says. Owning real estate is an entirely different type of investment for which different analysis is necessary. The market and the local economy should dictate the decision, not whether the company has a better use for those funds, he says. There are certainly circumstances in which it makes sense to own, he says. When the business is established and has plenty of cash flow, owning property locks in costs and you avoid unexpected costs such as escalating rents. If, at the end of a five- or 10-year lease, rent has gone up three or four times, it would make sense to own, he says.
It is important to make a decision based on the business you operate as well as the location’s attributes, such as the amount of traffic it gets, Zahorsky says. “You are going to pay for it,” he says. “So leasing for a lot of smaller businesses makes a lot of sense.”