A number of strategic decisions should be considered when making the decision to own or lease facilities for your company, says William D. Saltzman, SIOR, CCIM, executive vice president and director of office services at Cushman & Wakefield/CRESCO Real Estate.
“Needless to say, it’s an important decision and a complicated process,” Saltzman says. “The key to making a good decision is to have solid information that is based upon thoughtful, credible assumptions. The more successfully you’re able to anticipate your company’s future needs, the better off you’ll be.”
Smart Business spoke with Saltzman about key considerations when making the decision to lease or purchase commercial property for your business.
What are the pros and cons of owning real estate versus entering a lease agreement?
Leasing provides flexibility. Generally, with leased facilities, business owners can be more nimble. They are able to expand or contract based upon changing needs, and can do so more quickly. The risks associated with ownership are eliminated; for example, the possibility that you may need to sell your property during a downturn in the market. In the event you plan to sell your business, the prospective purchaser may have little interest in owning the real estate.
In leasing, business owners typically avoid the headaches of maintenance, repairs and valuation risk and are better able to concentrate on core business activities without being distracted by the concerns of real estate ownership. Conversely, there are significant advantages to owning the real estate your company occupies, including valuable financial and tax benefits. You can modify the premises for your specific requirements and you’re making improvements in your own asset as opposed to an investment that benefits the property owner. There is also a certain mystique that can be associated with property ownership. Investment in real property conveys financial stability, success and greater control of your company’s future. As a property owner, you have greater influence on the compatibility of adjacent businesses, which is something that would be difficult to accomplish as a tenant.
What’s the key to making strong assumptions about your company’s future?
Take the time to build realistic financial models that are based on thoughtful, informed projections. Adjustment of just a few percentage points in these forecasts can significantly impact the outcome.
Within your business, look at the ways in which your space requirements will change over time. What is the cost and availability of capital today? What are the projected returns from additional investment in your business? If the right facility is available for acquisition at a fair price today and your preference is to own the property that your company occupies, it may be prudent to act now.
You also must consider the residual value of the asset, if you own it. What’s the estimated future value if you hold onto it for X number of years? The analysis should consider total occupancy cost, which includes line items for rent, operating expenses, utility costs and tenant-funded improvements. Evaluate it on a net present value basis to come up with your true occupancy cost over that same period of time. On a purchase, you’re going to look at the debt service, the annual operating expenses and the opportunity cost of that equity that you’re putting into the acquisition. Look at the period of time during which you own the building and assume what the equity reversion is or what the sales price would be at the end of the holding period. What assumptions are you making to reach your conclusion? And what do the numbers look like when you compare leasing the space to owning it?
What is the difference between a triple net lease and a gross lease?
In a triple net lease, 100 percent of the expenses are borne by the tenant, including responsibility for maintenance, repairs, insurance and taxes. In a gross lease, by contrast, the rent paid by the tenant typically includes an allocation for expenses and taxes. In this case, the increased cost of occupancy over the term of lease is limited to incremental adjustments that the landlord passes on to the tenant over that base allocation.
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