With interest rates still very low, 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.
“One 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 have an opportunity to participate in any price appreciation of a building which they wouldn’t participate in if they leased it? That’s an advantage that should be taken into consideration when deciding whether to lease or buy.
The second benefit to owning real estate is that there are some tax advantages, as the building itself is depreciable. This means, the owner gets to depreciate the building and the improvements over the useful life of the building, which offsets an owner’s taxable income.
A third benefit to owning real estate is securing your location beyond the time that may be available with a lease agreement. This may be very important when business owners need geographic-specific locations near ports and freeways or simply need to secure parking or storage space. It’s also important for growing companies to secure contiguous properties to make room for manufacturing or distribution growth. Non-adjacent properties can lead to operating inefficiencies. When you own a property, you guaranty yourself the security of a long-time location.
What are some methods that businesses can use to finance real estate?
The most active method used today is fixed or variable rate bank or institutional debt financing. Bank financing typically involves up to a 75 percent loan to value on purchased property with a mortgage style amortization. In this case the buyer is required to put up 25 percent of the purchase price. A popular alternative product that is really attractive would be tax free or taxable 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, owners 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-guaranty programs.
What types of businesses can benefit from industrial development revenue bonds?
There are some limitations on eligibility. Usually you have to be a manufacturer, but you can also be a nonprofit organization. But, if you qualify, tax-free rates further reduce your borrowing costs.
With respect to revenue bond financing, the buyer will be utilizing the credit strength of the bank or financial institution that issues the letter of credit in support of the revenue bonds. The bank then takes a deed of trust on the subject real property.
What are some factors that a business owner should consider when deciding whether to use a fixed or variable rate?
The buyer’s tolerance for risk is one factor. When you choose a fixed-rate loan versus a variable-rate loan, you are hedging against increasing rates. Obviously, if rates don’t move or if rates decline, buyers are better off with a variable product.
Another factor would be a business’s ability, or lack thereof, to absorb increased interest costs on a variable rate loan. Most business owners like to know what their fixed costs are so they prefer to lock in rates or use interest rate swaps to trade variable rates for fixed rates. By using rate swaps, a business owner can effectively create a fixed rate.
Alternatively, variable rates do allow for repayment flexibility. Some owners prefer to pay off their loans early. A variable rate gives owners flexibility to make early repayments.
What advice would you give to a business owner who wants to refinance the property that the business already owns?
Today’s rates are still at low levels, so a business with a variable-rate real estate loan might want to lock in a fixed rate or swap a variable rate for a fixed rate and reduce future interest rate risks. It’s still a good time to lock in and move from a variable-rate to a fixed-rate loan.
Call your banker and get rate quotes. Ask your banker about fixed products and swap products. Some owners may be in a position to also take advantage of existing price appreciation when refinancing. This could be a good time to cash out by refinancing the building and using the additional proceeds to reinvest in the business. Refinancing is an alternative to selling a building if new capital is needed.
JOE YUROSEK is a senior vice president and regional group manager at Comerica Bank. Reach him at (562) 590-2561 or email@example.com.