Buying vs leasing commercial space

October 8, 2014

 

By JORDAN AMARANT
NAI Benchmark broker associate

As an entrepreneur and business owner who occupies commercial space, this is a question you must know the answer to: why are you still paying rent?

The Central Valley’s improving economic climate is prompting many business owners to buy commercial property. Interest rates remain the lowest they have been in years and commercial property values have not yet realized the same upturn that many residential markets have over the past two years.

That being said, deciding whether to purchase or lease property can still be very challenging. There are many factors should be analyzed carefully, aside from the obvious financial considerations.

For new business owners who are uncertain of future space needs and who want to ensure maximum cash flow as they grow a business, leasing may be a wise option. But for new or seasoned owners with strong financial profiles, a clear picture of future growth and the ability to take advantage of the tax benefits of ownership, commercial real estate purchases can provide a solid foundation for growing their businesses.

Space costs represent significant business expense, but making a prudent decision goes far beyond short-term financial considerations. It is a broad process that should include thoughtful consideration of the following benefits:

Appreciating Commercial Property Values

Commercial properties are far less expensive today than they were before the recession. In some areas, it may ultimately cost less to purchase and outfit commercial real estate than to lease and improve space.

While property values likely will not rise at the aggressive rates seen from 1998 through 2005, it is a safe bet that at today’s lower prices, commercial real estate values are likely to appreciate, especially following the recent jump in residential prices that the Central Valley has seen. Property owners will receive the full benefit of that appreciation.

Historically Low Rates

The most significant cost of purchasing real estate is the mortgage interest rate. Rates for commercial real estate purchases are still at an all-time low, ultimately saving significant money as you pay down your commercial mortgage.

However, obtaining financing can still be a challenge, so it’s critical to maintain a spotless financial profile and prepare a comprehensive business plan that shows your business is viable. Also, consider working with a lender who specializes in commercial property financing and understands your particular needs.

Equity Appreciation

As you build equity in your business real estate, it becomes a more valuable asset that you can leverage to further grow your business without putting the business itself at risk. This gives you greater flexibility to manage your business growth.

It also gives you additional options when the time comes to retire. As a commercial property owner, you can sell your business and underlying property outright when you retire, or you can sell the business only and lease the commercial property, which produces an ongoing income stream.

Cash Flow Opportunities

If you purchase commercial property that has space for additional tenants, you have opportunities for creating cash flow through rental income. You can use tenant income to help pay down the property purchase to offset the cost of your investment.

However, it’s important to remember that having tenants involves property management responsibilities that may distract from your core business. That’s why many property owners use a management company. The additional cash flow from multiple tenants is a proven method for building long term wealth and maintaining additional cash flow well into one’s retirement years.

Tax Advantages

Owning the property your business occupies allows you to depreciate your asset while writing off all of the mortgage interest you pay during the year. You can also enjoy the benefits of several tax deductions designed for the business or property owner:

Section 179 — IRS Tax Code Section 179 allows deductions for equipment and furnishings you buy and put into service during the the same year. Congress has granted a generous deduction of $500,000, which can be a significant contribution toward offsetting the cost of the property purchase.

Cost segregation – This technique allows commercial building owners to generate cash flow by accelerating depreciation deductions on their buildings and deferring taxes. Using this method, buyers view a real estate acquisition as consisting not only of land and buildings but also tangible personal property and land improvements. The tax savings come from the accelerated depreciation deductions and possible easier property write-offs.

1031 exchange — Investment properties used in a trade or business can be sold and the funds applied toward the purchase of a similar property within 180 days of sale without reaping any tax consequences. The purchased property must be of equal or higher value to avoid a tax penalty. This provides leverage to move your business to a larger facility as it grows, without being hindered by tax penalties.

As with most decisions there is no one-size-fits-all solution. The benefits of ownership are many –- provided that ownership is the right strategy for your business. Be sure that your business goals align with real estate ownership and you can fully realize the value of commercial real estate ownership.

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