A common question among small business owners is whether to buy or lease commercial property. The most important thing they want to know about are the costs. To help, we ran an analysis on a real commercial property for sale and created a detailed example of the costs and benefits of buying vs. leasing commercial real estate.
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Summary Of Buying vs. Leasing Commercial Building
We conducted a detailed analysis on a real commercial real estate property for sale. We found that buying commercial real estate is a better option than leasing if you plan to stay in the same location for 7 or more years. If you plan to stay in a single location for less than 7 years, then leasing might be a better option.
This is because we found that over a 15-year occupancy period, leasing commercial real estate costs as much as 86.6% more in our example than buying commercial real estate. However, when the expected occupancy period drops from 15 years to 7 years, the cost of leasing is actually less than buying commercial real estate. This makes 7 years the “breakeven” point for buying vs. leasing.
Our analysis takes into account the following:
- Up-front costs
- Monthly recurring costs
- Opportunity costs
- Tax savings
- Asset price appreciation
- Increases in business equity
- Money earned in the sale of property
However, when deciding to buy or lease commercial real estate, there are other factors you have to consider, including:
- Will you outgrow your space?
- Do you want to deal with the hassle of maintaining a property?
- Can you afford to tie up liquid capital in commercial real estate?
- Do you want the flexibility of a lease or the stability of a mortgage?
- Local trends in the commercial real estate market.
For an in-depth look at our detailed analysis and how we arrived at our conclusions, jump down to the example section below.
With this in mind, let’s take a look at the general benefits and drawbacks of buying vs. leasing commercial real estate. This should give you a better understanding of the right option for your business.
Benefits Of Buying Commercial Real Estate
Commercial real estate is a long-term asset that stores its value fairly well. For this reason and more, many business owners are interested in investing in an owner-occupied commercial real estate space. The benefits of owning your own commercial real estate property are as follows:
1. Equity Upside
The beauty of buying commercial real estate is that your monthly loan payments help you build equity. This is because a portion of those monthly payments goes towards paying down your principal loan amount. When you eventually sell or refinance your property, you can extract the difference between the remaining loan amount and the current fair market value as equity for your business.
This is in contrast to leasing commercial real estate since lease payments go to the landlord and no principal is paid down. Buying commercial real estate gives you more upside when compared to leasing commercial real estate.
2. Asset Appreciation
When you own commercial real estate you can also take advantage of asset appreciation. This appreciation represents the increase in the value of your property over time.
For example, the U.S. Commercial Property Price Index has increased by as much as 26.2% over the last 10 years. When you eventually sell your commercial property, you earn capital gains equal to the difference between the purchase price and the current fair market value. We discuss capital gains in the detailed example below.
3. Rental Potential
Businesses that buy commercial real estate typically occupy more than 51% of the commercial space. The remaining space can be rented out to tenants. These tenants can include retailers, restaurants, companies that need office space, and more. This means that there is a lot of rental income potential when buying commercial real estate.
However, keep in mind that if you rent out part of your space to tenants, you’ll typically have to act as a landlord and deal with the various requirements. If this is too much of a headache, you can also hire a property management company, but this will eat into your profit potential from renting.
4. Tax Benefits
Those who buy commercial real estate can deduct the following when calculating tax payments:
- Interest expense
- Depreciation expense
- Non-mortgage related expenses
These expenses can be multiplied by an average corporate tax rate of 35% to find the dollar tax savings. However, since the full amount of the monthly loan payments can’t be deducted (only the interest expense), the tax benefits when buying commercial real estate are typically lower than leasing commercial real estate.
Most mortgage-related expenses, such as closing costs and origination fees, typically can’t be deducted for tax purposes.
5. Control Your Property
When you buy commercial real estate you control your property. When leasing, landlords have certain rights built into the lease. For example, many landlords negotiate rental increases, giving them the legal right to raise the rent on a tenant’s lease at least once a year.
This means that when you lease a commercial space you might be at the whim of your landlord. If average rental increases are around 3% a year, and if you have a 36-month lease, your rent can increase as much as 9.3% over the life of the lease, if not more. This can create instability for a lessee.
However, situations like these won’t arise when you own your own property. Instead, you’ll have peace of mind that you have a fixed monthly payment for as long as you stay in the space. This means that your monthly payment will not be tied to the commercial rental market.