Pros and Cons of Buying V. Leasing Your CRE Space
Is Buying or Leasing a Better Fit for Your Business?
Tenants who operate out of commercial spaces often question whether they are making the right decision for their business model. They ask themselves, as a renter, am I wasting money on rent? Could I improve my position if I purchased a commercial space? What are the benefits and disadvantages of both scenarios? To help those faced with these challenging questions, let’s look at the pros and cons of buying your commercial space (becoming an owner-user) versus the pros and cons of leasing your commercial space.
Benefits of Buying Your Commercial Space
As with any real estate investing, purchasing a commercial space as an owner-user comes with a multitude of benefits. Let’s look at the most prominent ones for commercial investors.
1. Build Equity
First and foremost, buying real estate allows you to build equity. Instead of paying your rent to your landlord, you pay down your mortgage, building wealth as both an individual and company.
2. Tax Benefits
Owning real estate comes with many tax benefits – all of which should be reviewed with your CPA. But in a nutshell, real estate offers write-offs and deductibles associated with your interest expense, depreciation expense, non-mortgage-related expenses and more. Additionally, you can trade into new properties utilizing a 1031 exchange.
3. Potential for Additional Income
Depending on the building you purchase, you can split the space and rent out the additional units. This can provide income to help you pay down your mortgage.
4. Known Mortgage Rate
Unlike your rent, your mortgage rate (as long as you have a fixed interest rate) will not change over time. This can allow you to plan for the future and build your company.
Downsides of Buying Your Commercial Space
As an owner-user, buying may not prove to be the most optimal decision; it can prohibit your business growth in many cases. Here are the downsides Orange County investors may face as CRE investors.
1. Significant Upfront Expenses
Purchasing real estate is expensive. First off, you will typically need to save at least 20 percent for a down-payment, and depending on which market you are interested in purchasing your real estate, the amount can fluctuate greatly. In addition, property owners will need to consider the cost to build out each unit to accommodate tenants.
2. Lack of Affordability
If you are in a market such as Orange County, purchasing real estate can be pricey – Some tenants find that buying real estate is out of reach, and they must rely on leasing. *Hint: For tenants in this position, consider looking into an SBA loan for owner-user acquisitions!
As a landlord, you will be responsible for your building, which can become time-consuming for many business operators, especially if they are renting out additional units. This can reduce the time spent on building a business due to the time required to manage the property.
4. Loss of Capital
The upfront costs to purchase real estate could be used for business growth. The lost capital could be a financial burden for a business operator.
Benefits of Leasing Your Commercial Space
For businesses focused on growth and for those who seek mobility and flexibility in the future, leasing may be the best option for their operations. Tenants in many markets have found that leasing offers them benefits buying does not.
1. Negotiable Rates
When the market experiences a shift, as a tenant, you have control to negotiate your rent. For example, during the 2020 pandemic, many tenants requested rent reductions to match their declining business income. Landlords, however, are often still responsible for their mortgage payments.
As a company, things change, and you want to have the flexibility to accommodate these changes. For example, you may want to move locations, expand your footprint, or leave your space entirely and transition to remote work, which many tenants decided to do in 2020. Leasing your space provides you with this flexibility that owning does not.
3. Tax Breaks
Just like owning, leasing also provides tenants with tax breaks. Which option is best suited for your business model should be reviewed with a CPA.
4. Tenant Improvements
Most landlords offer tenant improvements, meaning they will pay for the renovations to your space when you move in. This reduces the expenses for businesses, and the capital they save can be utilized to grow their business.
Downsides of Leasing Your Commercial Space
In today’s CRE environment, leasing your commercial space may prove to be detrimental to your bottom line and future potential. Business owners who plan to lease instead of buy should be aware of the disadvantages this decision may present.
1. Upkeep without Return
If a tenant is responsible for maintaining their space, such as in an absolute triple net lease, they will be required to pay for repairs without benefiting from the upkeep outside of immediate return.
2. High Rents
If you seek a space in a highly demanded area, such as Orange County, you may be facing extraordinarily high rents. This could prohibit your ability to select a premier location for your business or cause financial hardships for your operations.
3. Zero Equity
As a tenant, you are continuously paying rent to your landlords; instead of building equity yourself, you are helping your landlord build equity.
4. Reliant on Landlord
As a tenant, you are at the mercy of your landlord when requesting repairs for both the inside of your unit (dependent on lease structure) and the common areas. Poorly maintained common areas could deter potential clients, resulting in a financial loss for your business.
What Tenants Should Know Considering Today’s Landscape
In addition to the pros and cons listed above, tenants and prospective property owners need to consider the current market landscape and understand how specific commercial real estate trends could impact their decision.
We have recently seen a major market shift: Interest rates dropped significantly, offering an additional advantage for tenants interested in purchasing real estate. This factor has drastically impacted the current market, making it an even more ideal landscape for prospective tenants considering purchasing their commercial real estate. If you are interested in learning more about whether you are in a position to buy, reach out to our team of professionals for a free consultation.