In decades past, it was unusual for businesses to own their office real estate. The exceptions were doctors and dentists, who often converted their homes or parts of their homes into office space. But in today’s market, more and more businesses—law firms, advertising agencies, and financial planning companies, to name a few—are choosing to buy rather than lease.
The attractions are obvious: real estate investment can build equity, increasing a company’s net worth over the long term, particularly in areas with rapidly appreciating property values. Alternatively, the principal’s of a business may choose to purchase a building and lease it back to their own company providing a steady source of rent to offset the loan payments. Owners can also take advantage of tax deductions for mortgage interest and building improvements, as well as special capital gains treatment.
And, for many business owners, the idea of having predictable, fixed payments over the life of a loan rather than the variable costs of fluctuating rents makes great sense. Owners are no longer subject to leasing market conditions and rising rental rates, and have complete control over decisions about remodels, maintenance, and how the space looks and feels to clients and customers.
So what stops businesses from making the leap from lessee to landlord? One obstacle can be the scarcity of available properties. Nationwide, the number of properties available for purchase is usually dwarfed by the number of spaces available to lease.
But the commercial real estate landscape is evolving and new possibilities are opening up. Some developers are catering to businesses that prefer to own their real estate. Small office parks with individual buildings each owned by separate businesses are being developed throughout the country. This set up is ideal for insurance agents, dentists, or virtually any small business requiring 4,000 to 8,000 square feet of office space.
Another possibility for companies looking to buy in prime locations is the office condominium option. Condos are available even in hot downtown and suburban markets, where few buildings are up for sale.
Building ownership is not for every business—much depends on a company’s current growth phase. Young companies and start-ups may not be able to predict their growth accurately enough to understand their future real estate needs. Leasing offers them maximum flexibility to be able to adapt quickly as the company grows or downsizes.
Cash flow is also an issue. Buying real estate requires a down payment and funds for closing costs, which ties up working capital that many businesses are not willing to commit. Young companies may not have acquired the financial assets needed to meet commercial lenders’ requirements.
For some businesses, leasing makes more sense because in general, lease payments are deductible immediately, while the tax advantages of ownership are more complex and only realized over the long term. Keep in mind that it is critical to review any tax-related decisions with an attorney and tax adviser.
Room to Grow
Owning often works best for mature, stable businesses, whose growth curve has leveled out or is easy to forecast. Future growth is an important consideration. If your business grows larger than the building can accommodate, you may need to sell and buy something else, a time-consuming process. Or, you may end up leasing the entire building to another company.
To manage this possibility, businesses often purchase space that is larger than their current need and lease the additional space to another company. That way the building owner can expand into the additional space when their tenant’s lease expires.
Outgrowing a space doesn’t have to be a financial crisis—it can even be an opportunity for generating new cash flow. One of my clients saw his business grow so rapidly that he quickly needed more than twice the space of the building he’d purchased. He was able to lease that building to another company at a profit, and move into a new, larger space for his own business.
Add it All Up
If you are on the fence over the buy vs. lease subject, keep in mind that leasing appeals to businesses that are in constant flux and need the ability to make fairly rapid adjustments in their office space; whether it be in the size or type of the space or the location. In addition, if you need to keep your capital liquid for future business investment, it makes more sense to lease. Buyers will be stable companies that know they will be in the same location for several years. They will also have significant financial assets and the tolerance for taking on the responsibility of building maintenance and other ownership issues.
If you think owning your own office space might be an option for your business, do the numbers. Make a long-range plan. Consult your real estate professional, attorney, and tax adviser.
Who doesn’t have a soft spot for elegant vintage buildings full of local history? Take a walk around the blocks lying just south of Front Street in downtown Boise and you’ll see an intriguing combination of revitalized old structures and sleek, modern retail storefronts.
Projects like these, called property conversions or redevelopment, are popping up all over the country. Rather than starting from scratch on new buildings, many developers are finding new ways to utilize existing space. In the process, they are revitalizing neglected pockets of downtown real estate, as abandoned warehouses metamorphose into elegant offices and storefronts.
In Boise, Idaho and other cities commercial building owners and landlords are getting creative as construction costs rise and rental rates don’t. Developers are finding that, in order to get adequate financing for new construction, their property rental rates have to start at $25 or more per square foot. With market rates hovering around $20 per square foot, redevelopment becomes an attractive strategy for providing new office space at lower rents than a completely new building would require.
Boise’s redevelopment renaissance got a major boost several years ago when the property between Front and Myrtle Streets—stretching east to Capitol and west to 9th Street—became available. The anchor for the collection of sidelined buildings and warehouses was the 8th Street Marketplace. Developer Mark Rivers had a vision of turning it into a shopping and entertainment destination. The result grew into BoDo (short for “Boise Downtown”), which now hosts a theater complex, upscale boutiques, retail stores, sidewalk cafes, and office space.
Many businesses are attracted to office properties with vintage character. BoDo accommodates a wide variety of them, from one- or two-person shops to large firms, from high-tech companies to ad agencies to law and accounting firms. Even small office users can find a home in Boise. Individual offices suites of 125-400 square feet are available with short-term leases in the 8th Street warehouse building.
Near the corner of 9th and Front Streets is one of Boise’s most unique office warehouse conversions. Known as the Foster’s Building, this 4-story structure at 314 South 9th Street was built in 1910 for the W.P. Fuller Paint Company. The building has an unusual triangular shape and one of the walls is curved to conform to the path of the adjacent railroad tracks.
Instead of tearing Foster’s down, the BoDo developers chose to take advantage of its historical value and distinctive architecture. The building was saved by a creative plan that literally enveloped the old warehouse in the middle of a new office building and parking garage.
Environmentally speaking, re-using an old building and bringing it up to modern standards and codes is an infinitely greener move than demolishing and rebuilding. But revitalizing has its challenges. The BoDo project developers had to deal with numerous environmental issues, including lead paint and petroleum contamination. Seventeen fuel tanks located underground near the corner of Front and Capitol that had to be removed at a remediation cost of $1.5M.
BoDo isn’t the only property conversion in town. Just down the street off Grove and Main, the Linen District is staging a major comeback. Already a vibrant spot just slightly off the beaten path, the Linen District houses Big City Coffee, Second Chance Building Materials, Evans Keane law firm, and the Visual Arts Collective.
The Empire Building at 205 North 10th Street is a shining example of what redevelopment can do. It was originally constructed of heavy timber and masonry, and had reached the point where it needed to either be drastically renovated or torn down. The decision to keep this landmark meant completely reinforcing the infrastructure with a new steel framework.
It’s no mystery why property conversions are so popular. They preserve and enhance the character of downtown streets and communities. They make sense environmentally, recycling structures and materials and advancing the trend toward greener building practices. And they offer an economical, creative real estate strategy, enabling developers and landlords to offer unique, chic commercial space at reasonable rents while keeping beloved old buildings alive.