Is Your Business Ready to Buy Office Space?
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.
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