Is owning a commercial property better than leasing it? Should you be solely responsible for your space, or are there perks to being a tenant? Depending on your business type and goals, both options have benefits and drawbacks.
Whether you purchase or lease commercial real estate hinges on your current financials, how long your business has been around, and if you’re projecting growth soon.
Let’s compare owning commercial property to leasing commercial property. Once you know the pros and cons of each, you can determine which is best for your business.
- Why should you purchase commercial real estate?
- Disadvantages of buying commercial property
- What are the benefits of leasing?
- Disadvantages of leasing commercial real estate
Owning Commercial Property
When you own a property, you call the shots. You can renovate the space and make the adjustments you need. While you get free rein of the property, you build equity over time. But you take on all of the responsibility.
Property taxes, insurance, structural damage and maintenance costs can come out of your pocket. Of course, you may have tenants. Under certain types of leases, some or all of these costs may be split between you and your tenants.
You need a down payment upfront to buy commercial real estate, and you must be able to finance your purchase with a loan. It’s up to you to decide if the money invested as the down payment could provide larger returns when invested in the operation of the business instead.
Many small businesses apply for loans every year. The average small business bank loan is around $633,000, and the average Small Business Administration (SBA) loan is near $107,000. Businesses can use SBA loans to purchase land and real estate.
In the fiscal year 2021, the SBA granted nearly 52,000 7(a) loans totaling $36.5 billion and 9,600 504 loans totaling $8.3 billion.
Advantages of Buying Commercial Real Estate
1. Commercial Real Estate Maintains Its Value.
As long as you maintain the property, it will retain its value. Commercial property will likely appreciate as time passes, adding to its overall value. When the market fluctuates, commercial real estate investments stay relatively stable.
2. Owning Property Builds Equity.
When you own property, you build equity over time. The equity in your property is the difference between the property’s value and your mortgage balance. You can use that equity to get a loan in the future.
Commercial equity loans or lines of credit help you get cash quickly for remodeling or business expansion. A conventional equity loan gives you a one-time lump sum and usually allows a 65% to 75% loan-to-value ratio (LTV). Commercial equity lines of credit offer ongoing credit over a set period, such as five years.
3. Fixed Mortgage Payments.
Depending on the mortgage type, mortgage payments often stay at a fixed rate for periods of time, allowing you to plan for the future. On the other hand, rent payments can change with each lease renewal or year if increases are built into the lease. Having a fixed cost helps you plan for future expenses.
4. Gain Tax Advantages.
You may qualify for tax savings as a business and property owner. For example, you can deduct the interest and annual depreciation on your property as a tax break.
5. Opportunity to Make an Income.
Many companies don’t use all of the space available to them. Typically, businesses occupy at least 51% of a property. If you’re the property owner, you can rent out the remaining spaces to tenants and make extra income. Plus, you have the space available to expand your business in the future.
Any unused office spaces or storefronts shouldn’t sit vacant. Allowing tenants to lease the spaces makes your business more money.
Disadvantages of Owning Commercial Real Estate
1. Big Down Payment.
Purchasing commercial real estate requires substantial capital. A down payment may make cash flow tight and decrease your savings. When you buy real estate, you need to make a down payment, pay closing costs and cover appraisal fees. Down payments are usually 10% to 40% of the property value.
You may also need renovations before you can use the space. The total cost of owning commercial real estate includes your mortgage payment, property taxes, insurance, landscaping and maintenance costs.
2. Must Qualify for Financing.
In most cases, you wouldn’t buy a commercial building outright. Even if you could, you wouldn’t want to spend that much capital at one time. Your business must be able to qualify for financing, and it may be hard to find financing options with reasonable interest rates.
3. Loss of Flexibility.
Purchasing commercial real estate is not as flexible as leasing. If you wanted to move, you would need to sell the property before finding another location. Businesses that know their target market, have been successful for several years, and are ready to stay in one spot are excellent candidates for property purchases.
4. Responsibility Falls on You.
Commercial real estate owners can be held responsible for any accidents or injuries that occur on their property. When you purchase real estate for your business, you will need liability insurance in case something unexpected happens on your property.
As the owner, there’s no landlord to turn to—unless you have tenants and the landlord is Y-O-U. All maintenance costs and repairs fall on your shoulders. Be sure to have the property properly appraised and inspected before making your purchase. You want to know what needs to be fixed before you move in and what may need your attention soon.
Leasing Commercial Property
A lot of small business owners aren’t ready to become property owners. Purchasing commercial property is a big investment that takes significant capital. Leasing office, retail or restaurant space gives you the flexibility to move if things don’t work out or your business grows.
Some landlords offer lease-to-own agreements. These agreements allow the tenant to purchase the property after renting it for some time. Under a lease-to-own agreement, a portion of the tenant’s monthly rent goes toward the down payment should they exercise their option to purchase.
Advantages of Leasing Commercial Real Estate
1. Lower Upfront Cost.
You don’t have to pay a sizable down payment or seek financing when you lease commercial property. You pay monthly rent which may include common area maintenance fees and other expenses, depending on your agreement with the landlord. Tenants also have to pay an initial security deposit.
Some tenants are responsible for more maintenance than others. You may be responsible for the interior while the landlord is responsible for the exterior. Or the landlord may want to assess all maintenance issues. Either way, you will likely save money as the landlord may also pay for some of the property’s maintenance costs.
2. Limited Responsibility.
At the end of the day, the property is not yours. Different leases assign tenants a range of responsibilities—or things they agree to pay. Triple net leases require the tenant to pay for real estate taxes, maintenance, and insurance, whereas double net leases require the landlord to pick up repair costs.
3. Lots of Flexibility.
A lease doesn’t lock you in for the next 30 years. You can renew the lease, find a new location when the lease is up, or pay an early termination fee to end the contract. Depending on the lease term, you may be able to change locations in 3 to 10 years if needed.
Leasing is best for new businesses projecting growth soon or companies that want to try out a particular geographical area. If you’re planning to be in the “best” part of town, it’s usually less expensive to lease there rather than purchase.
4. Get Tax Advantages.
Everybody enjoys a tax break. Small businesses can deduct several expenses from their taxes, including lease and rental payments, property insurance, and utilities.
Disadvantages of Leasing Commercial Real Estate
1. You Won’t Build Equity.
A big downside to leasing is that the money you put in doesn’t give you anything in return. You pay the landlord to use the space. That’s it. When you purchase real estate, your mortgage payments build equity, and the property appreciates.
Commercial property can become a significant part of a business owner’s retirement. The business can be sold separately from the real estate, or the two can be sold together. If only the business is sold, the retiring owner can lease the property to the new business owner, which lowers their cost of entry.
2. You Don’t Have Control.
When you lease an office or retail space, you don’t have complete control to remodel or make modifications. You need to get permission from the landlord, who may or may not want you making changes to their property.
If you make improvements, they won’t help your business build value over time. When you leave the space, the renovations stay behind.
3. No Opportunity to Make Extra Cash.
As a tenant, you won’t have the chance to make the income you could as a landlord. Purchasing a building may be more advantageous if you see your business staying in one location and wish to make extra money.
4. Higher Monthly Payments.
Rent costs can be high depending on the area. You want to find a property with rent your business can afford each month. Regular rent payments often exceed what the property’s mortgage payments would be. If you’re a retailer, you may pay a percentage rent where you give the landlord a fixed base rent and a percentage of sales.
Should You Buy or Rent Commercial Property?
Why do companies lease buildings instead of buying them? Is it better to buy or lease? Whether you should buy or rent depends on your current financials and long-term goals.
When you purchase commercial real estate, it’s ideal to have enough cash available for the down payment and six months of mortgage payments. Leasing is a better option for start-ups and growing businesses, especially if cash flow is tight.
|Quickly Growing Business||X|
|Immediate Need for Space||X|
|New to the Area||X|
|Needs Full Control||X|
|Wants to Rent to Tenants||X|
|Flexibility to Move in Future||X|
|Less Responsibility for Maintenance||X|
|No Cash Tied Up||X|
|Build Equity & Value||X|
Are you ready to find a new location? Talk to our expert brokers about whether buying or leasing commercial real estate is better for you. We can help you discover your company’s new home.