FEATURE ARTICLE, OCTOBER 2004

CRITICAL CHOICE: TO BUY OR LEASE
Company owners must look at more than just the monthly payments before choosing to buy or lease office space.
Judi Woodyard

Woodyard

As a business owner, buying office space — rather than leasing — has many pros and cons. To make an educated decision, a number of factors should be considered.

Fueled by the same low mortgage rates that have moved many people toward homeownership, more small and mid-size businesses have considered purchasing office space. While historically low interest rates are the primary reason companies are more inclined to purchase office space, other advantages may exist for certain businesses.

For example, an enterprise may need the fixed costs that a long-term mortgage might provide. Additionally, the associated costs of owning commercial space can offer tax deductions for mortgage interest, property taxes, maintenance and depreciation. Companies that purchase office space must have an accurate prediction of future growth requirements, however. A detailed business plan is a necessity when answering the “to buy or not to buy” question.

A business owner that takes the leap to ownership of his or her commercial space must take the appropriate steps to understand real values based upon historical price escalations, rents, land costs and replacement costs. When interest rates are low, buyers can be persuaded to overpay for the property.

The greatest difficulty in buying office space is formulating an exit strategy. Many entrepreneurs that purchase commercial spaces plan to profit substantially when they sell the properties. This investment strategy carries risk, as the rate of appreciation, if any, is based on many factors. Those who purchase office space bank on the property increasing in value. Unfortunately, owning real estate does not always guarantee this type of profit, even in hot markets like Las Vegas. Much like the stock market, the commercial real estate market cycles, and investors must buy based on measurable value.

Another issue to consider is the added responsibilities of owning property. While owning office space may be profitable, the headaches of being a landlord are included with the deal. A lease allows a company to focus solely on the operations of a business, rather than being a landlord or property manager.

Additionally, the up-front costs of leasing are considerably less, eliminating the expenses of appraisal, financing, down payment and improvements associated with purchasing. This frees up working capital to invest in the growth of the business, which often pays better returns. A company’s available credit and ability to borrow funds may be impacted by a mortgage loan as well.

Leasing also allows businesses the opportunity to position themselves in prime locations with high visibility and accessibility. For those smaller businesses that depend upon being seen and upon the convenience to their customers, leasing may be a better option.

If market factors are influential in the decision-making process, leasing still provides plenty of opportunities. With the national vacancy rate at 16.3 percent, businesses can negotiate advantageous leases that include improvements to conform to their operational needs. Leasing also allows for a date-certain commitment not based on the ability to dispose of a property when it becomes inefficient for use.

Lease rates today range from a low of $1.55 per square foot per month to a high of about $2.80. While the contract rent is usually not a negotiable item in this marketplace, most other economic factors of the lease are, allowing for economic terms that fit the business’ financial situation today and in the future.

It is important to remember that, while leases do have their advantages, they may subject a business to cost pass-throughs and annual rent escalations that are difficult to predict.

“To buy or not to buy” is a question that can have a substantial impact on the financial growth of a business. For any business owner that is considering purchasing office space, detailed research should be done. With interest rates at an all-time low, it is easy to focus on comparing the monthly payment of the lease against the monthly loan payment, which is a valuable measurement. However, the ability to predict the value a building will hold over time is not simple — you may not recover your investment when all of the exit issues are considered.

Judi Woodyard is president of Las Vegas-based Commercial Associates, where she concentrates on consulting and brokering services.


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