Written by Sophie Arkelidis
In today’s volatile economic environment, business owners need to carefully consider their investment strategy and capital outlay prior to making a decision on the future of their business.
“Do I buy or lease commercial property for my business?” is a question that many business owners are often faced with and the answer needs to carefully weigh up the pros and cons of both options.
Commercial properties can be broken down into three main categories – office, industrial and retail. In order to make the decision easier, the key facts of leasing versus buying commercial space across these three categories are outlined below.
Pros of Leasing
• Choice of properties: Choosing to lease provides a business with a wider choice of properties in a high profile location. For example, a retail business is dependent on location and image, therefore leasing is a less expensive option than buying in an upmarket area.
• Working capital: The business is free to respond to market opportunities as capital is not tied up in real estate. The ability to borrow funds from the banks will not be as limited as with buying commercial property.
• Fast business decisions: If the business grows exponentially, a decision to move to larger premises can be made and executed quite quickly, without the hassle of having to sell the property.
Cons of Leasing
• Rent increases: The business may be exposed to annual rent increases and other costs when the lease expires.
• Limited control: If the owner of the property decides to sell, the business will need to be relocated and the costs associated with the relocation can be exorbitant. In retail, there could also be a loss of “goodwill” that their property has gained over time.
• Lack of equity: The business has no equity in the property and the lease repayments essentially fund the property owners retirement.
Pros of Buying
• Fixed costs: Locking in a commercial mortgage long-term can give the business clear, fixed costs.
• Tax advantages and deductions: Tax deductions can be claimed for costs associated with owning and running a commercial space – these include interest on the mortgage and property taxes.
• Rental income: Owning commercial space can offer the advantage of renting out extra space, adding another source of income to the business.
• Capital growth: The prospect of owning commercial space and having the property appreciate over time, allows the owner to sell and fund their retirement.
Cons of Buying
• Speed to move: A new business may experience unexpected substantial growth; therefore the owned space may become inadequate forcing the property to be sold. The average days on market for a commercial property are 60 – 120 days.
• Capital required: A substantial capital outlay is required – a deposit, stamp duty, appraisal, business set up and infrastructure costs, as well as maintenance costs and possible property improvement costs. This money could be used as cash flow for the business.
• Capital loss: If the property is sold for less than what it was purchased for originally, the business will experience a capital loss which in turn affects profitability.
What the experts say
Managing Director of Commercial Property Group, Hayden Bennett said each business needs to consider their specific needs before making a decision on whether to lease or buy a commercial property. “When leasing, the security of your business is only as good as your lease agreement,” Bennett says.
Kevin Stanley, CB Richard Ellis says, “The improvement in the Australian economy is being driven by business. What this means for commercial property is the office and industrial property sectors are expanding first, while retail will start to expand more strongly in 2011, when interest rates stabilise. The earliest indication of a pick-up is employment growth – leading companies to occupy more space and, in time, to lower vacancies and higher rents. Sydney, Melbourne and Adelaide are leading this process, with the other capitals likely to lag a year or so.”
Commercial sales are quite strong at the moment, with the number of investor transactions completed in the past six months at pre-global financial crisis levels. This is tipped to change in 2011 with future rises in interest rates.
The answer to lease or buy commercial space is not clear-cut. The decision should be made with careful consideration and take into account financial, tax, and personal implications. The advice of an accountant and financial planner should be sought to guide the business with the best advice.