Buying vs. Leasing Office Space

The Office Space Dilemma

Many businesses reach a point in which they should consider whether it would be beneficial for them to purchase office space rather than continue to lease office space. Perhaps you will be able to find an existing property that meets all of your requirements and offers an affordable, long-term lease. However in many cities, finding an existing and affordable lease property is becoming increasingly difficult, and what is available is going for a premium price.

While every business is different, there are a few common factors that should be taken into consideration when evaluating whether to purchase a property or continuing to lease office space. You should compare the benefits of leasing versus buying your property from a cash flow standpoint, as well as considering your business requirements such as long term space needs and expansion possibilities.

Benefits to Leasing:
  • Credit ratings are not quite as crucial compared to buying.
  • Don’t need to worry about selling if moving to a new location
  • Monthly rent expenditure is a tax deduction as a business expense.
  • Freedom to sublet or relocate at the expiration of the lease term
  • No loss of resources incurred as if owning in a declining market.
Disadvantages to Leasing:
  • Rental rates with annual escalations written into the lease.
  • Loss of the reversion or the value of the property at lease end.
  • No opportunity for equity buildup as with owning property
  • Tenant may be forced to relocate at the end of the lease term
Benefits to Purchasing:
  • No more annual rent increases
  • Ability to sublet excess space to other occupants
  • Interest on the mortgage loan is tax deductible
  • Improvements can be made to the property as you wish
  • You can take annual depreciation deductions on taxes
  • Possible benefit if you sell in an expanding market
  • Opportunity to stay in one location as long as you decide
Disadvantages to Purchasing:
  • Usually requires a larger initial capital outlay to secure financing
  • Opportunity for property values to drop in a declining market.
  • Owning property subjects the owner to various legal and regulatory risks
  • Requires owners to invest much time and energy in property management
  • Inexperienced owners operate their real estate inefficiently and increase costs
As you can see there are pros and cons to both sides of this decision. Yet each business has it's specific requirements, and are at different stages of their evolution. To properly evaluate whether to lease or buy office space for requires the consideration and thorough analysis of many different variables:

Determine Your Cash Outlay

Typically if you are planning to purchase an office, you can expect to make a down payment of between 10% and 25% of the purchase price, depending on the particular lender and your creditworthiness. When you lease commercial space, you won't need to put down nearly as much. With good credit, the typical cash outlay for a commercial lease is the first and last months rent ,which calculates to only about 10% to 15% of the outlay required when purchasing commercial space.

The OfficeFinder Wizard (www.officefinder.com/scripts/wizard.cfm) also allows you to make office space lease or purchasing requests online from their broker network in over 500 markets worldwide.

Calculate The Opportunity Costs

Opportunity costs are the benefits you could have received by taking an alternative action. Here we are referring to difference in return between a chosen investment and one that is necessarily passed up. Say you invest in a stock and it returns 3% over the year. By purchasing the stock, you gave up the opportunity of another investment - perhaps a bond yielding 6%. In this example, your opportunity costs are 3% (6% - 3%).With the large outlay of cash required to purchase office space, the opportunity cost of that money needs to be taken into consideration. What return would you expect to receive on that money compared to the returns if you invested the money back into your business or into other investments?

   

Evaluate Your Business Development Phase

Another major factor to consider in the office space lease vs. purchase decision is the stage of your businesses development. If your company is a startup or relatively new, leasing will probably always be your best option, due to the cash outlay requirements for purchasing. For businesses currently in a high growth phase, leasing allows more flexibility and fewer constraints to that growth. On the other hand, if your company happens to be more mature and relatively stable, purchasing office space can be the best way to meet your future office space requirements.

The OfficeFinder Wizard (www.officefinder.com/scripts/wizard.cfm) also allows you to make office space lease or purchasing requests online from their broker network in over 500 markets worldwide.

Examine the Tax Implications

The tax implications of the office space leasing vs. purchase decision are important to consider as well. Lease payments are usually fully tax deductible, but many the expenses of owning office space must be deducted over longer periods of time - up to 39 years. Another tax benefit to purchasing office space is that you get to take depreciation on the improvement portion of the property and can usually deduct all of your interest payments. When considering the tax implications of this decision it is always very important to consult with your attorney and tax professional about the legal and financial considerations to owning office space.

Here is a direct link to an article on Entrepreneur.com regarding the office space lease vs. purchase decision: http://www.entrepreneur.com/money/moneymanagement/article173312.html

Perform a Comprehensive Cash Flow Analysis

In order to really understand the financial considerations of purchasing office space, you need to prepare a detailed comparative net present value cash flow analysis. This takes into account your predictions on the future including the holding period of the property, anticipated appreciation vs. rental increases, interest rates, and cost of expenses increases. To obtain the most reliable result possible, it's is a good idea to perform three separate calculations - optimistic, realistic and pessimistic. There are tools available to help you perform a comparative net present value cash flow analysis yourself, however this is a complicated process, so consider engaging the services of an financial advisor to perform these calculations.

Free calculators and analysis tools including Cash Flow,  Capital Budgeting , and NPV:
http://www.exinfm.com/free_spreadsheets.html

Investopedia offers this free Net Present Value calculator: http://www.investopedia.com/calculator/NetPresentValue.aspx