Outgrowing Your Office Space? Should You Lease or Buy?

Should you lease or buy office space?

To determine whether leasing or buying office space is better for your company, ask yourself the following questions.

How long can you commit to a location or building? 

Financial studies have shown that, for the short term, leasing is more cost-effective than buying. However, if you are considering a property where you can make your headquarters for a decade or more, then buying becomes more financially attractive. See the section below on financial considerations to review before you lease or buy.

How fast is your business growing? 

If your business is booming and you anticipate rapid growth in the next few years, leasing gives you greater flexibility to move if you outgrow the new facility. If you purchase, you may outgrow the building or purchase more space than you need, with the associated expenses. This also applies if you think your business may downsize in the next few years.

Your anticipated headcount will also determine how much office space you’ll need. [Read related: Here’s How to Determine Your Office Space Needs]

How’s your local economy? 

Real estate used to be a sure investment, but now it’s more volatile. If your local area is emerging from a slump, this could be a good time to invest. However, if property values are declining or overinflated, leasing might afford you a better location and prevent you from losing money if the property depreciates. 

What’s the rental market like in your area?

If your business is located in a large urban area like New York City, where rents are high, it may make more sense to buy, since your mortgage payments may be equivalent — or even lower than — your rent would be. 

Madison Sutton, a commercial and residential real estate salesperson at Serhant, pointed out that instead of paying $10,000 or more each month for rent, business owners could be building equity while protecting themselves from future market disruptions and rent hikes. 

Sutton also has seen a trend of business owners investing in mixed-use properties. “Buyers are taking a hybrid approach — operating their businesses in the retail space while utilizing residential units for either personal use or rental income to offset costs,” she said.

As you read the pros and cons in the next sections, evaluate how important each is to you and weigh them accordingly.

Pros and cons of leasing

The main advantages of leasing are the low initial commitment, flexibility and ease of maintenance. However, you sacrifice equity and control over your facility.

Pros

• You have a low initial financial commitment with no down payment, just a deposit.
• Lease payments are tax-deductible.
• The landlord handles repairs and maintenance.
• Some landlords will remodel to suit.
• Generally, you can lease in a nicer area than if you buy.
• The higher cash flow helps your credit rating.
• The landlord may pay for a particular utility, such as waste management or water, or for housekeeping.
• It’s easier to leave if you outgrow the space.

“Leases allow flexibility for more types of businesses, and some companies can benefit from the prior occupants’ build-out and furnishings,” said Kristina Chervenka, co-founder and chief operating officer of Five Buffalo Capital.

Cons

• If you use a broker, you will pay an annual broker fee for the duration of your lease. This is usually a percentage of the annual lease amount and is negotiable.
• Rent usually increases when you renew a lease.
• You are at the mercy of the landlord for the timeliness and quality of repairs, which could be frustrating for companies like construction firms.
• The landlord may have rules concerning the use and state of outside areas that may impact your ability to store vehicles and materials. Be sure you discuss these beforehand.
• Even if you have a good landlord now, that could change in the future.

Pros and cons of buying

Buying provides equity, and you have complete control over what you do with the property. However, you commit a lot of capital from the outset and are responsible for all maintenance.

Pros

• You build equity, which you can use as collateral for loans.
• If you have extra space, you can rent it out to add to your revenue.
• Your mortgage payments will stay steady.
• Interest payments are tax-deductible.
• You can claim building depreciation.
• You can make changes to the building (within local ordinances).
• You control what happens on your property.
• Because you own the property, when you retire, you can sell it and use the profits for your retirement.

Cons

• There are large initial expenditures, such as the down payment, closing fees and real estate agent fees.
• There is a higher opportunity cost. In other words, the money you invest in the property could be used to grow your business in other ways. You need to determine if that is an issue.
• You pay for remodeling, repairs and maintenance.
• If you outgrow the space, you will have to sell the property.

Chervenka noted that there may be additional risks. “Property tax and interest rate increases can negatively impact the company’s cash flow, and property values may lower when it is time to move the company [or sell],” she said.

Whether you opt to rent or buy, Chervenka cautioned, “[Businesses] should also consider the other businesses in the building or space, which may either elevate or potentially harm their reputation.”

Financial considerations when deciding whether to lease or buy

As noted above, the longer your commitment is to a location, the more cost-effective it is to purchase rather than lease your office space. However, before you commit, run some numbers or have your accountant analyze the costs over time. Here are some key considerations.

• Mortgage versus rent
• Business insurance 
• Down payment (10 to 25 percent) versus security deposit
• Taxes (consider tax advantages with leasing as well as buying)
• Regular maintenance (factor in about $1.50 per square foot per year for maintenance and improvement costs)
• Equity (but take resale value with a grain of salt)
• Opportunity cost — how much a certain amount of money could earn if you invested it in your company. (When buying, you use the down payment to calculate this cost. If there’s a difference between the monthly mortgage and the lease, use that difference to determine an opportunity cost against whichever costs more.)
• Security deposit 
• Broker fees (annually, if leasing) versus real estate agent fee (one-time fee, if buying)
• Lawyer fees for lease negotiations (real estate commissions cover this when you buy)
• Closing costs, if buying
• Remodeling expenses
• Leases covering utilities (if yours does, consider that bill as an added expense if you buy)

There’s no blanket answer for whether to purchase or lease your next property. It depends on how your business is faring, whether maximizing your cash flow is more important than building equity right now, if you prefer to control your property or have the ease of someone else caring for it, and myriad other factors. Take the time to make an informed choice.

Jennifer Dublino contributed to this article.