When you need a new office space for your construction firm, should you lease or buy? Learn the pros and cons of each.
The decision of whether to lease or buy your next office space involves several factors. Choice of property, of course, is the first consideration: If you can't find what you need for rent, you may have to commit to purchase, and vice versa. However, depending on your local economy, you may find landlords who are willing to work with you, even to remodel existing properties to suit your needs.
Cost is also important, and if you are choosing between two equally attractive properties, it pays to do a cost comparison for the short and long term. However, each option has unique benefits and challenges that affect how you do business as well as your pocketbook. Here, we discuss key aspects you should take into account, the pros and cons, and what financial aspects you need to take into account to help you make the best decision for your business.
The three questions you should ask yourself
How long can you commit to a location or building? Financial studies have shown that, for a 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. One analysis indicated that seven years seems to be the tipping point, but each case differs. See our section below on doing a financial analysis.
How fast is your business growing? If your business is booming and you anticipate rapid growth in the next few years, then leasing gives you greater flexibility to move if you outgrow the new facilities. If you purchase, you may outgrow the building or purchase more building than you need, with the associated expenses. This also applies if you think your business may downsize in the next few years.
How's your local economy? Once upon a time, real estate was a sure investment, but now it's more volatile. If your local area has been in a slump but is coming out of it, then this could be a good time to invest. However, if property values are declining or are overinflated, leasing might afford you a better location and protect you from losing the money it could cost you if you had bought and needed to sell.
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 to leasing include low initial commitment, flexibility and ease of maintenance. However, you sacrifice equity and control over your facility.
- 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, sparing your time.
- Some landlords will remodel to suit.
- You can generally 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, like waste management or water, or for housekeeping.
- It's easier to leave if you outgrow the space.
- If you used 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 timeliness and quality of repairs, which could be frustrating for a construction firm.
- 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, but you commit a lot of capital from the onset and are responsible for all maintenance.
- You build equity, which you can use as collateral in 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 any changes to the building you like (within local ordinances).
- You control what happens on your property.
- Since you own the property, when you retire, you can sell it and use the profits for your retirement.
- There are huge initial expenditures, such as 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.
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Run the numbers
As noted above, the longer your commitment 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 do an analysis of costs over time. These are some of the things to consider:
- Mortgage vs. rent
- Down payment (10 to 25 percent) vs. 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; realtor fee one time if buying
- Lease negotiations = lawyer fees (realtor 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 cash flow is more important than equity, if you prefer to control your property or have the ease of someone else caring for it, and myriad other factors. Take time to make an informed choice.