Is Renting Or Owning Commercial Property Best For My Small Business?

When finding the perfect property for your small business, there are many factors to consider. Location is of course the most crucial factor, but knowing whether to rent or buy a commercial property can be just as important. There are pros and cons to both renting and owning a commercial property, and in today’s discussion we hope to provide clarity on which option is best for your small business.

Pros Of Owning

1. Building Equity

By owning commercial real estate, you give yourself the opportunity to build equity. This means that as you pay off your mortgage, you own more of the property. Having more more equity allows you the opportunity to take out a second loan, a line of credit against the property or do a cash-out refinance. Building equity also gives you additional options for retirement. You can sell the property outright, or sell your business but retain the property, giving you the option to lease the property and maintain a steady income.

2. Tax Breaks

If you are the business owner and have purchased a property, you are able to write off all mortgage interest you paid during that tax year as a business expense. There are also a few tax deductions designed to benefit business and property owners:

• IRS Tax Code Section 179: This allows deductions for equipment and furnishing purchases that are put into service the same year that they are purchased. For the past three years, Congress has granted a deduction of $500,000 which can be a significant contribution to offsetting the costs of purchasing property.
• IRS Tax Code Section 1031 (1031 Exchange): Investment properties used in a trade or business can be sold and the funds applied toward the purchase of a similar or like property within 180 days of sale, without receiving any tax penalties. The purchased property must be of equal or higher value to avoid a tax penalty. This can be used for a business owner looking to move to a larger property as their business grows, without incurring any tax penalties. 
• Cost Segregation: This allows a business owner to have personal property assets reclassified in order to shorten the depreciation time for tax purposes, which in turn reduces current income tax obligations. 

3. Appreciating Asset

Owning commercial real estate allows you to benefit from capital appreciation, which is the increase in your property’s value over time. Appreciation can be affected by inflation, supply and demand conditions, interest rates, neighborhood conditions, among other factors. Ensuring the building is maintained and up to code can help increase it’s appreciation. Real estate investors call making improvements to the building “forcing appreciation”. Consulting a local real estate expert or North Consulting Services can help you asses the cost-benefit of these upgrades.

4. Rental Income

If you are the owner of a commercial property, but you choose not to operate in the building, or only operate in a part of the building, you have the opportunity to rent out the extra space. Renting out part, or all of your property can help significantly decrease operation and mortgage costs.

5. Control Over The Property

By owning a commercial property, you have full control over it. This means as long as code permits, you can do anything you’d like with the property and not have to negotiate with a landlord or property owner. You will also be able to make fixed monthly mortgage payments instead of a rent payment that could be subject to increase when a commercial lease expires. 

Cons Of Owning

1. Higher Cost Up Front

Typically, when purchasing a commercial property, or any property for that matter, you will need to make a down payment. When purchasing a commercial property the down payment is generally anywhere from ten to forty percent of the property’s value. Additionally, you will most likely have to pay for closing costs, origination and appraisal fees.

2. Difficulty Qualifying For Financing

If your small business cannot get approved for bank financing, you may have trouble qualifying for a commercial real estate loan with a reasonable interest rate. Your company may not have been established long enough, have enough working capital (debt-to-income), or you may be unwilling or unable to provide a personal guarantee acceptable to the bank. If you plan on only occupying part of the space, most banks prefer your business occupies the majority. 

3. Liabilites

Insuring the property is solely your responsibility. In addition to insurance you would normally carry, you also need to insure the entire building. If someone injures themselves on your property, you could be responsible. This means that you will have to pay for a liability insurance policy to protect yourself from a potential lawsuit. If you rent out a portion of the property, you have liability from the entire building, even though your small business may only occupy a portion of it. Many loans also require a personal guarantee, which makes you liable to repay the loan if your business cannot.

4. Loss Of Liquidity Or Capital

While there is a good chance of your property gaining value throughout your ownership, it also has the chance to decrease in value due to market conditions or your use of the property. If this is the case and you sell your property, you run the risk of taking a financial loss.  A large down-payment may be used better to fund growth or operations making ownership a hinderance to growth. 

Pros Of Renting

1. More Liquidity

When leasing, you have much less cash tied up in the property. Because of this, you can use the extra cash for operations and growth. You do not need to make a down payment with a lease (other than a possible security deposit), leaving you with more cash as a result. 

2. Flexibility

Given that your business will need to meet certain requirements to qualify for a loan, leasing gives you more options when looking for the right space. It is also far easier to move locations when compared to owning a property. If your business relies heavily on location, buying a property may be too expensive in the area you desire, but you may be able to afford the rent. Depending on the structure of your commercial lease, you may also be absolved of unexpected costs that can arise from property ownership, allowing for better cash flow management.

Cons Of Leasing

1. No Equity Or Appreciation

When leasing a commercial property, you do not accrue equity in the property. You can look to renovate a property to meet your specific business needs, but that would need to be approved by the building owner or landlord; even then, the possible appreciation from this renovation does not go into your pocket.

2. No Additional Income

As a tenant, you are the one paying the rent. When owning a commercial property you have the option to rent a portion out and gain a secondary income. This is not possible if you lease a commercial property. 

3. Rent Can Be Expensive

While the upfront cost of owning a commercial property is far higher than leasing, the rent from leasing can get expensive. Monthly rent tends to exceed mortgage payments for the same property. Depending on the type of commercial lease you have, you may get stuck paying for costs such as insurance, property taxes, utilities and maintenance costs that don’t contribute to your equity in the building. 

4. Less Control

Leases are for a finite amount of time. Depending on who owns the building, they may choose to significantly increase your rent based on your success or investment in their building. 

Extra Considerations For Buying

1. Location Is Key

With buying a commercial property being a long-term commitment, be sure to select the right location. Depending on what line of business you are in, location can make or break your small business. As the saying goes, location, location, location.

2. Evaluate Cash Flow

When considering buying a commercial property, be sure to know exactly how much money your business makes and if your cash flow is consistent. Knowing this can let you know if you can afford or will be approved for a mortgage. 

3. Understand Existing Debt

If your business has existing debt, buying a commercial property may not be the best option. Consider your debt-to-income (DTI) ratio which could look unattractive to lenders. You should talk to a mortgage lender and have any existing debt under control before looking to buy a commercial property for your small business. 

Extra Considerations For Leasing

1. Find The Right Space And Lease Terms

If this is your first time leasing a property for your small business, we suggest starting with a right sized location, and choosing a short-term lease with an option to extend. By doing this, you ensure that your business has enough room to grow with a predictable rent increase. Like most contracts, rental agreements are negotiable, and you can use this to your advantage to ensure you get the best lease for your small business. 

Businesses need to find the right location in order to get off the ground.  According to the latest data from the U.S Bureau of Labor Statistics, about twenty percent of small businesses fail within the first year. Finding a low-cost, right-sized rental property may be what your business needs to get up and running efficiently. 

2. Understand The Property

When deciding where and from whom to rent, make sure to do thorough research. Make sure the building is zoned for your use, and that there are no deferred maintenance expenses that will become your responsibility. 

In Conclusion

Deciding whether to rent or own commercial property can mean the difference between success and failure for your small business. If you are unsure of whether renting or owning is best for you, please CONTACT US at North Consulting Services and we can help you analyze what’s best for your small business. 

The post Should My Small Business Rent or Own Commercial Property? first appears on North Consulting Services

Understanding Commercial Leases For Small Businesses

When trying to find the best real estate lease for your business, it’s important to have a full understanding of how commercial leases work. Commercial leases come in a variety of different forms, with each one having their own advantages and drawbacks. At North Consulting Services we can help your small business understand which commercial lease is right for you.

Gross Lease

A gross lease is a type of commercial lease in which the landlord is responsible for the majority of operating costs. That said, these costs are essentially being passed on to the tenant. Property managers tend to calculate the operating costs into the lease payment. As the tenant, you would be paying the amount agreed upon when you signed the lease. 

Although a gross lease is a fixed number, many small business owners wonder how a property owner calculates their rent. The landlord accounts for operating costs by using the ‘load factor’. The load factor is typically made up of a percentage of the costs relating to common area maintenance (CAM) of the property. That percentage typically corresponds to the percentage of the building that the tenant occupies. These costs are then incorporated into the rent price that the landlord sets. 

Who Is This Kind Of Lease For?

A gross lease might be ideal for consultants, accountants, or attorneys, because it primarily involves a fixed monthly rent (aside from the cost of any required utilities.) This type of lease does not typically require any tenant contribution for operation or maintenance costs. If reliability and consistency are important, this is the most straight forward lease for most small businesses. 

Triple Net Lease

Another common commercial lease is a triple net lease (NNN). This kind of lease requires the tenant to share the risk. While it could potentially involve higher operating costs for a tenant in an older property, it does mean the tenant gets peace of mind knowing the bills are paid and the right vendors are being used. 

With a triple net lease, maintenance and repair costs are paid by the tenant. These costs are in addition to rent, property taxes and insurance premiums. Because the landlord generally charges a lower base rent with this type of lease, the additional expenses are the responsibility of the tenant. 

There is such a thing as a double net lease in which the tenant needs to meet a base rate, plus pay insurance and taxes. NNN leases include everything a double net lease includes, plus maintenance. A triple net lease is less responsibility than an ‘Absolute’ lease, which involves the tenant paying for rent, plus all other property related expenses.

Build-To-Suit

Build-to-suit is a commercial real estate agreement in which a developer or landlord agrees to construct a property according to the lessee’s requirements. The lessee agrees to lease the property upon its completion. The developer finances the entire construction of the commercial property to the business’s specifications, meaning the tenant or lessee does not need to provide much capital upfront.

The lease in a build-to-suit is usually a longer commitment than others, with contracts typically ranging from ten to twenty years. Generally, triple net leases are used in a build-to-suit agreement. The rent is typically determined by the developer, who applies a desired return to the costs of the project. These costs include land costs, site improvement costs, costs of the building itself, legal costs and other expenses.

Build-to-suit agreements are particularly beneficial to businesses that do not want to tie capital up in a specialized building. Because the property is constructed to a tenant’s specifications, this is an ideal lease agreement for businesses with unique real estate needs.

Who’s This Kind Of Lease For?

A triple net lease is most common in large manufacturing facilities, grocery stores, quick service restaurants, heavy industry and businesses like auto shops. These types of businesses are often heavy utility users and are more likely to cause wear and tear on the property they occupy. Many large national businesses, known as credit tenants, agree to this type of lease.

A triple net lease is also attractive for companies who want to grow quickly and don’t want the commitment of owning real estate, and prefer to reserve their resources for operations. 

Triple net leases can be less expensive than gross leases, because the tenant is not absorbing all of the insurance, taxes and maintenance expenses. Additionally, when talking about properties with high occupancy rates, these costs are shared by a greater number of tenants. 

Ground Lease

A ground lease is an agreement in which a tenant is permitted to develop a piece of property during the lease period, after which the land and all improvements are turned over to the property owner. Because the lease allows the landlord to assume all improvements once the lease expires, the landlord may sell the property at a higher rate. With a ground lease, tenants generally assume responsibility for all expenses and the lease term is generally longer.

Who’s This Kind Of Lease For?

Ground leases are most commonly used by franchises and big box stores. Occasionally, ground leases will be used by investment firms looking to convert or renovate a property.

Modified Net Lease

Sometimes referred to as a modified gross lease, a modified net lease is a combination of a triple net lease and a gross lease. This hybrid arrangement can be a good compromise between a landlord and tenant.

The tenant and landlord work out how the cost of property maintenance is divided, but the tenant is responsible for the cost of insurance and tax expenses. As a part of a modified net lease, utility costs can also be negotiated. Modified net leases are popular with retail tenants, multi-tenant offices and industrial buildings. 

When it comes to older buildings, modified net leases offer a nice alternative to NNN leases. With triple net lease, the tenant is responsible for all maintenance expenses, but with a modified net lease the tenant only pays a portion of the maintenance expenses.

Who’s This Kind Of Lease For?

A modified net lease is ideal for commercial spaces that contain multiple tenants or a new business that needs a year or two to become profitable. If you are unsure if this type of lease is right for your small business, don’t hesitate to CONTACT US at North Consulting Services.

Percentage Lease

A percentage lease is a lease in which the tenant pays their base rent as usual, but also an extra cost. That extra cost is equal to a set percentage of their monthly sales volume.

The location and nature of the business can have a large bearing on the rent. For instance, seasonal businesses make larger profits during their peak periods of the year. When business is booming (usually during Christmas), the business pays more in rent. When business slows down after the holiday season, the rent drops as well, helping to alleviate cash flow problems.  

Who’s This Kind Of Lease For?

Because of how they’re structured, percentage leases are the best option for stand-alone retail outlets or stores at your local mall.

Additional Considerations

When finding the right commercial property for your business, be sure to consider additional factors besides the lease itself.

Depending on what type of business you have, consider factors such as freeway accessibility, parking, amenities, internet infrastructure, fire codes, zoning and any other factors that may apply to your business.

Another thing to consider when choosing a lease is a renewal option. Generally, renewal options are often found in rental lease agreements. A renewal option provides the lessee the option, but not the obligation, to renew or extend a lease agreement beyond its initial term at a predefined rate. This can be beneficial for cost forecasting and gives a business a sense of security that they will not be subject to a substantial rent increase.

Common Area Maintenance

Depending on the type of lease you opt for, you may need consider Common Area Maintenance (CAM) expenses. CAM expenses are paid to the landlord to cover the costs associated with maintaining common areas, i.e. lobbies, parking lots, hallways, elevators and public bathrooms.

CAM costs are generally quoted on a per-square foot basis. For example, if the total leasable square footage of the building is 50,000 sq. ft. and your office space is 10,000 sq. ft., your CAM fee would be twenty percent of the total cost of your lease. The cost is also based on forecasts that make up part of the annual building maintenance budget. It is very important to understand commercial lease aspects like the CAM before signing the lease.

Business Requirements

Depending on what type of business you own, make sure to find a property that meets your needs. Manufacturing companies should check that the building has the required voltage and amperage for their machinery. If required, check that the building you are choosing has proper drainage. It is also important to understand clear height, as this can be an effective cost saving measure.

A building’s clear height is the usable height in which a tenant can stack their product. For example, Costco uses a clear height of twenty-two to thirty-feet when building a new warehouse. This allows them to construct a property that uses less square footage when compared to other warehouses. While buildings with higher clear heights can cost more per square foot than buildings with lower clear heights, the overall cost of the property is much cheaper because buildings with higher clear heights tend to use less land.

Understanding Commercial Leases Is Key To Business Success

The difference between success and failure can be small, particularly when it relates to startup businesses. If a business owner were to choose the wrong type of commercial lease for their needs, it could have huge ramifications for the company’s profitability and cash flow.

Popular places for small businesses to start their search are with local commercial real estate brokers, loopenet.com, facebook marketplace, or by calling signs in the area where you would like to locate your business. When looking for the right commercial property it could be wise to have different Realtors® from multiple brokerage firms. Many commercial listings are kept in-house, so having different Realtors® at different brokerages can allow you the opportunity to find the best listing for your business.

At North Consulting Services we can help you evaluate the type space your business needs, help set a budget for leasing and buildout expenses, help with owner’s representation during tenant improvement projects, and help you decide if your company should rent or own. 

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