Leasing your company's office building or manufacturing facility may work well for you right now, and even provide certain advantages. But any entrepreneur heading up a healthy, growing business would be wise to explore the compelling financial and practical benefits of owning your company's real estate.
When deciding whether to lease or own, you must consider various factors, including your life plans, the local real estate market and personal preferences. However, in most cases it pays to at least weigh the significant benefits associated with investing in your company's home, especially if you plan to stay there for decades.
Use as an Investment to Support Retirement
Business owners often have their eventual exit plan and retirement in mind when they decide to buy a building.
The idea of being able to sell the company but keep the real estate appeals to many business owners, noted Craig Caliger, manager of commercial banking at City National Bank. For many, he said, "that seems to be the big driver."
This strategy may not work well for those planning to sell their companies in a few years, but entrepreneurs with longer time frames are more likely to be able to pay off their commercial mortgages, keep the property and collect substantial income from future tenants in retirement. Meanwhile, long-term real estate trends should work in their favor.
Economic cycles typically last about seven to 10 years, so businesses looking to hold onto a property in a high-density area for two or three decades are likely to see the facility appreciate in value over the company's life cycle, according to David Cameron, City National Bank's head of business banking.
Even an owner with only 15 years until retirement could benefit from investing in a property in a desirable commercial market, Cameron said, noting that during the Great Recession and recovery, from roughly 2008 through 2012, commercial real estate values "performed very well."
Generate Rental Income Now
Owners, who often form LLCs to buy their property, may not need to wait decades to derive some income from the building.
Depending on the type of business, the building and their real estate loan restrictions, entrepreneurs may be able to rent out parts of their industrial facilities or office buildings to tenants, thereby subsidizing their monthly mortgage expenses or perhaps breaking even on the property.
Commercial real estate development trade group NAIOP reported strong industrial space demand in U.S. markets in early 2019, with an historically low 7 percent national vacancy rate - decreasing the chances of a downturn in the industrial market. Meanwhile, record high asking rents across the country indicate that market supply continues to tighten steadily.
"Overall, the U.S. industrial real estate markets appear to be healthy and stable. It is the asset class that is potentially in the best position to weather any macroeconomic downturn that may come in the next several years," the report said.
Of course, there's no guarantee that every retiring business owner will instantly reap financial rewards from his or her real estate investment, but the property itself can provide some protection nonetheless.
Alan Wolberg, head of Wealth Planning at City National, cited a client who sold a business but held onto the property in order to seek a more attractive sale price in the future.
The owner is covering costs by renting out the building and "feels like it's a great deal," despite just breaking even - for now, Wolberg said. The owner should be able to make "significantly more money" by selling at a more opportune time, he added. "It is a business decision, and having a tenant who just covers the costs have allowed them to wait for the larger sale payout in the future, without additional cost to them."
Combining present-day benefits with the potential to build wealth long-term can make building ownership particularly powerful.
Lower Costs with Fixed Mortgage Payments
By fixing your monthly mortgage payments for a decade or longer, you can hold down costs by protecting your business against rising lease rates, which a landlord could increase annually. While you'll have to make a down payment up front, you may well enjoy lower monthly mortgage payments as a building owner than you would with lease payments as a tenant.
Those making monthly lease payments, meanwhile, are missing the opportunity to build equity and own something, Cameron noted.
In addition, business owners who've invested in their commercial real estate may be able to borrow against the property to extract cash flow for their company, Caliger said.
Customize the Facility to Suit your Business Needs
Business owners who lease rather than buy also may find themselves facing greater environmental, zoning or landlord-imposed limits on what they may do with the property, according to Wolberg, who noted that manufacturers in particular need significant latitude to customize their facilities.
"The building is very integral to the business," he said.
It's important for business owners looking to buy a particular property to explore the surroundings and the regulations and covenants affecting the real estate. "You've got to be sure that you know what the restrictions of the community are," said Wolberg.
He suggested that buyers walk around the area, talk to neighbors, check with the local government and use a knowledgeable broker. “You don't want to get in there and have a legal fight. I've seen that a lot," he said.
Leverage Tax Advantages such as Depreciation and Interest Deductions
While businesses leasing their space can deduct rent payments from their income taxes, ownership also brings significant tax advantages, including potential depreciation on the property, which lowers taxable income, and a mortgage interest deduction. Consult a tax expert to help you analyze the numbers to see if they work in your favor compared with renting.
Despite the strong advantages of owning your company's building, an entrepreneur facing the decision should consider the positive aspects of leasing as well, including a certain amount of freedom.
As a tenant, for example, you're less likely to have to worry about major building maintenance and repair. Along the same lines, a tenant generally doesn't take on the same level of potential liability as a building owner does.
Depending on the type of business, a company leasing its space also may enjoy greater flexibility in moving to a new location. While a manufacturer may not be able to pull up stakes quickly or inexpensively, retailers and professional service firms typically find it relatively easy to move to a new storefront or office high rise.
Leasing also enables you to hold on to more of your cash now rather than coming up with a 10 to 25 percent down payment to buy a building. Further, if a sleek address is important for your business, leasing may give you more financial leeway to secure space in an upscale area where you might not necessarily be able to afford to buy property.
You will want to consult with professionals with the needed expertise in your local real estate market, industry and local regulations to help you make the decision to buy or continue leasing.
City National Bank's team can help you determine whether owning or leasing is best for your business. To learn more, contact us.
This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.
City National, as a matter of policy, does not give tax, accounting, regulatory or legal advice. Rules in the areas of law, tax, and accounting are subject to change and open to varying interpretations. You should consult with your other advisors on the tax, accounting and legal implications of actions you may take based on any strategies presented, taking into account your own particular circumstances.
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