If your small business is going strong — perhaps on pace to outgrow its current space — you might wonder whether it makes sense to buy your building rather than leasing it.
While the answer depends on the details surrounding your company, plans, location and personal preferences, the potential advantages of buying make the decision worth exploring for most business owners.
Investing in a property to house your business can bring financial and operational benefits now and significant wealth and retirement income later.
“If you're paying rent, you might as well pay a mortgage and own it," said David Cameron, City National Bank's head of business banking. “Often times the real estate is worth as much as the business in high-density markets. It's a secondary way to accumulate wealth."
The first question a business owner must answer before looking at the financial analysis is whether he or she wants to own commercial real estate, said Cameron. Many entrepreneurs simply want to focus on running their business and therefore aren't good candidates for real estate ownership.
But for those interested in adding real estate to their portfolio, it can be a worthwhile investment.
If businesses are growing and profitable, enjoy strong cash flow and don't carry excessive debt, their owners are generally very good candidates to buy a building, noted Cameron.
Cash flow is critical, he said.
“As an entrepreneur and potential real estate owner, I want to be confident that my business is sound and can support the debt on the building because it's really the cash flow of business that has to service the loan," Cameron said.
For entrepreneurs whose firms have a strong cash flow and little debt, commercial property can improve their financial foothold.
“It's advantageous in almost any case for a business owner to own their building," Cameron said, noting the significant expense associated with property rental. "It's about controlling costs."
A business owner who can keep building costs consistent even as other expenses escalate will make more money in the future, Cameron explained. “You're controlling your largest fixed expense when you own your own building. You're also able to customize the building to maximize operating efficiencies."
Building ownership isn't a one-size-fits-all prospect, and owners need to closely evaluate their particular needs and circumstances beyond the balance sheet.
There are many circumstances entrepreneurs need to understand about their operations, leased property and business location that weigh on a decision to purchase.
“The different business objectives that owners have and the limitations of the building they are currently in, play a major role in the decision to buy," said Paul DeLauro, head of Wealth Planning at City National Bank.
Manufacturers typically have a much greater need to customize than retailers or businesses occupying a standard office building, and many even build facilities to their own specifications, he noted. Customizing a facility can be more challenging when leasing the property.
Even so, some owners find that leasing makes the most sense in their particular circumstances.
DeLauro recalled a pair of manufacturing clients, who leased a building in an area with electricity-use restrictions that prevented the company from operating the three shifts typical in facilities.
The owners thought about buying a property but zoning restrictions would have forced them to move the business to the outer edges of their county. Not wanting to add a long daily commute to their lives, the pair realized they were satisfied with their incomes and decided to keep their lease and run only two shifts.
In that case, quality of life outweighed any desire to ramp up production.
DeLauro also worked with a manufacturer who had upgraded and later outgrown a leased structure. The company wanted to buy the building and make more updates, but it wasn't for sale. Rather than pulling up stakes completely, the client stayed in the leased building and expanded by purchasing and renovating a neighboring facility.
Getting the details right for your particular situation requires having a broker who understands your property needs and projected growth, DeLauro said. You want someone who can help you do a cost-benefit analysis and plan for the future within the scope of affordability.
If you're going to be at capacity in a couple of years, he noted, you'll need to look for something to support production levels in three to 10 years. "Doing financial projections is a very helpful way to make that decision," said DeLauro. “If you're continuing to be displaced, yes, of course, buy someplace, but do it in a meaningful and educated manner."
An entrepreneur's exit strategy often plays a big role in the decision about purchasing a facility, as many owners view real estate as a major part of their retirement plan.
"It's a big retirement asset," Cameron said, noting that retired business owners who purchased buildings decades earlier are likely to consider the move one of their best decisions.
"You get to use somebody else's money — the bank — to buy an appreciating asset — the building. Eventually you own 100 percent of the building and keep 100 percent of the cash it generates, he noted. “That's very powerful when you look out 15 or more years and further into retirement."
Not only will real estate potentially appreciate over the long term and bring immediate tax advantages, but owners can hold onto the property when they sell the company and — assuming they've paid off the mortgage and own the building free and clear — generate significant income by renting to their company's next owner or third-party tenant.
For that reason, owners interested in real estate ownership often make the commitment relatively early in their business life cycle, although those with shorter retirement horizons sometimes invest as well.
Generally, Cameron said, owning a building makes sense unless the business is in a highly variable industry, or geographic location makes the real estate less attractive.
Owning the only building in a rural area might not present great advantages, but buying a facility in a high-density, low-inventory market could help a business control their fixed expenses, he said.
Entrepreneurs considering building ownership should take the economy into account, but less-than-ideal conditions shouldn't necessarily preclude the investment.
Buying a building now may be a little riskier than it was three or four years ago because the economic cycle appears to be near a peak, Cameron said. He added, however, that low interest rates help offset high market prices and can make it "very affordable" to secure a real estate loan.
Over the long term, real estate prices are likely to appreciate, he noted.
Many entrepreneurs who own their buildings are happy about it, and many derive income by leasing out portions of the facilities, in some cases renting space to vendors to secure better deals or minimize certain costs, DeLauro said.
Cameron agreed, noting, “The majority of business owners that I've met over the years think that it's a very good investment to own the real estate that houses their business."
With any major purchase, it's critical to evaluate your situation and determine if it makes financial sense for your business.
City National's business bankers and wealth planners can guide you through the process. To learn more, contact us.
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