- Posted by Selina Bradley
- On May 26, 2017
You’re not alone in considering if it would be a better decision to purchase your own office space instead of continuing to lease office space.
Yes, every organization is unique with its own set of specific needs, but there are major common factors that come into play for every business when evaluating your next move in commercial real estate for your company. As with anything in business, bottom line costs (while hugely compelling and influential) are not the only factors. There are several other important factors to consider that can make leasing or buying attractive depending on your business goals.
This guide is a little on the long side, so feel free to bookmark this and come back, or jump around to the sections that you are most interested in using the clickable table of contents below.
Let’s take a look at the pros and cons in the showdown between commercial office spaces: to leasing vs buying.
Sections in this Guide (click to jump to that section):
- Upfront Cost
- Opportunity Cost
- Fixed vs Variable Cost
- Growth Considerations
- Property Management
- Tax Considerations
- Cash Flow Analysis
Buying is going to cost a significant amount more upfront than leasing an office space. Prepare to make a down payment between 10% to 25% of the total purchase price if you plan to buy an office space.
You won’t need to put down nearly as much when you lease an office space. The typical outlay for a business with good credit is the first and last month’s rent. That amount typically comes to about 10% to 15% of the cash outlay incurred if you were to purchase an office space.
With that large initial upfront cost to buy, you’ll need to decide if you can you afford to tie up money in the down payment for a mortgage and lose that interest. Even if you can afford it, would that money be better spent if you invest it in growing your business? Talk with your advisors or leadership team about potential returns you could expect to receive on that money as a down payment versus investing the money back into your business or other investments.
We’d be remiss to not mention that you should consider that at the end of your term, you could potentially sell the space at an increased value and either earn back any “lost” interest. In this case, you are not really losing interest, but you are deferring it until it sells.
If the only thing you did with the money you would have spent on a purchase down payment were to let it sit in the bank, it would earn interest. And since we’re doing a lease vs buy analysis here, you’ll want to put the same opportunity cost amount into the lease analysis, but as a CREDIT rather than a debit.
If you put the opportunity cost into the lease analysis as a credit, the cost of your lease goes down by the same amount of interest your buy analysis went up.
In the end, you’ll be left with more money to put toward company growth, partnerships, or other investments.
You will have a fairly good idea of what your costs will be over time when you buy office space. This is especially true if you have a long-term fixed rate mortgage. Financial predictability can be a blessing if your business ever experiences a slow time.
The market will dictate what you end up paying for rent over the long run when you rent office space. Annual escalations could be written into the lease.
Mature, stable businesses tend to benefit most from buying when it comes to the growth aspect of the equation. If you plan on staying in the same place for more than seven years, you can buy an office space that allows for future growth. It’s a sound way to meet your future needs.
It’s a no-brainer that leasing allows for much more flexibility and fewer constraints when you’re in growth mode — this is particularly the case for newer businesses who are always focusing on growth.
Winner: Tie depending on stage of businesses development
Time is money, and office spaces take a lot of time to manage. Even the basics of maintenance and repair, security, janitorial services, landscaping, snow removal, etc. are all now your responsibility. And since owning a property subjects the owner to various legal and regulatory risks, you will also need to stay up to date on a vast array of regulatory and insurance logistics to maintain compliance with laws and ordinances. You’ll hire this out which means you’ll need to consider this as part of your costs of ownership as well.
Property Management is typically baked into your lease to include all that was mentioned above and more. It will be your responsibility to keep tabs on your property manager to ensure they are holding up their end of the deal, but it is altogether much less time-consuming than being responsible for managing it yourself.
You can typically deduct mortgage interest expenses, recurring maintenance costs, and depreciation on the improvement portion of your property if you own an office space. Many costs must be written off over longer periods of time (sometimes up to 39 years).
You can generally deduct all of your costs if you lease commercial real estate.
Buying & Leasing Combined
The only way to get the full picture in terms of costs when deciding between leasing and buying an office space is to prepare a detailed comparative net present value cash flow analysis.
That cash flow analysis will account for your predictions on the future holding period of the property, interest rates, expenses increases, and anticipated appreciation vs. rental increases.
The best practice is to run three separate calculations: optimistic, realistic and pessimistic. It’s a daunting task, but we found a few free tools to perform a comparative net present value cash flow analysis yourself.
- Free spreadsheet calculators and analysis tools including Cash Flow, Capital Budgeting, and NPV
- Free Net Present Value calculator from Investopedia
It’s a complicated process, so consider engaging the services of a good broker to help you.
Buying is going to cost you a lot more upfront than leasing. So if you’re new or in a high-growth phase, buying an office space is not for you. Based on our experience and research, buying is generally much less expensive than leasing an office space if you plan to remain in the same business location for more than seven years. However, it’s cheaper to lease than to buy if you stay in the same space for seven years or less.
Don’t forget about those additional considerations:
- Do you want to deal with the added hassle of maintaining the property?
- Will you outgrow your space and need to move in the next few years?
The Next Step
Evaluating whether to lease or buy your next commercial property can become very overwhelming very fast, but you don’t have to deal with it alone if you don’t want to. There are services where, at no additional cost to you, you can get advice and assistance from commercial real estate brokers who focus only on representing the best interests of tenants. Working with a tenant representative who is involved in the business every day will significantly improve the accuracy of any analysis and simplify the entire process.