Comparing the small business economics of leasing vs. buying

There are many factors every small business owner needs to consider when getting ready to make the decision whether to buy or rent a small business facility.

Comparing the Economics of Leasing vs. Buying

The main advantage of leasing a business facility is that your initial outlay of cash to gain the use of an asset is generally less for leasing than it is for purchasing.

However, perhaps the main advantage of purchasing is that you end up paying out less in the long term than you would have paid if you leased the facility. Moreover, if you purchase, you get the benefit of any appreciation in the value of the property.

How do you reconcile these factors?

One way is to do a mathematical analysis of your net cash flows that would result from leasing and from purchasing.

Cash-flow analysis.

A cash flow analysis provides an estimate of how much cash you would need to set aside today to cover the after-tax costs of each facility acquisition alternative.

To perform the analysis, you need to know or assume certain facts, including:

• purchase and financing terms, including closing costs
• lease terms
• your combined federal and state income tax rate
• the facility’s expected useful life to your business, for depreciation purposes
• the asset’s estimated value, when you sell it, or at the end of its useful life to your business
• your cost of capital
• any other costs that you would incur if you leased the facility but not if you purchased it, or vice versa (for example, you’d need to account for expected maintenance costs if the landlord was assuming responsibility for those costs)

Long-range effect of the decision.

If you are a new business owner considering whether to acquire a to acquire a facility by purchase or by lease, you may have a tendency to concentrate on the short-term, such as the first year cash flow projections that would result for each of the alternatives.

This is natural, and probably altogether necessary: If things don’t go well enough in the first couple of years of the business’s operation, it may not be around to see how a particular decision would have benefited it 10 years down the road. But having said this, it’s still worthwhile to consider how a lease or rental could affect your business in the future.

Will it be important for your business to be able to stay at the location for as long as you want? Do you foresee the need to modify the facility in a way that a landlord may not agree to?

Ten Factors to Consider When Making the Lease or Buy Decision

What factors should you consider when deciding whether you should buy or lease a business facility?

1.  You want control of the property.

Maybe you intend to make substantial additions or renovations to the property. Or you decide to change your business hours or change something else about the way you are doing business. If you rent your facility, you may have to get your landlord’s permission to make these changes. If, however, you own the property, there will be no one looking over your shoulder (expect maybe the zoning board!) to question your moves.

2.  You can consider the long-term cost.

A lease may sometimes beat out a purchase in terms of cash flow, particularly in the early years. But over the long haul, a purchase is usually cheaper because a landlord, in addition to paying all of the costs associated with purchasing and maintaining the property, will attempt to build in a profit for himself. You can avoid paying this profit premium by buying, rather than renting, the property.

For some businesses, such as certain retail and service businesses, location is all important. If you have established a winning business location, you don’t want to lose it because of a rent escalation or because the landlord just wants the property for another use. If you own the facility, you won’t have these worries.

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