To Lease or To Buy? Issues Relating To Both In Today’s Market
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.
3. You haven’t found a suitable property to lease.
You may want to lease, but have found all properties that would be suitable for your needs have been offered only for sale, rather than lease.
4. You are in an area of appreciating land values.
If you will locate in an area where you think land values will continue to increase, it would be better to own the property (and thereby get the benefit of this appreciation if you ever sell) rather than to rent it. This is would be particularly true if you are able to spot this real estate trend before prices jump up in recognition of it.
5. A purchase may bring you tax savings.
Although, unlike rent, the money you use to purchase your facility is not deductible, you are allowed to recover this outlay over time by yearly depreciation deductions. If you financed your purchase, interest-paid deductions are also available.
Depending on several factors, such as how long your have been in business, how profitable your business has been, and what portion of the purchase price or rent relates to the land itself — rather than to buildings — a purchase may actually cut your tax bill when compared with a lease.
On the other hand, the following factors, if relevant to your situation, may lead you to conclude that you should lease, rather than purchase, your business facility:
6. Your current cash flow is of vital importance.
Particularly in the early years, a lease may be better than a purchase from a cash flow perspective.
This is because up-front outlays associated with a lease are usually less than those required with a property purchase. With a lease, your main initial cash expense may well be limited to your security deposit, plus first rent payment.
With a purchase, you have to have the lump-sum purchase price, or at least a down payment on a mortgage.
7. You don’t want maintenance duties.
Many leases place the duty of maintaining the property on the landlord. Examples of such maintenance can include the things that are necessary to ensure the continued structural soundness of the building (such as roof repairs and periodic maintenance and maintenance of heating and cooling, electric, and plumbing equipment), and those that go to the facility’s ease of use and appearance (such as snow shoveling of walkways and parking lots and cleaning of windows and common hallways).
8. You want to retain your mobility.
Maybe you’re not sure that the facility that you will select now will serve your needs several years in the future. You may need more or less space, your target market may have moved elsewhere, or better-suited properties may later be built.
9. Your company’s credit rating may not support a mortgage.
If your business is rather new, or has experienced some financial difficulties, lenders may not be willing to extend it sufficient credit for a mortgage on the facility. With the same financial situation, however, a property owner may well be willing to rent a property to your business.
9. You haven’t found a suitable property to buy.
You may want to buy, but have found that all properties that would be suitable for your needs have been offered only on a lease basis.
10. The facility may be in an area of declining real estate values.
You may find a facility that meets your needs, but you are concerned that the real estate values in the area are stagnate, or may actually drop in value. In this case, leasing makes sense: let the landlord suffer the effect of the declining values, not you!
Next part 9 will cover the Familiarizing Yourself With Standard Commercial Lease Provisions
Realted articles:
Should You Rent or Buy Your Office?
10 Don’ts for Small Business Owners and Entrepreneurs
This series ongoing series handbook prepared by Marjorie Weber was prepared will also be part of the Miami Bayside Foundation to qualify small business owners for the Miami Bayside Foundation loan program.
Handbook series Small Business Start Up Part 1: Small Business Start Ups Making It Legal; Part 2: Small Business Start Up Capitall Access Primer and Key Steps ; Part 3 Definitive Steps to Create the Optimal Small Business Growth Team; Part 4: Once You Have the Dream Team, It’s About Employee Retention, Part 5: Delegating Responsibilities Policies and Procedures – Letting Go Part 6: Breaking Down the Set Up of Small Business Financial Records Part 7: Three Best Bet Picks for Small Business Accounting Software
