Introduction to Lease vs Own Commercial Real Estate Analysis
At face value, it makes sense to own the business premises you occupy. Why let someone else build wealth off your business?
There are both pros and cons to owning versus the traditional leasing model. The ownership proposition may not necessarily be the best fit for your organisation.
The Pros of Owning
Ownership will provide you a fixed rental that is flatlined for the duration of your occupancy
Annual rental escalations are generally not in line with inflation – they are based on an initial return on investment.
At an 8 % annual escalation, the effective escalation in your 5th year of leasing is 36% based on your 1st years rental
Security of tenure – no risk of your lease agreement not being renewed.
If there is substantial customisation required to the premises to make them fit for purpose, you will be adding value to your own asset, and not a landlord’s. This customisation creates additional equity in the property.
Provides the shareholders with an opportunity to create wealth
Branding of the property is at your discretion and not dictated by a landlord, who may have an opposing view.
The Cons of Owning
Capital required – when purchasing business premises, you may be required to inject as much as 30% equity into the property. Can your business afford this?
Are there better returns investing your equity elsewhere – for instance is the money better spent expanding your business operations?
Are you tying up capital that may prevent future growth in your business?
Very limited flexibility
Do you want to be a landlord? Owning a property means you are getting into the property management business
You will be responsible for all the maintenance in the building
The decision to own vs lease is a complex one. The factors to consider are plentiful. What type of industry are you in? Are you dictated to by the zoning of the property, and what is the availability of property with your zoning requirements?
Have you taken growth into consideration – leasing premises provides you with the flexibility to grow or shrink and move out of an area that is no longer desirable after a certain period of time.
Traditionally companies that own their premises, tend to make do with what they have as opposed to doing what’s best for the operating company. Invariably companies that own their properties tend to use more space than those leasing. Wearing 2 hats is not ideal when making real estate decisions for your business.
Further complications arise when the share holding in the operating company differs to the property holding company or changes over time. This invariably leads to conflict as the owners of the property holding company have a different agenda, that is to protect their own interests and income on the property.
How important is location? High visibility sites with good access in well-established sought-after nodes are hard to come by. A good node today may not be good in 10 years down the line. If you are an owner occupier, location may not be that important.
Are the buildings in the area well maintained and occupied? If most of them are empty, are you in an area that has lost its shine? If the area is struggling to find tenants currently, is there a future for the area?
Have you looked at the trends in the area where you operate? Is there a steady degradation or is it up and coming with new builds and refurbishments?
These factors are critical in making an informed decision because if your needs change and the property must be sold, will there be a market for the property?
I think the best answer is an operational solution taking the financial implications into account. If the site is critical to the continuation of your business, it will make sense to buy. Remember that there will always be someone out there who is prepared to overpay for the best site in the best location. The adage of location, location, location still stands.
Get in Touch
Steve is the Managing Director of 5th Avenue Properties with over 20 years’ experience in the Commercial leasing market. Get in touch with him for all your commercial leasing needs.
