In many markets across the country, commercial property vacancy rates are on the decline, and that may mean that commercial rents will be on the rise in 2014, according to the National Association of Realtors (NAR). NAR predicts average increases nationally of 2.8, 2.6 and 2.3 percent respectively, for office, industrial and retail rents in 2014. For businesses facing increasing occupancy costs, and with interest rates still near historic lows, it begs the question: Is now a good time to buy, rather than rent, your place of business?
The answer will depend on your own particular situation and financial picture.
Deciding whether to buy or lease
The decision to buy rather than lease one's space is generally dependent upon two primary considerations:
- Will buying enable you to do a better job of controlling occupancy costs?
- Will buying enable you to lock-in a location that is advantageous for your operation?
Other considerations that may be factored in include:
- Tax benefits—While it is true that depreciation and interest expense are tax deductible, so is lease expense, if you choose not to buy.
- Ownership costs—Expenses you may not have been responsible for as a tenant, such as repairs and maintenance, will become your responsibility once you’re a property owner.
Knowing where to start the process
Here are some key questions to consider when evaluating your current leasing situation:
- Are you in a long-term lease that would expose you to significant penalties if you were to break it?
- Does your existing lease enable you to sublease your space, allowing you to avoid the charges for breaking the lease, and result in little to no cash drain?
- Do you have a short remaining lease term, such that you could transition to another property if you were to purchase one?
- If you're going to be vacating your current lease, but the timing of the new property acquisition will occur after your current lease terminates, check for a provision in your lease called "holdover," which describes your ability to remain in the space, and the rental rate you'll pay each month you remain there after your lease expires. It will be some premium above the rent you had been paying.
- Do you have the opportunity to purchase the space you are currently leasing?
- Will making a move from your current location adversely impact your revenue stream and/or cost structure?
- Will a new location be equally convenient for your employees to get to? If not, to what extent would the loss of some employees potentially impact productivity/profitability until new employees can be hired and trained?
If you decide that buying is right for you, generally, early communication with your landlord is better than springing the news on him or her just prior to the date you give notice.
Evaluating property considerations
Depending on the nature of your business, there will be different factors to take into account, including:
- Do you operate a business that relies on high-traffic or is your business a destination point in itself? For example, customers coming to your business plan ahead to make that visit, possibly even scheduling appointments.
- Do customers visit your place of operation? Or is most of your business done through eCommerce?
Answers to these questions will factor into the location you need. In general, locations with higher traffic also have higher prices, so if you operate a business that is not reliant on traffic in order to succeed, paying a premium for such a location may not be your most economical choice.
Qualities to look for in a space
Here are a few traits that business owners should pay particular attention to when evaluating a space:
- Industrial/warehouse property—Ceiling heights, truck/tractor-trailer access, number of bays, floor bearing capacity, proximity to major roadways, railways, airports, etc.
- Retail property—Visibility, signage, ease of access, higher-traffic counts, complimentary businesses in the area, stability of businesses in the area, parking sufficiency, etc.
- Office property—Similar considerations as retail, but with less emphasis on being in a high-traffic area, depending on the nature of the business. Visiting one's accountant, attorney, doctor, etc. are not impulse visits; they are planned events. So while they should not be in out-of-the-way locations, by the same token, they needn't be in high-traffic locations.
Assembling your team
As you move forward, it’s important to seek the guidance of the following advisers:
- Real estate counsel—Early in the process—long before you execute a purchase contract—you should engage real estate counsel. Real estate legal considerations are highly specialized, so it’s crucial that you have an expert real estate attorney in your corner. The real estate attorney will assist you with everything from how the property should be held, to ensuring you’re not exposed to various liabilities.
- Buyer's representative—Navigating the world of commercial real estate on your own and trying to find the right property can be daunting. Commercial real estate agents who have the property listings have a fiduciary responsibility to the seller, not you. You need to have someone in your corner who is knowledgeable about commercial real estate and can identify the strengths and weaknesses of a property relative to your individual needs.
- Accountant—Your accountant should be able to advise you on the financial benefits and detriments of owning vs. leasing and assist in your evaluation of whether it’s financially feasible for you to purchase your own property.
- Banker—Your banker should have a familiarity with each of the elements that the other team members are expert in. Based on your business and personal financial condition your banker can give you an idea of a loan amount for which you may qualify. That information should help your other team members as they assist you in identifying a suitable property to purchase.
Conducting due diligence
Your real estate purchase contract should have a “due diligence” period that enables you to perform inspections and examinations of the property, including, but not limited to:
- An appraisal report to help ascertain whether the purchase price is fair.
- An environmental report to help ascertain the likelihood that the property has contamination for which you could then become liable—not just for the subject property but also for neighboring properties.
- A property conditions report to identify any deferred maintenance or deficiencies in systems that are in need of repair. When the property conditions report identifies areas in need of attention, those items usually factor into negotiating the ultimate price for the property, deducted from the sales price or fixed before the sale is completed—just like when you are purchasing a home.
If you finance the property, your banker is going to require these things and more. Even if you do not finance the acquisition of the property, you should have this due diligence performed for your own protection.
Here are some general financial guidelines that vary according to the type of real estate and your particular situation:
- A loan to value and a loan to cost that do not exceed 80 percent.
- A debt-service-coverage ratio of at least 1.25 times.
- A successful history of business operations.
Personal guarantees of the loan are normally required. The way you have handled your personal credit obligations over the years will also be taken into account.
Deciding whether it’s in your best interest to own or lease your place of business is a process for which you should bring to bear the expertise of your trusted advisers. Going it alone can result in hard lessons that could have been avoided.