Buying vs Leasing
Date Posted: Jul, 2017
In Australia, we’ve been brought up with the concept of owning our own home. The indoctrination of “rent money is dead money” has been passed down from generation to generation. In terms of buying or leasing a commercial property for your business is more appropriate though depends on a host of factors including your cashflow, risk appetite and business objectives. The pros and cons of each should be carefully considered before taking the leap because there can be significant costs and delay involved if your priorities change down the track, not to mention the foregone opportunities.
Buying a Commercial Property
As rightful owner of the commercial property, you can do whatever you wish with it (so long as it’s legal). It is yours to control and there isn’t a landlord to subject yourselves to. Dislike the interior design? Change it. Want to make some building extensions? Go ahead. By buying a commercial property, you are the dealer of the cards. You are in control of the decision on how best to manage your property and what you want to do with it.
Owning a commercial property is obviously an asset to your company. It adds to the value of your company’s net worth and will grow in value over time. In addition, it gives you the opportunity to complete extensive value adding. We can discuss some of these strategies with you.
On the flip side, there are substantial upfront costs to bear when buying a commercial property. Banks usually require a 30% to 50% deposit for commercial property (compared to only 20% for residential property with no mortgage insurance). While this is likely to be a substantial sum of money, business that have been operating for some years may have built up a cash reserve that is being underutilised and this may be an effective way to increase the return on that money and secure a long term physical location for the business.
Maintenance costs can also be a wallet drainer. There is a legal saying ‘caveat emptor’ or ‘let the buyer beware.’ This holds true when buying a commercial property as once the ownership passes on to you, any problems with the premises are now your problem. It is therefore imperative you complete adequate due diligence before signing on the dotted line. In addition, capital improvement costs are not tax deductible in the current year and therefore your cashflow must be able to sustain this potential cost.
Comparing the capitalisation rate of the property with the current interest rate for commercial loans as well as the extent of the fitout required may help you decide whether to buy or lease. It is not uncommon for industrial property to have cap rates of 8-10% and extensive fitout may be required before the business can begin operations. If the landlord decides to sell the property because a higher and better use becomes available (such as redevelopment into smaller lots or a different use) and decides not to renew the lease, there will be substantial costs incurred to relocated the plant and equipment (if cost feasible at all). In this case, it may be preferable to buy the premises. Fringe office space is not immune from redevelopment risk
Ultimately shareholders must weigh up the additional risks and expenses of owning the business premises with the stability and wealth creation it can provide. The legal entity the property is purchased in will also be a major consideration as it will dramatically affect the taxation consequences and risk the business takes on. Separating the ownership of the business and its property assets can have many benefits including concessional tax treatment if you purchase the asset within your self-managed superannuation fund (SMSF). If you don’t have a fantastic legal advisor to provide advice on this aspect we can recommend one.
Leasing a Commercial Property
Leasing is the default option for most businesses. It provides businesses flexibility to upgrade to larger premises when the time comes or use options built into the contract to stay in the same location for an extended period of time. It is not uncommon to have renewal options on larger properties for 15 years or longer and some businesses lease the one property for decades. Smaller properties tend to have shorter lease terms, which is suitable for businesses that have outgrown the home office but want to conserve capital and limit risk.
The value of the flexibility to relocate premises will partly depend on how easy it is for your business to relocate. This will depend on many factors though such as the type and size of your business, how much plant and equipment there is, the market conditions at the time and your required desired type of property. Many creative businesses seek premises on the city fringe with a warehouse feel, however demand for these is strong in Sydney and supply is tight due to tenants staying put and the conversion of many of these buildings into residential apartments. Supply in other areas has been depleted lately due to compulsory acquisitions for major transport projects. When the renewal of the lease came for tenants in these areas, many have been forced to either pay higher (because it was too difficult to find an alternative space) or vacate the property as the property is worth more vacant than it is with a tenant. This highlights the risk of short term leases.
On the positive side, a key benefit of leasing commercial property for your business is that the expense is tax deductable in the year incurred. This is a boon for your cashflow, which is the lifeblood of any business. Any plant and equipment you install after your lease begins may also be depreciable. You may have all the assets in the world, but if you can’t pay your bills, you can’t operate.
Lease contracts can be as detailed as sale contracts and should not be entered into lightly though. They often incorporate annual rent increases based on inflation or a fixed percentage (whichever is higher). If inflation is low the landlord still gets the price increase. If inflation is high, the landlord still wins as rent maintains its real value and the value of the asset increases (all else held equal). Council and water rates can also be included in the lease, which benefits the landlord but doesn’t help you!
Many business owners don’t invest in commercial property because their expertise is in their field of business – not real estate. While this may be true, it would be foolish to not consider the opportunity and weigh up the pros and cons and the business expands. As Buyer’s Agents, we deal with commercial real estate and sales agents on a daily basis. We know the market inside out. We will act as your trusted advisor and act solely for you and in your best interests. This includes sourcing appropriate properties, completing all required due diligence, negotiating and providing advice right through to settlement and beyond. We can also recommend any other required professionals to get the job done if required.
To see how we can help you, please contact our Commercial Property Expert, David Hayter on 1300 655 615 or visit propertybuyer.com.au to find out more information.