Lease Vs. Own Decision Entrepreneurs Need to Take Long-Range Outlook
Fledgling entrepreneurs -- be they owners of accounting firms, machine
shops, local restaurants, clothing stores, dry cleaning establishments or other
small businesses -- face the question of whether to lease or own the property
housing their business.
According to a national commercial real estate expert, there is no “right”
or “wrong” answer. A variety of factors pertinent to the individual business
and the owner’s objectives, as well as local market factors, must be taken
into account before an informed decision can be made.
Whether or not the company will grow -- and grow substantially in the future --
is one of the principal factors influencing the lease versus own decision.
If the business is expected to grow dramatically over the next three to five
years, owning is probably not a good option. An entrepreneur is better off
leasing in that situation.
By leasing, the entrepreneur avoids the prospect of either purchasing a building
that’s too large, with the expectation of growing into it, or one that only
accommodates current space needs, which will be too small in a few years.
The next issue to consider is the availability of flexible lease terms.
Landlords in many markets today offer a long-term lease of seven to 10 years
with a clause allowing the business to exit the lease after five years with six
months notice. In this case the tenant would pay the unamortized cost of
getting out.
Obtaining this kind of lease flexibility for small entrepreneurs is a more
prudent option than owning real estate.
Small business owners initially should try to avoid tying up valuable capital in
real estate assets. Leases tend to lower fixed costs because there is no
required down payment or amortization of loan principal. Lowering fixed costs
reduces overall business risks.
Leasing real estate offers a business the option to still occupy and control a
property, but utilize capital in other ways.
From the perspective of purchasing a business property, an entrepreneur in
business a few years with few plans to grow the business significantly might
consider an outright purchase. If a business owner knows he can manage the
company effectively in the same building for 10 years or longer without
requiring additional space, then he should take a hard look at the cost
differences between leasing and owning.
In this case, owning appears to be a viable option. But even with
ownership there are pitfalls. If you purchase the property and 10 years in the
future the business gets into financial difficulties, you as the owner do not
have the flexibility a lease would offer. If you file for bankruptcy and you are
a tenant, it is most likely you can tear up the lease and claim you need to move
to a lower cost building in order to get back on your feet. An owner simply does
not have that flexibility.
Another problem with ownership is it carries a potential opportunity cost.
Owning real estate through either equity or mortgage loan financing ties up
capital that might otherwise be invested in the business, for expansion or
renovation. Such operations investment might produce greater returns than the
real estate investment, creating an opportunity cost that accompanies real
estate ownership.If the entrepreneur opts for a lease over ownership, certain criteria must be
followed in order to secure the best possible lease. For example, leases should
provide the tenant with an acceptable level of control over the asset. These
control issues include assignability, reasonable condemnation and taking
provisions, and purchase options. Lease escalation clauses should be manageable
and potentially tied to sales growth in order to lessen downside risk.
If the entrepreneur opts for purchase, when to make that purchase is paramount
to getting the best price. Analyzing current market conditions and available
sales information provides the buyer with valuable insight.
Lease vs. own analysis is definitely a situation-by-situation equation.
There are many factors to consider and the decision should be made in
conjunction with a qualified real estate professional who has proven experience
in that particular market.