There are a number of factors; financial, practical and even emotional that influence whether to lease or buy where you do business. When a business grows to the point it can consider for ownership, it is, or arguably should be considering purely the investment value of leasing to that of owning.
However, key variables, some of which are not financial, are significant in this consideration: 1) Market value, or the probable price it would sell for at a specific point in time to an informed buyer; 2) Investment value which differs based on its situation or goals. Investment value is unique to each business. Location, features, personal finance of the principals, tax situations, flexibility, and personal pride of ownership can affect how a business perceives investment value. In addition to pure "number crunching", it is critical for a business to understand which components define investment value to it when considering whether to lease or buy.
Advantages to leasing include having physical and partial economic use of a facility for an agreed to period for a specified monthly fee. This increases the availability of cash because it is easier to negotiate lease terms than get a loan. It preserves working capital for use in running the business rather than using it to invest in or maintain real estate. Also, lease payments are 100 percent tax deductible. Even real estate can become obsolete by fast changing technology or changing demographics. By leasing, a business is protected against this risk by allowing a relatively easy move to another property which supports cutting edge technology, or it can easily move to a premier location that would otherwise be unaffordable. Finally, a business can focus on its core profit center instead of having to become a property manager.
Of the disadvantages to leasing, the main one is that without an ownership interest, there is no participation in equity build-up, or appreciation. In addition but harder to quantify, some business need to substantially alter the property to meet technological requirements, make physical changes to accommodate staff or equipment, or just make cosmetic changes to impress customers.
If the improvements alter the property or reduce the range of potential uses, the landlord may not permit them. In any event, the investment is lost when the lease expires. Leasing does not allow control of other tenants who may not conform to the type the business started out with or the image it seeks. No operational control over business amenities, or input regarding changes to the building typically come with a lease. Finally, if the property becomes obsolete or the lease becomes uneconomical, the business must keep making the payments and may not cancel without substantial penalties.
Ownership, especially as the primary user, overcomes all of the disadvantages of leasing as a business now has the means of to have the full economic use of the property for an unspecified period of time. Other advantages include tax savings, appreciation, income if a portion is rented, and control of how to use the property. Through ownership, a business has the freedom to make changes, control the appearance, and significantly, control expenses.
With an understanding of investment value, a business can assign a value and use it in connection with internal performance numbers to develop its own unique opportunity cost percentage. Once the opportunity cost percentage is established, the decision to lease or own becomes a simple mathematical comparison of the after tax cash flow requirements of either leasing or buying for the anticipated holding period. This gives us the internal rate of return (IRR). If the IRR is greater than the opportunity cost then buy. If the IRR is less than the opportunity cost, then lease. If they are equal or close, have fun and go with your gut. Your CPA or a qualified Real Estate professional can help here. Happy shopping.
Tyler Merrill can be reached at [email protected]
However, key variables, some of which are not financial, are significant in this consideration: 1) Market value, or the probable price it would sell for at a specific point in time to an informed buyer; 2) Investment value which differs based on its situation or goals. Investment value is unique to each business. Location, features, personal finance of the principals, tax situations, flexibility, and personal pride of ownership can affect how a business perceives investment value. In addition to pure "number crunching", it is critical for a business to understand which components define investment value to it when considering whether to lease or buy.
Advantages to leasing include having physical and partial economic use of a facility for an agreed to period for a specified monthly fee. This increases the availability of cash because it is easier to negotiate lease terms than get a loan. It preserves working capital for use in running the business rather than using it to invest in or maintain real estate. Also, lease payments are 100 percent tax deductible. Even real estate can become obsolete by fast changing technology or changing demographics. By leasing, a business is protected against this risk by allowing a relatively easy move to another property which supports cutting edge technology, or it can easily move to a premier location that would otherwise be unaffordable. Finally, a business can focus on its core profit center instead of having to become a property manager.
Of the disadvantages to leasing, the main one is that without an ownership interest, there is no participation in equity build-up, or appreciation. In addition but harder to quantify, some business need to substantially alter the property to meet technological requirements, make physical changes to accommodate staff or equipment, or just make cosmetic changes to impress customers.
If the improvements alter the property or reduce the range of potential uses, the landlord may not permit them. In any event, the investment is lost when the lease expires. Leasing does not allow control of other tenants who may not conform to the type the business started out with or the image it seeks. No operational control over business amenities, or input regarding changes to the building typically come with a lease. Finally, if the property becomes obsolete or the lease becomes uneconomical, the business must keep making the payments and may not cancel without substantial penalties.
Ownership, especially as the primary user, overcomes all of the disadvantages of leasing as a business now has the means of to have the full economic use of the property for an unspecified period of time. Other advantages include tax savings, appreciation, income if a portion is rented, and control of how to use the property. Through ownership, a business has the freedom to make changes, control the appearance, and significantly, control expenses.
With an understanding of investment value, a business can assign a value and use it in connection with internal performance numbers to develop its own unique opportunity cost percentage. Once the opportunity cost percentage is established, the decision to lease or own becomes a simple mathematical comparison of the after tax cash flow requirements of either leasing or buying for the anticipated holding period. This gives us the internal rate of return (IRR). If the IRR is greater than the opportunity cost then buy. If the IRR is less than the opportunity cost, then lease. If they are equal or close, have fun and go with your gut. Your CPA or a qualified Real Estate professional can help here. Happy shopping.
Tyler Merrill can be reached at [email protected]