Should You Buy a Building for Your Small Business?For some small businesses, it can make sense to kiss the lease goodbye and start building equity in your own property. But it’s not for everyone.
If you’re tired of pouring profits down the lease drain, you may have considered buying a space for your business. Assuming you have the capital to do it, it might make sense to escape the eternal 5-year lease cycle and take ownership of a property.
There are obvious advantages, such as building equity and the promise of more predictable payments. What’s more, noted Rob Wilson, head of C7a, a Small Business Administration lending firm, “When you finally sell your business, you can keep the building and lease it to the new owner as an additional income stream, sort of like a 401(k).”
But there are a lot of factors to consider. Here are some of the main ones.
Is the market timing right?
One key reason to buy property is to lock in a mortgage payment at a known price rather than dealing with fluctuating leases over the lifetime of your business. Worried that lease prices might be headed up in the near future? You can get a sense of lease trajectories by seeing how much commercial space is currently under construction in your area. (More construction means more leasable space, which generally means lower lease prices.)
In many areas, less commercial construction is the trend, not more. “Retail is kind of weird right now,” said Bill Conerly, an economist and business consultant. “Amazon is presenting real challenges to retail. While there’s still some retail construction, often it’s just repurposing existing locations.” Bottom line: Lease prices are likely to stay at their current levels or go up for the foreseeable future.
To find out how attractive purchase prices are right now, research your local real estate market. “Get comfortable with your local market and ignore what the Wall Street Journal has to say about the national real estate market. Seattle is very different from San Diego,” said Conerly.
Is your landlord thinking of selling?
One disadvantage of renting: A landlord can sometimes force your hand.
“If your lease is coming to an end and the owner wants to sell, they might be able to get more for a property if it’s empty and ready for redevelopment,” warned Wilson. That means you can find yourself with a 90-day notice.
On the plus side, said Craig Melby, founder of commercial property leasing firm LeaseSmart, “You can renegotiate your lease at any time, and locking it in early can actually be attractive to some buyers.”
Is the type of space you need available for purchase?
Carrie Wood, chief marketing officer at LeaseRef, noted, “As a general rule, the number of leasing options will out-number purchase options by at least 20 to 1. Given this incredible imbalance, the pool of leasing options almost always yields the best overall space for a business.” If you buy, you may have to make sacrifices with respect to location, amenities, parking and so on.
Is the capital better spent for other purposes?
Consider the opportunity cost of purchasing. If you’re going to spend significant capital buying a structure, that’s money you can’t spend on internal investments.
“You probably aren’t an expert at real estate; you’re an expert at your own business. So you are generally better off spending money on marketing or to otherwise grow your business,” Conerly said. Also, if you tie up your capital in a building, there’s a good chance you won’t be able to take advantage of an unexpected opportunity that comes your way.
Are you planning to open more locations?
“If you’re a doctor, lawyer, or CPA and not planning to expand your square footage or to open multiple locations, then you may as well buy rather than pay rent,” advised Melby. But if you see scale in your future — you plan to expand or open other locations — it may make less sense to buy.
And what if you need to move your business due to changing demographics or other factors? “Depending on your lease, you may be able to get off the hook quickly and relocate,” said Melby. With a mortgage, not so much.
Do you want to be your own landlord?
“One thing people often don’t take into account is the long term cost of ownership. Be aware of how old major items are and when they need to be replaced. If you buy a 35 year old building with a 40 year roof, you’ll probably have to pay for a new roof in a few years,” said Wilson.
And that’s not all. You no longer have a landlord to complain to about plumbing or heating issues — now you own them. You can always hire a management company to deal with many of these issues, but that’s another expense.
The bottom line? “If you can afford it and if you are keeping the building a long time, it can be worth it to buy,” Conerly summarized. But he and other experts agree that many stars should align before you invest in a building. And you shouldn’t buy real estate for its own sake; it needs to make sense within the context of your business.