Phoenix-area office tenants have had it pretty good these last few years. Tenants have enjoyed competitive lease rates, landlord-paid improvements, and even free-rent specials. For many small-business people, renting seemed to make more sense than investing in buying their own office space.
The market in greater Phoenix has started to tighten. Lease rates aren’t as attractive, and more tenants have to pay out of pocket for improvements. Demand is finally catching up with supply, which bodes well for commercial real estate prices. This has many business owners in the Valley of the Sun wondering if leasing a building for business or buying their own office space is the way to go.
No one can provide a one-size-fits-all answer. Market forces are undoubtedly increasing the benefits of buying and decreasing the attractiveness of leasing, but that does not mean buying is appropriate for every business.
Business stability, predictability and location needs are far more important than the vagaries of the real estate market. For example, a retail store dependent on foot traffic doesn’t benefit from buying in a place where its business will suffer. It’s better off renting in a location where it thrives.
Before making this critical decision, consider the pros and cons of each option.
Pros of buying
Buying your own office space controls costs. Businesses that lease are often forced to renew at much higher rates. Rising expenses are the bane of the business owner. They eat up revenue gains. With your real estate costs fixed, you know future profits will stay in your pocket.
Additional benefits of owning your company’s commercial space include:
- Making long-range planning easier and more effective.
- Taking advantage of the tax benefits that add to your bottom line.
- Deducting mortgage interest, property taxes and other items.
- Renting extra space for additional revenue.
- Selling the office space at retirement to fund your golden years.
Cons of buying
As with buying a home, you lose flexibility. When your business needs the flexibility to move in the foreseeable future, buying commercial space can be a bad move. Having to move after a short time creates expenses and may even cost you business. It’s better to rent until you are certain of staying put long term.
Additional cons of buying commercial space include:
- Business growth requires a larger space.
- Big down payment.
- Transaction fees, such as appraisal charges.
- Maintenance costs.
- Costly property improvements.
- Decreased profit margins may occur.
Leasing business property pros
When you need a prime location, leasing usually provides the more cost-effective way of obtaining the most profitable location. Retail stores and restaurants, for example, are dependent on prime locations. The cost of buying in prime areas is often so high that the business would struggle to survive under a giant mortgage payment.
For small business owners, working capital is king. Without it, the business can become constrained and unable to take advantage of opportunities because of a lack of available cash. Additional reasons to lease your commercial space include:
- Prime location occupancy guaranteed for the long term with an affordable lease.
- Stronger cash flow.
- Leasing keeps working capital free.
- Easier to borrow capital when leasing at a comfortable payment.
- Leasing puts a little constraint on your time.
- No extra property management duties.
As many Phoenix-area businesses are finding, leases subject them to the market at the end of the term. A sizable increase in rent can put business owners in a difficult position. Moving may be impractical while the rent increase squeezes margins too tight. A fixed cost of office space keeps this problem at bay.
Businesses need to build equity. Equity secures their future, provides working capital, and opens financing opportunities. When renting, much of your revenue goes into an equity black hole. Cons of leasing include:
- No equity building.
- Costly increases at lease renewal.
- Triple net leases make you responsible for property taxes, improvements, and maintenance.
The decision to buy or lease depends on the needs of the business. Owning has its advantages in the long run, but it comes with short-term risks and is impractical for some businesses. Either way, it’s a good idea to create a separate entity for a purchase or to sign a lease from an ownership entity. Finally, when considering an office purchase or lease, remember these two critical questions:
- Does this purchase make sense as an investment?
- Is the lease rate competitive with similar properties?