Weighing the Decision to Buy or to Lease
After paying rent for several years, many business owners no longer want to help their landlord build equity in the building they lease. Ultimately, they may regret not purchasing the property from the outset.
The principals at the commercial real estate firm Beckner & Associates (B&A) in Lenexa, Kansas, think most businesses should own their own property. The hard questions are when and how. This is why it’s critical for small-business owners to consider the advantages of owning their property as well as understand the issues accompanying purchase.
Advantages of Property Ownership
The costs of owning a building can provide tax deductions in the form of mortgage interest, property taxes and other items. As B&A stresses, business ownership is one of the last tax advantages available to small-business owners.
Real estate pundits advise small-business owners to buy property using a limited liability company (LLC) set up specifically for that property. The company can lease space in the building from the LLC, and the owners can show the rent as interest and expenses as deductions. As an LLC, the owner can then depreciate the building, providing these tax advantages:
- Business owners pay market rents and can move money to the building owner (the LLC), which reduces the tax obligation.
- Company owners are now landlords, which means they can stabilize lease rates for as long as they like and can avoid paying rate increases.
In sum, company owners benefit from control of rental rates. And as B&A points out, thanks to the benefits of setting up an LLC, real estate investors can make money by cash-flow appreciation and reduction of debt. Property ownership offers other advantages, too, such as control of operating expenses and careful management of maintenance issues.
Disadvantages of Property Ownership
Before putting the wheels in motion to purchase property rather than lease, B&A cautions, small-business owners shouldn’t assume one-size-fits-all solutions. Remember that business ownership doesn’t work for every business, which is reason enough to consider the following:
- The down payment required to buy a property means owners must tie up significant funds (typically a 10–20 percent down payment). These are funds that otherwise would be available to fund growth.
- B&A advises owners with large capital expenditures to think carefully about committing funds to a building.
- If a business anticipates outgrowing the building in a short period of time, owners should postpone purchasing until growth has stabilized. Or, consider buying a larger building and leasing part of it to other companies.
As you can see, the decision to buy rather than lease a property is not as clear-cut as many business owners might think. Why risk making a bad decision? Give us a call, so our advisers can identify advantages and unseen negatives that weigh into this important business decision.