Lease vs. Own
When Does It Make Sense?
Charlotte’s current economic climate is prompting many business owners to examine the option of property ownership.
Understanding the financial impact of owning versus leasing is important for entrepreneurial firms and in some cases, larger companies. Charlotte’s current office climate is prompting many business owners to examine the option of property ownership. Office rental rates across all submarkets have never been higher, and with interest rates remaining high and many banks requiring higher down payments, deciding whether to purchase or lease property can be very challenging. There are many other interrelated factors aside from the obvious financial considerations that should be analyzed carefully. Making a prudent decision goes far beyond short-term financial goals. It is a broad process that should include a careful examination of the following factors:
Merits of Owning and Leasing
Company Structure / Goals & Objectives
Operating Space Requirements
Market Conditions
Financial Analysis
The Merits of Ownership
It is important that a company understand the basic factors that contrast ownership and leasing. The pros and cons of ownership and leasing include:
Advantages
Leasing
Initial cash outlay tends to be lower than owning
Rental payments are tax deductible
Less capital commitment
Less debt on balance sheet
Stability of costs
Remove ownership risks
(obsolescence, loss on disposition, cap rate volatility)Maintain operating flexibility
(size and location)Focus on core business rather than property management
Owning
No exposure to market rent increases
Property appreciation
Rental income from tenants
Financial leverage (equity, mortgage loans, etc.)
Tax benefits (Favorable capital gains treatment, depreciation, interest)
Control over image
Promotes a foundation of strength and stability
Ability to control operating expenses & maintenance
Control over other tenants and uses in the building
Disadvantages
Leasing
Renting can cost more than owning
No tax savings from depreciation/interest
Less control of asset
No benefit from value appreciation and equity buildup
Rental rate increases
Less control over Operating Expenses
Owning
Upfront cash outlay
Possibility of property value depreciation/obsolescence
Managing property/maintenance
Non-liquid asset
Less flexibility (expand/contract)
Uses up borrowing capacity
Increases balance sheet debt
Company Structure / Goals & Objectives
The goals and objectives of a company are a key factor when analyzing a lease vs. own situation. The following questions should be answered carefully:
Consider the consequences of becoming a landlord. What is your core business and how will it be impacted by your responsibilities as a landlord/property manager?
Does the building or property lend itself to your business?
Is proximity to another location important?
Do you plan to sell the company within the next ten years?
Is your firm a start-up?
When business growth is unpredictable it usually makes sense to lease until cashflow and growth levels are stable.
Is your company a public company?
Do you need to keep real estate off the balance sheet?
Real estate debt may hamper future borrowing. Owning real estate tends to absorb more cash flow.
What is your firm’s required rate of return (opportunity cost of capital or weighted average cost of capital?)
Operating Space Requirements: Questions to Consider
Operating space requirements are another important piece of the puzzle. Companies should carefully consider the physical requirements of their space. By performing a qualitative analysis on the physical aspects of a building, business owners can determine if the facility will meet certain functional requirements.
Here are a few points or questions a firm should consider:
How does the space lay out? Is it efficient? What will the cost be to build it out to your specifications above the purchase price?
Are you unsure of future space requirements? If so, leasing is a good idea.
Is your business likely to expand or contract in the next 10 years and if so will you require some flexibility? Leasing can give companies the ability to adapt to changes.
Conversely, an owner may have greater flexibility in using the property than a tenant. As space needs change, an owner can make choices that support these needs.
Do you require more control over the image, appearance, use or maintenance of the building? Do you need more control over the heating and cooling systems?
Is your business highly specialized or is it equipment or space intensive? If so, moving could be too costly.
Market Conditions
In-depth market research is essential when analyzing a purchase or lease option. Market research should include a thorough property search and analysis as well as economic, social, and demographic studies of the market areas in question.
The Financial Analysis: The Most Vital
Without question this segment of the process is the most vital and any mistakes made here could be costly. Analyzing the financial ramifications of leasing and ownership is not an easy task, and business owners should seek the help of a professional real estate consultant.
The principal focus of the analysis is to determine if leasing will cost a firm less than buying property outright over some holding period. In a nutshell, that involves calculating the net present value of the cash flows over the term of the lease and comparing this number to the cash flows to purchase the asset. Sound simple? In theory, it is. But there are many factors that complicate the comparison.
