Expert Advice - July 2005

Buying vs. Leasing Commercial Space

The Pros and Cons

by Lucinda Stanley

Buying commercial space has many advantages over leasing the space. Most landlords have not kept up with the rising costs of construction, which puts the burden on the tenant to finance the difference (also known as cost overage) for tenant improvements. Also, if the building is not already equipped with common restrooms, private restrooms are an added expense the tenant must absorb. Most general contractors agree that the average cost for a general office build-out would range from $40 to $50 per square foot. The $25-per-square-foot allowances offered by landlords no longer attract tenants going into raw space. Medical companies get hit even harder with their typical build-out requirements.

Other "pros" of buying include: attractive interest rates – even with rising rates and anticipated increases, the monthly debt service is still at or below what a typical lease payment would be; appreciation of value – one year ago, small office-building shells sold for an average of $170 per square foot and now exceed $200 per square foot; and various tax advantages a CPA can explain. Not to mention pride of ownership, being able to tailor the space to one’s needs, and getting a return on the investment.

Obtaining financing has never been easier for the small business owner, with attractive rates, creative ways of showing equity and even financing for the furniture and trade fixtures. Commercial space inventories have increased, where in the past it was difficult to find a small building available to purchase or a small quarter- or half-acre site to build on. If you really want to calculate the cost of constructing your own building, consider the time value of money as well as the hard costs. Small business parks are a sure answer to alleviating the headaches of designing, building and supervising the construction process and save the small business owner money as well (using the economy-of-scale method).

The "cons" of buying must also be analyzed before purchasing a building. Leasing allows the small business owner options for growth (or downsizing) and requires fewer out-of-pocket dollars at the beginning. Those buying a building typically need a down payment of 10 percent of their total cost (building, closing fees, furniture and fixtures), which may deplete their liquid assets. Loan interest rates are not always fixed, and may have an adjustment date or balloon date when the rate would increase after a period of time. Leasing makes it easier to relocate. It’s often hard to predict when construction on a new building will be completed, and buyers may be subjected to various delays they cannot control.

When purchasing a building, plan for future growth by buying more space than is currently necessary. This avoids being locked into a building with no options to expand. However, this means the owner must finance more than he or she currently needs. A common fix for this situation is to lease out the unused portion on a short-term lease, thus reducing the debt service until such time as the owner needs the space.

  Whether planning to buy or lease, seek advice from a CPA and an experienced developer and/or commercial real estate agent to review the pros and cons for your particular business and situation. But before you make that call, check their credentials first and find out how long they’ve been in the business and what  they specialize in. Making the right decision rides on your shoulders, and the more time you spend doing the legwork, the easier the process will be.

Lucinda Stanley
Lucinda Stanley, CCIM, CPM, is a corporate broker/senior vice president for Shea Commercial.