In this blog, we will review a number of key considerations that may assist you in determining the best option for your business and circumstances when it comes to renting vs buying commercial property
We will also review some of the advantages, and the disadvantages, of buying and leasing commercial property.
The key items we will cover include:
- Business growth
- Borrowing capacity / financial position
- Business objectives
- Market opportunity
- Pros and Cons
Do you know what your business growth looks like? Are you growing quickly, or is your business in a stable cycle.
If your business is growing rapidly, then buying a property may not be your best option, as you could outgrow it quickly, which may necessitate you selling your premises again not long after purchasing it. While this may not be a big issue in an upward trending market, it may cost you in a flat or down market. Even if you sell for a higher price, you’ll still have costs you won’t recover, such as stamp duty, legal fees, loan establishment and discharge fees, agent’s commission, and more. Leasing a commercial property may give you greater flexibility to accommodate your growth and offer more cost effective options if you move your business quickly.
Additionally, if your business is growing quickly, you may need to retain your capital to support that growth, rather than tying up the capital in a commercial property.
While buying a property may seem like a great investment, if that comes at the expense of being able to leverage your capital to take advantage of a business opportunity, then that investment in the commercial property could prove costly, by comparison. Of course, this is just an example and something to remain mindful of when considering your options.
Borrowing Capacity / Financial Position
Historically, for commercial properties, most lenders will only lend you around 65% to 70% of a property’s value, referred to as the loan to value ratio, or LVR (while this ratio is most common, there are various exceptions outside of this). This means that you need to have 30% to 35% of the property’s value as a deposit (or available equity). That is a lot of cash (or equity) to take out of your business, especially if you need to retain that cash as working capital to keep your business healthy, growing and remain viable.
There are many ways to structure the purchase of a commercial property, so if you decide that buying a commercial property is the right decision for you and your business, you should consult with your accountants and a good finance broker to review your specific options. For many businesses, the cost of buying a commercial property may be insurmountable, however, the owners of the business may be in a better position to buy the commercial property (perhaps utilising equity in their primary residence) and then Lease it back to their business. This provides the advantage of stability for the business, given the business owner now controls the property, and at the same time it can alleviate the financial impact on the business if it had to borrow the money to purchase the property. Business can be hard enough at times, let alone when you add the extra burden of debt. If the business is in a great financial position to buy a commercial property, such as strong capacity to service a loan, and sufficient cash in order to borrow only a limited portion of the property’s value (say 50-60%), then a range of favourable lending options should be available. Securing favourable lending terms is a crucial ingredient when purchasing a commercial property (or any property) to make the transaction a successful one. If you’re not in a strong enough financial position to purchase a property with favourable lending conditions, then it may be premature to buy, as paying down a loan with onerous conditions can be crippling. Make sure you consult your accountant and a good broker to get an understanding of your position and lending options before you rush into a purchase. Buying property is exciting, but it’s worth taking your time to make sure you get it right from the outset!
What is the purpose of your business? Have you given this serious consideration. Is that purpose best served by taking the cash out of the business for the sake of purchasing a commercial property, or can that money serve a more important objective? This question may have different answers depending on what stage you are at in the journey of your business. Having clarity around the objectives and purpose of your business will give you a great platform to determine if this is the ‘best’ decision for your business and those it serves. Take for example an organisation that provides services for people living in homelessness. At one point in time, that organisation may be best served by using their available cash to establish or improve essential services, such as food, clothing and shelter for the people they care for. At another point in time, their available cash may be best invested in buying a commercial property that provides them with the security and stability necessary to provide continued and reliable services. Only having real clarity around the objectives, goals and purpose of the business or organisation will provide the clarity needed to understand and make this decision.
You may determine that buying a commercial property is the right decision for your business, but that doesn’t guarantee that there will be a good opportunity available in the market that suits the needs of your business. While many types of business will have some flexibility in the type and size of the property that could accommodate their needs, many aren’t afforded this flexibility. If your business has unique needs, there may not be an opportunity for you to purchase the appropriate property and leasing may be the most viable option. Of course, there may be an option to purchase land and build specific premises to suit the needs of your business, but with that option comes other risks, such as the time it will take to acquire the land (or site), plan the development, obtain approvals and ultimately to build/develop (or redevelop) the site. This option of building to meet your specific needs can also come at a higher cost, as the cost to acquire land and the cost of building, in aggregate, can exceed what it would cost to acquire an existing building. Given the potential complexity in finding a suitable commercial property, especially if your needs are very specific, our top tips are: 1) To plan well, so you have as much time as possible to find a suitable opportunity, and 2) To cultivate a good relationship with a commercial agent(s), so they can use their knowledge of the marketplace, connections and skills to seek out the right opportunity for you.
Pros and Cons
- Cheap money. Interest rates are at historic lows, so paying a mortgage may, in many cases, be cheaper than paying rent. Budgeting to pay a loan may also be easier than budgeting for rent, given the rental market is likely to increase, but your loan repayments should decrease, over time.
- Stability. As you are in control of the premises, you don’t have to rely on a landlord continuing to offer you a lease for the premises.
- Growth in value. History has taught us that property values generally appreciate over time, so while you continue to run your business from a premises you own, you’re also growing the value of your asset.
- Interest rate rises. If interest rates increase sharply, that can have a huge impact on the cash flow of your business. It also could make selling your property more difficult, as purchasing property may be less attractive to others while interest rates are high.
- Less flexibility. If the needs of your business change, moving to a larger or smaller premises will be more complicated and costly.
- Ongoing costs. As the owner of the property, you will be liable for the cost of the repairs, replacements and upgrades to the building that will inevitably be required from time to time.
- Flexibility. In contrast to the lack of flexibility in owning a property, leasing a property allows you to expand to a larger premises more easily and more cost effectively.
- Affordability. As we’ve noted on this blog, purchasing a commercial property can require a large deposit. Leasing a property allows you to secure the space your business needs without having to come up with such a significant sum at the outset.
- Ongoing costs. Again in contrast to the above con for purchasing, a lease should protect you from certain property related expenses that an owner would be liable for, such as replacing a roof, or even something simple like replacing a hot water service.
- Rising rents. Over the long term, rents will usually increase and represent a larger and larger impact on your can flow, compared with a loan that becomes more affordable as you pay for the loan.
- Limited benefit from improvements. If you make improvements to the property, such as renovating amenities or office space, you don’t benefit from the value that adds to the property. Also, if you make improvements to the property that are peculiar to your business, you may be required to make good those improvements to reinstate the property to its former condition, which may be costly.
As you can appreciate from our brief overview of some of the benefits and some of the negatives to buying and leasing commercial property, there is much to consider.
Like any business decision, if you’re considering whether to buy a commercial property, please take your time, do your research, and consult with your professional network before you make a final decision for your business.
If you would like to talk to one of our agents about your circumstances to help in your consideration of a potential purchase (or lease), call or office today.