The pros and cons of buying a business property
Does buying my business property make sense?
- Substantial tax advantages
- More predictable costs
- Property appreciation benefits
- Prohibitive down payment and loan costs
- Other, better ways to spend the money
- Not cost-effective if you're planning to move soon
When you're in the market for commercial property, sometimes the best deal you can make is no deal at all.
That's especially true if you're the owner of a fledgling company and thinking about buying the building where you do business. Buying your place of business isn’t always the wrong choice, however — sometimes it's unquestionably the right thing to do — but there some important financial considerations to assess before going that route.
The most common reason business owners have for not buying a business property is the size of the down payment necessary for a commercial mortgage. You may simply not have the money — at least 20 percent of what could easily be a seven-figure purchase price — or decide that the money can be put to better use in other areas of the business, including as a cushion against cash-flow problems.
If you can raise the necessary down payment, your decision on whether it makes sense to buy will be closely tied to the length of time you expect to remain in the building. That down payment is a big upfront cost that can be a disincentive for buying, especially when it is accompanied by the closing, inspection and attorneys’ costs associated with real estate purchases. Those costs are countered, however, by the fact that your operating expenses are generally lower if you own the property and, at some point, those lower expenses will outweigh the impact of your down payment and other initial costs.
So, the longer you expect to stay at a location, the better the case for buying the property. One common rule of thumb cited by business advisors is that if you don't expect to stay in a location for at least seven years, think twice about buying it.
The terms of your lease also can enter into the decision. In some cases, you are saving money as a tenant, because the landlord is responsible for property taxes, insurance and maintenance. But in some rental agreements, known as triple-net leases, the tenant is responsible for those expenses, so the costs in those areas do not vary whether you lease or buy. Triple-net leases are especially common in the leasing of retail space.
There are two other deceptively simple reasons not to buy: First, the property may not seem right for your business. If you trying to convince yourself to buy for the sake of buying, you could find yourself tied to a flawed location, or end up absorbing the costs of purchasing again as soon as you find the property that really is perfect for your business.
Second, buying is less financially attractive if you expect property values to remain flat, or decline. If you're not anticipating rising property values, and the rising equity that comes with that, the chances that buying makes sense are much lower.
Just as the expectation of appreciating property values works in favor of buying your home, it also can support the case for buying a commercial building that will serve as a home for your business. In addition to receiving a payoff when you sell the building (and, perhaps, your business with it), you are also likely to have relatively stable mortgage payments, compared to the rent increases that are likely every time a lease expires and is renegotiated. Once you pay off the mortgage, you will eliminate an expense that would never go away if you continued leasing.
Among the biggest long-term factors that can make buying attractive is the tax advantages that come with owning your commercial property. You are able to deduct your lease payment as a business expense when calculating your taxes, but the range of tax deductions available to property owners tends to be broader.
As a building owner, you can claim as an expense your mortgage-interest payments — although generally not payments on the principal of the mortgage loan. Other tax deductible items, however, include the cost of maintaining the property, real estate taxes and depreciation of the building. The comparison between buying and leasing will vary depending on the terms of the lease you are considering, but in general your overall expenses, after tax deductions, are lower as the owner of the property.
Again, the lower long-term costs do not immediately outweigh the expense of your initial down payment and loan-closing costs, but at some point, if you occupy the property long enough, the savings will eventually make buying more attractive than leasing.
Many business owners establish other tax advantages by creating a separate corporation to buy the property. The business can then deduct the entire cost of the mortgage as a rent payment to the corporation that owns the property, and the corporation can still claim maintenance, real estate tax and depreciation charges as expenses. Also, the property's mortgage is not recorded as a debt for the original business, because it does not own the property.
If and when you decide to sell your business, you can sell your building to the new owner as well, or keep the property and lease it to the new owner of the company. That can be risky, however, considering that the new owner of the business could fail and, as a property owner, you might lose your only tenant.
Needless to say, professional advice is necessary when considering the tax advantages and disadvantages of buying property. Professionals also can help you determine whether buying makes sense at all, and also provide you with an accurate assessment of the number of years it will take to recover the high initial costs of becoming a commercial property owner.