Your business: The pros and cons of leasing
Pros and cons of leasing
- Leasing a building carries lower upfront costs and provides flexibility.
- Leasing generally carries greater tax advantages than owning a commercial building.
- With leasing, a business has less control, and will not gain any equity in the building, and lose the opportunity to rent out additional space in the building.
One decision that almost all small businesses have to grapple with is whether to lease or buy their building.
Both options have their advantages and disadvantages.
Advantages of leasing
Leasing has some advantages over buying. The first is that you won’t have to make a big downpayment and cover the closing costs on a building purchase. In a typical sale of a commercial building, the buyer must put down at least 20 percent of the purchase price. It is not uncommon in recent years for lenders to require a 40 percent downpayment.
There are also significant closing costs in commercial sales. All of this will require a significant capital expenditure that is typically much higher than a business entering a lease.
Another major advantage to leasing over buying is that it gives business owners more flexibility. Landlords typically prefer their tenants to sign longer-term leases, but the terms can be as short as three years. It makes sense for a start-up business to lease for the obvious reason that it is unclear if the business will succeed. Meanwhile, successful businesses often grow, and need more space. A lease can give them an easier path out of their current building.
Another advantage of leasing is that the owner is usually responsible for the upkeep and maintenance of the building. If you own the building and something breaks, you the building’s owner will typically have to pay for it.
Another perk to leasing is that it carries tax benefits. There are tax benefits associated with both leasing and buying commercial real estate. With leasing, however, you can usually deduct the full amount of the lease payments. When you are carrying a mortgage on a property, you can only deduct the mortgage-interest payments, not the full amount of the payment. Thus, the tax benefits are usually greater when you lease.
Leasing also has its disadvantages. In the short term, it is usually less expensive to rent because you’ll be avoiding the upfront downpayment and closing costs. In the long-term, the cumulative rent and the lost opportunity benefits from owning a building usually will be far more expensive.
Disadvantages of leasing
One of the major disadvantages of leasing is that a buyer gains none of the financial benefits of owning property. Just like homes, commercial properties typically gain value over time, and the owners can gain equity by making monthly mortgage payments. Commercial loans typically won’t be an interest-only loan, so the buyer will build up some equity through the payments. Landlords usually have some flexibility in raising the rents, and changing the terms, so the costs of leasing can escalate.
Another major downside of leasing involves control. A business may want and need to stay in a particular location, but landlord may also choose to sell the building, forcing the business to move. There is, therefore, less security in leasing.
Aside from less security and the lost equity gains, leasing can have other disadvantages. In many cases, owning your own building presents an opportunity to lease out a portion of it. In many cases, businesses don’t use all the space in their building and can find a tenant to take over the other space. So the building becomes a nifty source of revenue.
The final decision on whether to lease usually comes down to a company’s needs. Generally speaking, leasing probably makes the most sense for a startup or a company that plans to be in a building for a short period. Companies must weigh the benefits of controlling their own destiny through ownership of a building versus the flexibility of leasing. You must also consider the upfront costs of buying versus the long-term costs of leasing and potential lost equity.