There are multiple ways to invest in commercial real estate. If you run a business, one strategy is to own the building your business operates in.
Some of the benefits of utilizing this strategy are the tax advantages, additional cash flow or savings (no rent increases), and even having more control over the condition of the space (updates, repairs, etc.).
If you own the property in an LLC (limited liability company) and the business makes lease payments to that LLC, the tax-advantages are two-fold. The business can deduct the lease payments as a normal business expense, and the owner through the LLC is able to depreciate the building, as well as show any expenses as deductions.
That said, before you jump in and make the long-term investment of purchasing a building for your business, remember this decision is not to be taken lightly. Here are few things to consider first.
Do You Have Enough for a Down Payment?
For many companies, this discussion is very simple. If you don’t have sufficient capital reserves to allocate a sizeable amount of up-front cash for a down payment and closing costs, then the buying option is off the table. Regardless of the many benefits of ownership, if the cash is not available, or if spending the cash on a down payment would compromise the buffer of liquidity necessary to float business operations, then the buying option should be avoided, or at least delayed until sufficient cash reserves are available.
What is Your Growth Trajectory?
Assuming cash is not a problem; the next consideration is thinking long, hard, and realistically about how much your business will grow over the short, medium, and long term. Have you just landed a game-changing deal? Or, are you expecting a more measured and incremental sales growth trajectory over the next 3, 5, and 10 years? Are you outsourcing more components of your business, or are you continuing to grow your internal capabilities? Do you have new category-leading products in your pipeline, or are you simply refreshing your existing offerings? The speed and scale of your estimates, and your answers to these questions, will directly impact your decision regarding office space, as in-hand, large-scale, customer orders may require the immediate purchase of real estate, whereas measured growth could allow for leased or rented space to be added on an as-needed basis.
How Long Will You Stay in the Building?
Determining your horizon for remaining in a building will have a critical impact on whether it makes sense to buy, rent, or lease a facility. Just as deciding whether to spend money to refinance your home mortgage at a lower rate will be predicated on how long you plan to stay in your current dwelling, the decision of whether to swallow the down payment and other closing costs will be impacted by how long you expect to remain in your office building. For business owners, these considerations will often include a related discussion of how long they expect to remain in business, where they would like to do business geographically, whether they aspire to be purchased by a competitor or private equity group, and the impact that this property commitment could have on their desirability.
Do You Like the Area?
Many small business owners make the mistake of buying a building only to realize later that they don’t like the location because of insufficient parking, undesirable traffic patterns, restaurant proximity, or other neighborhood-related issues. Be sure to take all of these factors into consideration and “try out” the facility as much as possible prior to committing to the purchase of a long-term asset.
Are You a Handyman?
In commercial real estate there are two popular descriptions of facilities bookending the condition spectrum: “move-in ready” and “handyman special.” While typically more expensive, move-in ready buildings do offer the convenience and assurance of a relatively carefree ownership experience, at least in the short term. In contrast, handyman specials will require a lot of work to become a functional work place. When evaluating facilities, small business owners must be very honest about their abilities to fix things, and/or their patience for the hassles of dealing with an aging infrastructure.
Are You Ready to Take on Additional Responsibilities?
As a supplement to the handyman question above, small business owners need to be reminded of the extra responsibilities (and costs) that go with buying versus renting office space. Whereas renters can simply call up the landlord when there’s a problem with a leaky roof or to fix an electrical issue, as the owner, the responsibility for every aspect of caring for and maintaining a building falls on the small business owner should they choose to purchase the property. While some will readily accept these tradeoffs, other business leaders will see it as a distraction from their core competency and decide to effectively “outsource” the handling of these problems by opting to rent versus own their property.
Do the Risks Outweigh Rewards?
For those who weigh all of these issues and decide to proceed with the purchase of a building, the potential for upside benefits can be significant. In addition to the unquantifiable yet deep sense of satisfaction stemming from the simple pride of ownership, there are many other direct and tangible rewards, including numerous tax benefits, like allowing the capital appreciation of the property to count towards the business. In addition, if the property is larger than what is immediately needed, the owner can sublet a portion of the building, which can in turn help offset the cost of the mortgage and/or provide additional funds to help with the monthly cash flow of the business. Finally, the purchase of a facility which is larger than currently needed provides the owner with the confidence and assurance of knowing that, should there be a significant increase in demand, he can quickly scale his business and add capacity in the future, without having to worry about moving to another location.