ITRA Global News

Buying Versus Leasing in 2022

February 15, 2022

Buying Versus Leasing in 2022

For many companies with leases expiring in 2022 and beyond, purchasing real estate is certainly worth considering instead of continuing to lease space. There are risks and rewards to consider before making the purchase plunge.

Leasing space is ideal for businesses that don’t want their own equity tied up in real estate or like the flexibility. But companies that lease space have to deal with market rent fluctuations, bad landlords, annoying neighbors, and so on.  

Owning estate can make sense if you want control of the property and are looking for financial benefits. However, longer term commitments of capital and to the particular building as an owner can be a downside. Given it is a major commitment, any purchase decision should be well thought out in advance.

So, what should you consider before you decide to consider buying a building?

The Market Conditions: The market to purchase property will depend on product type, location, quantity of buildings for sale, and so on. If your company wants to purchase an industrial building, expect a lot of competition due to the high demand for industrial space. For office building purchases there should be less competition in 2022 as compared to industrial buildings, but smaller office properties could still see multiple buyers making offers.

Cost to Buy Per Square Foot: While interest rates are currently very low, asking prices are higher because of that and there is a risk of overpaying. This cost risk depends on your intended length of ownership. For instance, if you plan to hold the building for 10 years or longer, the entry price per square foot risk is lower than if you plan to sell the building in just a few years.    

Interest Rate Increases: Interest rates are going to increase and that could limit appreciation of your property, or it could even decrease in value. You should underwrite conservatively and assume that interest rates will be higher when you refinance the loan 5 or 10 years down the road as the amount of the next mortgage could be more than the initial mortgage. 

Increasing Costs to Build: Costs of construction have been going up for the past decade and sharper increases in costs have occurred recently due to supply chain and labor shortage issues. These rising costs bode well for owners of real estate, as property prices tend to increase during times of inflation. 

Due Diligence Costs: Most businesses don’t have to pay any money out of pocket to sign a lease. When a company purchases a building, there are upfront expenses pertaining to investigation of the property. Generally, a buyer will pay for a building inspection, a survey, an environmental review, a zoning review, and potentially other due diligence types of items. The buyer has to pay for these costs even if they decide not to buy the building, so these costs are a risk of buying property.

Equity instead of Rent: When you pay rent on a lease, that money is just an expense. When you own the building, the rent is paid to yourself (often a separate ownership entity) which is then used to pay the mortgage. A portion of that mortgage payment goes toward the principal owed on the building, which enables you to build up equity in the building. 

Cash Flow: If you own a building that has extra space you can lease out to other tenants, the rental income from those tenants can offset your occupancy costs and can be used to pay the mortgage. Collecting rent from third party tenants is an additional opportunity to increase your equity in the project. This situation can work very well for companies that need to grow over time and expand into their own building.  

"I own it!":  Absolute control of your space is clearly a benefit versus dealing with landlords. The downside is that you could also have issues to contend with, like building repairs and management. Property management can be outsourced quite easily if desired.

Capital Costs: When leasing space, the building owner generally pays for most of the capital expenses like space improvements pertaining to the lease, roof replacements, parking lot overlays, and so forth.  As a building owner, you would be paying for these items out of pocket.      

Depreciation: One primary benefit of owning property is depreciation, a non-cash expense that reduces the property’s net income on a dollar-for-dollar basis. Sheltering taxable income is a great benefit of ownership!  

While not mentioned above, businesses can also acquire land and build a new building for their own use and the fundamentals outlined above are applicable, but there will be higher initial costs and greater time commitments given the complexities of new construction. New construction can be an excellent alternative to consider, especially if the market to purchase older buildings is frothy and sales prices are very high.  

The decision to buy or lease can be difficult. ITRA Global advisors work with a variety of businesses that lease space and own buildings, providing them with guidance about the market conditions, financial analysis and comparisons, due diligence processes, zoning, and other pros and cons of buying versus leasing. If your company has a lease expiring in the next few years and buying a building is of interest, please contact us to discuss your particular needs. 

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Article submitted by Wayne Teig / ITRA Global Minneapolis-St. Paul, Minnesota USA


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