Should a Small Business Rent or Buy Commercial Real Estate?
In an increasingly digital age, a growing number of small businesses can exist (and even thrive) without a brick-and-mortar presence.
Physical space is still the norm, however. Some companies simply need it by virtue of their industry — restaurants, retail stores, and entertainment venues require Main Street storefronts, manufacturers need industrial space, and doctors and other medical practitioners must have offices. Still other companies might simply need office space because their operations require employees to frequently collaborate — doable on a virtual basis, but sometimes more easily accomplished in person.
And if your small business does need to establish a physical presence, one of the most significant decisions you’ll face is whether to rent or buy your commercial real estate.
The choice you make will have long-term financial and operational implications, making it crucial to weigh the pros and cons carefully. So read on as we explore several key factors to consider when deciding whether your company should rent or buy its real estate.
Financial Considerations
1. Initial Costs
- Renting: One of the primary advantages of renting is the lower initial cost. Typically, businesses only need to pay a security deposit and the first month’s rent. This can be particularly beneficial for startups or small businesses with limited capital, as it allows them to allocate more resources to operational, marketing and other expenses.
- Buying: Purchasing commercial property requires a significant upfront investment, including a down payment (often 10% to 30% of the property price), closing costs, and potentially renovation expenses. This substantial initial outlay can be an overly prohibitive barrier for many small businesses.
2. Ongoing Expenses
- Renting: Monthly rent payments are often predictable, which can simplify budgeting. However, rent can increase over time, especially in prime locations, potentially outpacing the rate of business growth. Indeed, some landlords include automatic rent escalators in their leases.
- Buying: Mortgage payments can sometimes be higher than rent. Additionally, owning property means being responsible for maintenance, repairs, property taxes, and insurance, which can be unpredictable and costly. On the flip side, mortgage payments likely will remain the same over time, and they allow you to build equity. Also, the aforementioned expenses are somewhat offset by tax deductions, such as mortgage interest and property depreciation.
3. Long-Term Financial Impact
- Renting: When you rent, you’re not building assets; money spent on rent is not recoverable. This can be viewed as a financial disadvantage over the long term. However, if your company grows in size, it’s much easier to adjust or change leases than it is to get out from underneath a commercial mortgage.
- Buying: Ownership can be a valuable investment. The property may appreciate over time, potentially providing significant returns. Owning a property can also offer stability and protection against market volatility, making it a strategic long-term asset.
Operational Flexibility
1. Business Growth and Mobility
- Renting: As I mentioned above, renting provides greater flexibility. If your business outgrows the space or needs to relocate to a different area, it is relatively easy to move once the lease term ends. This flexibility can be crucial for businesses in dynamic industries or those experiencing rapid growth.
- Buying: Owning a property ties the business to a specific location, which can be restrictive if the business needs to expand or relocate. Also, selling commercial property can be time-consuming, sapping valuable time you need to grow your business.
2. Customization and Control
- Renting: Lease agreements often limit the extent to which you can modify or customize the space. While some landlords permit alterations, others don’t, and any changes might need to be reverted at the end of the lease term.
- Buying: Ownership usually provides full control over the property, allowing for extensive customization to suit specific business needs. This can be a significant advantage for businesses that require specialized facilities.
Market Conditions
1. Real Estate Market Trends
- Renting: In a volatile market, renting can protect businesses from real estate downturns. If property values decrease, renters are not directly affected financially. This can be an advantage in uncertain economic times.
- Buying: In a rising market, owning property can be highly beneficial as property values appreciate. However, during downturns, property values can decline, potentially leading to financial losses if the business needs to sell.
2. Location and Demand
- Renting: Prime locations often charge prime rent, but renting still might be more feasible than buying in high-demand areas. Additionally, renting can allow businesses to be located in prestigious or high-traffic areas without the substantial financial commitment of purchasing.
- Buying: While owning in a prime location can be an excellent investment, the initial cost might be prohibitive. However, owning property in a high-demand area can result in significant appreciation and provide a steady flow of clientele due to the desirable location.
Should You Rent or Buy?
Ultimately, the decision to rent or buy commercial real estate is similar to the answer to many of business’s many questions: It depends.
Specifically, it depends on a litany of factors: your company’s financial circumstances, goals, industry, needs and more.
Small business owners should conduct a thorough analysis of their financial situation, business model and market conditions before considering a significant real estate move. McManamon & Co. can help. Our consulting services, tailored toward small and midsize businesses, can help you determine the best course of action.
Learn more about how McManamon & Co. can help you make a real estate decision you won’t regret. Call us today at 440.892.8900 or contact us online.
Tags: McManamon, McManamon & Co., small business, small business finances, small business financing | Posted in McManamon & Co., small business, Small business finances