Buying or leasing?

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7 factors to consider when entering the world of commercial real estate

 

An office or storefront is one of the largest expenses a small- and mid-size business owner will incur, and the expense can vary depending upon whether a location is purchased or leased.

“It really comes down to timing,” says Kevin Crowley, commercial sales manager for Iowa Realty.

Mike Musich at his desk in his leased office space at Regus in West Des Moines, where he also utilizes conference and meeting room space.

“If a small business owner has the ability to have the equity to put in the real estate and not in their business, and they know they’ll be in business for 15 years, it’ll make sense for them to own the property and pay themselves rent.”

A lease made more sense for Mike Musich, owner of Private Asset Advisory Group LLC.

“As a small business not looking to grow my population of employees (buying commercial real estate) wasn’t part of my agenda,” he explains. “I didn’t need some extra space.”

Instead, Musich rents an office from Regus West Des Moines, where he receives conference and meeting room space at his disposal and utilizes Regus’ front desk employees to answer his telephone calls and greet his clients.

There are a variety of options for business owners to consider when deciding where to house their offices.

Here is a guide to help in evaluating those options.

 

  1. Ask a professional for help, but do your own homework

 

As with most large expenditures, a business owner should consult with experts, but also do his or her own due diligence. The business owner needs to consider the situation and what he or she wants in a property.

An accountant, commercial real estate lawyer,

commercial Realtor and mortgage broker can initially assist a business owner in evaluating properties and making lease versus purchase comparisons.

Other experts who handle tax issues, along with notaries, appraisers, engineers or environmental specialists may be needed to handle more complicated issues that pertain to specific properties.

If a business owner proceeds with a real estate purchase, then a neutral third party escrow officer will be involved to help with the transfer of deeds and funds, and to ensure the appropriate documents are signed and filed to protect both the buyer and the seller.

Part of a prospective buyer’s homework is to know his or her rights. They will receive a due diligence time period to ensure all of documentation about the property is accurate and that the seller was truthful. If an issue arises during this process or the inspection, the buyer has the right to cancel the purchase.

A business owner also should familiarize himself or herself with the commercial real estate process and the vocabulary surrounding it.

 

  1. Determine whether you can afford a mortgage, costs

 

The next step in pursuing a lease or a property purchase is to evaluate the business’ finances, according to the U.S. Small Business Administration. The administration was founded in 1953 as an independent agency of the federal government dedicated to assisting, counseling and protecting the interests of small business.

A banker or financial consultant can help evaluate how much extra cash a business owner has, whether he or she would qualify for financing and determine the ability to make a down payment.

Purchasing property can be considered an investment, especially if the property is purchased when values and interest rates are low, according to Forbes. However, the business publication cautions that building and/or owning increases the business owner’s financial risk. A diversified investment portfolio can help protect a small business owner because having most of one’s worth in a small business can be risky.

Greg Grote, vice president and branch manager of Charter Bank in Waukee.
Greg Grote, vice president and branch manager of Charter Bank in Waukee.

Crowley with Iowa Realty says most business owners will break even with their commercial real estate purchase after 10 to 15 years. He cautions that purchasing property is not for every business.

Larger companies oftentimes want to put their capital into their business rather than a building, so they lease office space, he says. Small businesses tend to be cash-flow challenged, so it might not make sense for them to tie up money in real estate. If the business runs the risk of shrinking in size or being acquired, a lease is generally the way to go.

Greg Grote, vice president and branch manager of Charter Bank in Waukee,

says more than 50 percent of small- and mid-size Waukee business owners lease their offices or storefronts.

“Overall, you’re seeing more and more people lease and do a five- or 10-year lease rather than going out and buying a building itself,” he says.

Grote says the decision to buy commercial real estate also depends on the nature of the business — whether it’s a storefront or if the small business owner has previously operated from his or her home.

“It depends on the nature of their business or how established they area: Are they a start-up, or have they been in business for a while,” he says. “If they’re in business and have been leasing for a while, are they in a position where their profit margins are allowing them to (purchase property), and does it make sense for them to be able to do that?”

 

  1. Compare the pros and cons of leasing versus purchasing

 

Iowa Realty has sold almost every building it has listed in Waukee, Crowley says, and only about 15 percent of the business owners in the local market are property owners. Among those in Waukee that own their own property are the Jimmy Johns franchise and Mulch Mart.

New commercial construction in the Waukee/West Des Moines area sells for between $100 and $250 per square foot, he says.

Most properties are purchased by investors who then lease the storefronts and office spaces to businesses, Crowley says.

“There’s nothing wrong with leasing,” he continues. “It gives you the most flexibility. Sometimes owning your own property can hurt your business… It’s really a coin flip as to which one is better.”

Lori Aldinger, area manager for Regus, says leasing is a good option for small and mid-size businesses because leases range from month-to-month to yearly. The company provides ready-to-go office space and front desk staffing for businesses. Space leases for $49 a month for a virtual office up to $2,000 a month for a full-time lease.

“It depends on what your need is,” she says. “Terms are very flexible and allow them to not get locked into a long-term lease as they’re getting their business up and running.”

Regus, for example, offers office space on one floor of a building in West Glen Town Center. Those who lease space can opt for phone answering and mail service, or they can be a home-based business that utilizes the space for meetings. Front desk employees can also be available to answer phones for each business and greet clients for the business owner. Office space is available for one to five employees, and businesses range from financial planners and attorneys to healthcare companies and massage therapists.

“In those moments when the phone rings or somebody comes into the office to see me or work with me, those people at the front desk are trained to know they’re working with me in those moments,” Musich says.

Here are some things to consider about buying versus leasing:

Buying costs more upfront because a down payment is required for a mortgage, according to FitSmallBusiness.com, a web-based resource for small business owners. Down payments range from 10 percent to 30 percent, which means a business owner could tie up a substantial amount of money in property rather than investing or growing the business.

There is no down payment with a lease.

Expenses for maintenance and shared facilities upkeep can be incorporated into a lease.  Other costs could arise that pertain to renovation and decorating of the space or information technology system upgrades.

Business owners might qualify for government economic business programs such as small business loans through the state and other financial incentives, which can help offset or recoup some of the cost of a property purchase, according to the small business administration.

Property owners are required to pay income and sales taxes.

Buying a property can give the owner the option to refinance for a lower payment and eventually pay off a mortgage.

Rents can be subject to change and increase in price.

Business that rent from Regus can use the companies meeting rooms and facilities in other parts of the world, where Regus also is located.

“It gives you a global footprint,” Aldinger says.

This was a plus for Musich who has clients in Minneapolis and the Chicagoland area.

“It allows my business to be seamless in the different parts of the country that I work,” he says.

 

  1. Consider your ability to cover unexpected repairs, maintenance issues

 

As a property owner, repairs, maintenance and everyday oversight of the building would fall upon the business owner or need to be hired out or overseen by a property manager.

When a property is leased, the property management sometimes handles any maintenance issues, though the small business association cautions that some leases stipulate the tenant is responsible for all property upkeep and repairs.

Kevin Crowley, commercial sales manager for Iowa Realty, says most business owners will break even with their commercial real estate purchase after 10 to 15 years.
Kevin Crowley, commercial sales manager for Iowa Realty, says most business owners will break even with their commercial real estate purchase after 10 to 15 years.

Other leases charge the tenant with responsibility for air conditioning, plumbing and other systems.

Aldinger with Regus says some leased facilities provide furniture and have no separate utility bill for the business.

Before purchasing a property, have it evaluated to see whether any repairs are imminent. A business owner also needs to consider his or her ability to perform this work and the time dedicated to doing it and maintaining the building, and whether this will take away from the time they want to spend devoted to expanding or growing their business.

Ownership means the businessperson can make whatever changes he or she wants to the space without anyone else’s permission. In a leased space, any cosmetic changes would typically need approval or be regulated by the conditions of the lease agreement.

 

  1. Decide on the future growth of your business

 

Future business growth projections and likely retirement age also are factors that should play into whether a business owner purchases or leases property.

Grote with Charter Bank says leasing initially allows the business owner to get a handle on the market on and client base in the area. If the business owner determines the location is good for continued growth and success and wants to ensure they’ll be in the same location for their clients, then they might consider purchasing a property.

“One of the main benefits is your clients,” he says. “Your customers know where you’re at, and you’re not bounced around from space to space.”

A short-term lease of between one and five years allows the business owner to expand to a larger space as the business grows and needs change. Leases also give the flexibility to move the business to a different location based on client and customer needs.

If the owner had at least another 20 years to work, plans to expand his or her business and could purchase the property at a low price, purchasing would make sense, Forbes reports.

The business owner also needs to consider whether a building they purchase will be used for their own business, or if they’ll partially rent it or eventually sell it.

 

  1. Evaluate the property’s location, usage and effect on your company and its image

 

Choosing a business location may be the most important decision a small business owner or startup will make, so it requires precise planning and research, according to the small business association.

Musich knew he wasn’t going to grow his business, but he needed to move from a shared office space he was previously leasing.

“It was getting to be outdated, and I didn’t have any front desk personnel that were working directly for me,” he says.

He moved into the Regus leased space in October 2009.

“It was the image I want to portray to any perspective clients,” Musich says. “If I’m on vacation and have a client who needs to drop off something, I have front desk personnel who can take the document and lock it in my office.”

Business owners need to consider the area’s demographics, the supply chain for their product or service, the potential competition, and state laws and taxes among other things.

The location should be in a place that provides exposure to customers, is consistent with the company’s image, takes into account potential competition and avoids it if possible, has space to allow for future growth and meets all city and state zoning regulations, according to the small business association.

Before making a purchase or signing a lease, business owners should tour various properties and determine the pros and cons of each. Factors to consider include price, location, condition and allowed usage of the site.

Properties in certain locations will have a higher value and sell more quickly.

Things to consider:

Is it a fit in terms of price?

What is the property current used for?

Why is the owner selling?

Is the city/area business friendly? Are there programs that can assist small business owners?

Will you rent out part of the property? Any property should generate revenue after the principal, interest, tax and insurance are subtracted from rent.

How much are the taxes?

What is the land use surrounding the property? Are there upcoming changes?

 

  1. Carefully read the fine print, understand terms before signing agreement

 

DSC_0870
This sector of commercial real estate is for sale along E.P. True Parkway across the street from a new strip center of big box stores that have opened in the past year. Photo by Melissa Walker

Prospective buyers should not sign any agreement without review by their lawyer and team of experts. Any communication with attorneys should be done in writing, so the businessperson knows exactly with his or her rights are.

A number of documents will need to be signed, both for a lease and a land purchase. A business owner needs to make sure he or she reads through all documents in detail and possibly even hire an attorney to answer questions and navigate the finer points.

An attorney can help a business owner understand various terms such as sublease, which allows the business owner to sublet his or her space to another business.

A broker can help navigate the waters of the lease term. The lease and rent are negotiation points for the business person. Most small businesses can negotiate a one- to two-year lease with the option to renew, according to the small business administration.

Grote, the banker, says every lease is different in regards to taxes and insurance, so it’s prudent to get guidance from a loan officer and certified public account.

“Not only do you have the real estate taxes, which are a pretty significant chunk, you’ve got the insurance and the upkeep and the utilities,” he says. n

 

 

 

 

 

 

 

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