Owning or leasing?

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7 factors to evaluate when wading into commercial real estate

Janet Hoch with Cupcake Addict in Johnston.

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

Janet Hoch operated her cupcake business from her Johnston house for five years before she decided to move into a storefront. She knew the move would be a big one. She researched various markets and neighborhoods to locate and considered her commute time. She created a business plan that included how she would grow her customer base, and she talked to numerous landlords about the buildings they had available for sale or lease.

“In the end, it came down to what the landlord was willing to do for us,” says Hoch, who operates Cupcake Addict in Johnston. “Tenant build-out was a huge factor. I didn’t want to purchase a building and be $150,000 into it and not know if the community was going to support my business.”

Hoch signed a five-year lease for her building site, and says she’ll know at the end of her lease whether her business has
succeeded enough to move into a bigger building. She needed the flexibility and safety of a lease over a building purchase.

“The amount of money needed to risk to open the storefront was huge, and I did not want to burden my family with it if it didn’t work out,” Hoch says.

Leasing is the right move for many business owners, while others find success in owning their work site. There are a variety of options for business owners to consider when deciding where to house their office. Here is a guide to help you evaluate.

1. Ask a professional for help but do your own homework
Diane Harmening with City
State Bank in Grimes

As with most large expenditures, business owners should consult with experts, but also do their 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 tohelp 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 him or herself with the commercial real estate process and the vocabulary surrounding it.

2. Determine whether you can afford a mortgage, added 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 businesses.

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.

Diane Harmening, vice president of City State Bank in Grimes, says an owner will need a business plan and to be intimately familiar with his or her personal finances and those of the business before approaching a lender for money to purchase a building. The plan should include a long-range forecast of sales and income, as well as information about any investors and how expenses will be met
after the first year. A good business plan can be a guide for whether to purchase or lease property, she says.

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. Even so, 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.

Cindy Johnson, the property manager of Brad Johnson Investments in Urbandale, says business owners need capital in order to purchase a building, and that can be difficult for new business owners.

“It’s most cost effective to lease office space from a landlord,” says Johnson, who oversees property leases and management of landlord-tenant properties.

Realtors say most business owners will not break even with their commercial real estate purchase for at least 10 to 15 years.

Banks will usually require a 25 percent down payment for a commercial purchase and will loan up to 75 percent of the assessed value or purchase price for the property, Harmening says.

In Grimes, Harmening says she has seen business owners both purchase and lease their properties.

“If they’re a start-up, it’s leasing,” she says. “If they’ve been in the business and they’re looking to expand, they’re looking more to buy.”

Larger companies oftentimes want to put their capital into their business rather than a building, so they lease office space, she 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.

Paul Rupprecht, president of brokerage company R & R Real Estate Advisors in Grimes, says he asks small business owners about the amount of capital they have for their business and what they intend to do with it. Many want to invest in materials, additional acquisitions or employees rather than real estate, he has learned.

3. Compare the pros and cons of leasing versus purchasing
Dave Delger of Oakwood
Commercial Capital Group in
Urbandale

Properties are often purchased by investors who then lease the storefronts and office spaces to businesses. R & R Real Estate Advisors handles leases for two warehouse buildings, Prairie Business Park I and II in Grimes, that its parent company has purchased and developed.

Drive up and down any major corridor in Grimes, Johnston and Urbandale, and there are many “for sale” or “for lease” signs posted. New commercial construction can sell for between $100 and $250 per square foot, but lease prices can range depending upon the terms and conditions.

The Johnsons own commercial property in Altoona, Grimes, Urbandale and West Des Moines. Most of it is office or office/warehouse
space that is available for lease. Their leases are three to five years and have different terms. Some are a fixed rate that includes maintenance for common areas, lawn and trash service, sidewalk and parking lot repairs, and snow removal, as well as property taxes and insurance.

“I think it’s one less headache for somebody unless they get quite large,” says Scott Addington, owner of Ashcreek Executive Business Suites inUrbandale. “Your overhead is quite large for a building with taxes and insurance. It can be quite expensive for one individual.”
Addington owns two office buildings that he markets to small- and mid-size businesses, many of which are new. He says leasing provides new business owners a way to get started with a physical space.

“We have a lot of business start-ups,” he says. “Those people certainly don’t want to go out and buy a building.”

Dave Delger, owner of Oakwood Commercial Capital Group in Urbandale, says it made sense for him to own the building for his previous business because he had inventory and a fleet of vehicles to house. However, when he started his new company about 18 months ago, he knew a lease was the way to go.

“With my current business, it’s more consulting,” he says. “I’m out more than in. There’s not as much property management responsibilities, which allows me to focus on my core business, my clients and helping their needs.”

He settled his business at Ashcreek, where he has a month-to-month lease.

The Ashcreek offices draw a range of clients from attorneys to accountants to manufacturers who use them for their representatives’ office space, Addington says. Lease rates vary from $365 to several thousand dollars a month.

“We do everything from a month-to-month to five-year leases,” he says. “It depends on the tenant. We’re happy to do no lease if they wish. We keep our offices so competitive that we’re usually full.”

Here are some other considerations 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.

4. Consider your ability to handle 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. Other leases charge the tenant with responsibility for air conditioning, plumbing and other systems.

Delger says leasing gives the business owner less control over property maintenance and when improvements are made. Overall, he views leasing as less of a headache.

Addington has more than 100 people who work in his buildings. Most leases include utilities, high-speed wireless internet, snow removal, cleaning of the building and use of conference room spaces.

Hoch, the owner of Cupcake Addict, says her landlord is responsible for any building repairs or maintenance issues.

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

5. Decide 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.

Harmening with City State Bank in Grimes says leasing can be a way to start the bricks and mortar side of a new business.

“Usually, leasing is the cheaper option,” she says. “If you can make those payments and do well with that, then look at how the company is doing well overall. Then, we could take a look at purchasing.”

Delger, the Urbandale business owner, advises young entrepreneurs and sees their struggles to get their business up and running. Leasing takes one struggle out of the equation, he says.

“Why distract from your focus with property management when you can focus on growing your business and meeting your needs?” he says.

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.

“Flexibility is a big thing,” Rupprecht, the Grimes broker, says. “The business environment changes so rapidly. The piece of real estate may work for you today, but in a period of five or 10 years, that may become obsolete to what you’re doing, and now you have a piece of real estate that might not fit what you want to do.”

Hoch didn’t want the constraints of owning a building. Her business outgrew her home kitchen, and she wants the flexibility of being able to move to a different site if business outgrows her current storefront rather than having to acquire land to build on to an
existing building or sell it and buy a new one.

“You can always grow,” she says. “If you outgrow your space, that’s amazing. You can always find a new one.

She continues: “Don’t overextend yourself. You have these huge aspirations that your business will be amazing, and that’s what we want is to be hopeful, but what if it’s not amazing? You have to protect your business and yourself.”

6. 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.

Hoch says she studied where other bakeries were located before choosing her site on 86th Street in Johnston. She knew her bakery would be located between two restaurants, but neither serve dessert. She also didn’t want to move too far out of Johnston because her original customer base is located there.

Delger purchased his former office/warehouse building at a good price, which was a factor in his decision to own the building. He
sold the building for a profit but cautions that there are a lot of factors that can affect the sale price of a business site.

“The success of the business won’t alter the value of the real estate,” Delger says. “Market and demand does. Real estate is more of a longterm strategy for a business owner.”

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 currently 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?

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

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 business person knows exactly what 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 a 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.

Harmening with City State Bank says business owners also want to make sure they have the appropriate amount of life insurance or
that partners do if they are going into business together. This can help protect the partner or the business owner’s other assets if something were to happen to him or her.

The Johnsons require their tenants provide a financial statement that proves they can pay their rent and a plan to specify the details of the business they’ll operate from the site.

Ultimately, there isn’t a one-size-fits-all solution, and business owners must prioritize their decisions.

“There’s only so much capital a company and a person can have,” real estate advisor Rupprecht says. “Where do they want to invest it?” ♦

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