Buy or Lease?
While there are many benefits to buying a location including an tax benefits, appreciating value of the property and many times a payment that is the same or lower than leasing the same property for a startup business leasing is almost always the better choice. But, purchasing a building is a long-term prospect. While starting a business usually has long-term plans and long term intentions, those plans don’t always work out as intended (In fact about 50% of businesses fail by the end of the fourth year).
Leasing commercial real estate allows you more flexibility which is key in the beginning stages of business. There are so many uncertainties with starting a new venture that the last thing most entrepreneurs need is a giant financial obligation hanging over their head. Within a couple of years you could be needed to expand, you may need a different location closer to suppliers or customers, or you may need to close up shop. If you owned a building you would have to go through the timely and costly process of disposing of that building potentially hamstringing your businesses growth in the meantime. Leasing also has its tax advantages in that your lease payment is fully tax deductible (so long as the terms meet the IRS guidelines as an operating lease).
Leasing does not automatically guarantee that you can be flexible, it is imperative that your lease terms are structured so that you can change locations rather quickly. Here are some common arrangements that are favorable to a startup business:
· Cancellation of a Lease if a key financial metric is not met by a certain time period. For example, if net income is not over $XXXX per month by the end of the first year the tenant can give proper notice to vacate.
· Short term lease with longer term renewal. In this arrangement the lessee (you) agrees to a one or two year lease with a renewal for an additional five years at the end of the initial lease term. By the end of the first or second year you will have a better idea if the business will succeed, if the space still suits your needs, etc.
· An agreed upon fee to cancel the lease at any time in the first two years. Usually this involves the loss of your deposit and an additional sum of money agreed upon in advance that allows you to get out of your contract.
It is important to note that all of these terms may come at an additional cost in terms of rent rates but over the long term the option is almost always worth it. It is equally important to note that regarding real estate, no agreement is valid unless it is specified in writing. So make sure that the terms are written in the lease or added as an addendum to the lease.
When looking for commercial space to lease you often find that rent is quoted either in terms of cost per year per square foot or monthly rent rate. Most commercial property is leased Triple Net (NNN or Net, Net, Net) which means that you, the tenant, are responsible for property taxes (net), building insurance (net), and Common Area Management (net) in addition to the agreed upon rent and utilities. Common Area Management or CAM is the fee paid for the care of areas shared with other tenants such as lawn care, snow removal and parking lot maintenance.
When comparing two or more properties make sure you look at the total cost to lease the space. One may have a lower base rent but outrageous CAM fees. Call the utility companies to find out what the average heat and electric bill cost were historically. Check the listing report or the county tax record to determine what the property taxes are, when the property was last appraised and how quickly the taxes have increased over the years. Once you have all the information compare the total monthly costs for each property and weigh their features and benefits against their drawbacks and costs.
The old mantra is very true and very real. In fact many businesses fail because of location. But, is it true for every business? Of course not! There are certain types of businesses that rely on location including retail, restaurant and entertainment businesses. But other businesses can afford to be “one block off the frontage road”. Here we are speaking strictly in terms of traffic. Every business, even those who never have a single walk-in customer, has some location specific needs. These can be access to rail transportation, within a specific proximity to key suppliers or natural resources, or the need for hundreds of semi trucks to drop off and pick up shipments daily. Location should not be ignored…but don’t throw your money away by believing that you need to be in the highest traffic location, especially if you business is transacted off site, in your clients place of business or on the internet.
So find the location that is right for you, negotiate the proper lease terms and be fully aware of the total cost and your business will have a greater chance of success.