Commercial Space: Should You Lease or Buy?

The location of your small business is an important factor in whether it succeeds or fails.

Accessibility to customers, vendors, and employees, proximity to competitors, and zoning restrictions are just a few of the factors you have likely considered. Once you have determined the best location for your business, the next question is whether to lease or buy your commercial space. Several issues should be weighed before making this important decision.

1. What makes financial sense for your business?
Buying a commercial property is likely to require a substantial down payment—from 10% to 40% of the value of the property. However, if your business is already successful, and you have enough cash to make the down payment and several months of mortgage payments without depleting your cash on hand, purchasing a commercial space may be a good choice. It enables your business to benefit from the property’s appreciation, particularly if you are in an area where property values are rapidly rising. In addition, if the commercial space is larger than your business needs for its own operations, you can gain additional income by renting out part of the space to another business.

On the other hand, if your business is just starting out, or if you are short of cash, leasing commercial space may be a better option for a few reasons. To start, less of your cash will be tied up in the property. Next, there are usually fewer unexpected maintenance costs and a lower risk of unforeseen expenses (which are often the landlord’s responsibility). Moreover, because rental payments are generally the same from month to month during the lease term (though there is sometimes an escalation clause allowing the landlord to increase the rent at certain intervals by a certain percentage), there is more certainty in budgeting the amount you need to cover the rent each month. This will enable you to channel your cash back into your business, focusing on its growth. The downside is that monthly payments under a lease (which often include insurance, taxes, utilities, and maintenance costs) are likely to be higher than a mortgage payment on the same or similar property, and you will not be able to make an additional income by renting excess space to another business owner.

2. What degree of flexibility do you need?
If your business is growing or declining, a lease may provide you with the flexibility to move to a different size commercial space after the lease term ends without having to sell a property. Including a clause allowing you to sublet or assign your lease provides even greater flexibility if your business ever needs to move or if you need to sell your company prior to the lease expiration. In addition, it may be easier to qualify for a lease than for a mortgage on commercial space, which may expand the scope of available commercial spaces from which you can choose. In fact, if you lease a property, you may be able to afford a space in a desirable location which would have been too expensive to purchase.

However, if you anticipate that your business will remain in the same location for at least seven to ten years, have equipment that is difficult to move, or will be making substantial renovations to the leased property, buying may be more advantageous. Under these circumstances, if you cannot afford to buy a commercial property, you could negotiate a lease with a longer term to enable you to recoup the amounts you plan to invest in the property.

3. How much control over the property do you want?
When you are leasing a property, you must negotiate with the landlord if you want to renovate or reconfigure the commercial space. In addition, when the lease expires, the landlord is free to increase the rent. Also, depending upon the lease terms, you may have to continue to make payments even if your company goes out of business (unless there is an early termination clause).

If you own the property, you are free to change it in any way that will benefit your business—as long as the changes comply with local regulations. Also, you will not have to worry about increases in rent at the end of the lease term or being required to move if you do not have an option to renew the lease, and the landlord decides against renewing it.

Note: A lease agreement with an option to purchase may be a great choice for some business owners. This type of agreement provides a lessee with the option to buy the leased property at the end of a specific term, with a portion of the monthly rent credited toward the eventual purchase price. It enables a business owner who currently does not have the cash needed to purchase a desirable property to have additional time to save up to buy it or to improve the business’s credit rating. Depending upon the terms of the agreement, there could be some tax implications accompanying an option to purchase that we should discuss, however.