Leasing vs. Buying
You should compare the benefits of leasing versus buying your property from a cash standpoint, as well as the more obvious needs standpoint, such as long term space requirements and expansion possibilities. While there are benefits to both options, for startups there appear to be more benefits to leasing than buying. Cash flow is, of course, an issue and buying takes a larger portion of your hard earned cash up front.
Here are some other monetary benefits of leasing:
- Your credit rating will not be quite as critical for leasing as it would be for buying. So again, for startups, this might be a sticking point.
- Your monthly lease payment is tax deductible because it's a business expense.
- You may be free from paying for building maintenance.
Here are some non-monetary benefits of leasing.
- Freedom to sublet and move to another location if you find the need to.
- No hassle of selling before you can move to another location.
- No loss from owning a building in a bad real estate market.
- No assignment of personnel to oversee property issues that the owner should oversee.
Buying also has its benefits. It all depends on your situation and the type of business you're in. Here are some of the monetary benefits of buying.
- Interest on the mortgage loan is tax deductible.
- You can take annual depreciation deductions on your taxes.
- In the long run, you'll probably come out ahead because you won't be facing increases in rent.
- You'll benefit financially if the real estate market is good when you sell.
- You may be able to lease out a portion of the building if you determine that you have excess space.
- If you need to make substantial changes to the building to accommodate your business, those changes are owned by you and not your landlord.
Non-monetary benefits of buying include:
- You can make any changes you want to the property.
- The hours of your business can be whatever you want them to be.
- You are free to stay in the same location as long as you wish.
Cash Flow Analysis
If you can't make a decision based on these pluses and minuses, you can (and probably should) do a cash flow analysis to see which option makes more sense from a cash standpoint. Before you can do this, however, you have to have all of the necessary information for making your comparison. This includes information like the full cost of purchasing, the terms of the lease, the depreciated value of the property at the time you would want to move, an estimate of the property's value at that time, estimates of maintenance costs, and your tax rates.
To do the cash flow analysis, complete cash flow budgets (sample Cash Flow worksheet in Microsoft Excel format) that include all of the expenses you would incur for either buying or leasing over a set period of time. For the lease analysis, you'll need to determine your net cash outlay, which is the amount you end up spending on the lease once you've subtracted the tax savings you receive from it. (Remember your lease payment is considered a business expense.)
In order to compare apples to apples from a cash flow standpoint, you also have to take into consideration the change in the value of today's dollar versus a dollar five years from now. This are known as the discount factor and can be calculated using most spreadsheet applications.
You'll also have to know the amount of your interest deduction that you will get on your business's taxes. You can arrive at this number by multiplying the interest rate of the loan by each month's preceding balance.
Now for the tricky part... remember above where I mentioned estimating the value of the property when you would be selling it? This is the number that will ultimately determine who wins in the battle of the benefits of buying versus leasing. Obviously the longer you stay in the building, the better off you will be because you will be gaining more and more equity. However, do you know how long you will actually be there? Do you know what the real estate market is going to do in that time period? Not unless you have a crystal ball.
So, study the current market, as well as trends and predictions for as far into the future as you can get. Keep in mind that the farther out the prediction, the less reliable it will be. Arm yourself with as much knowledge as you can, and then make your best estimate. You know your business and you should have a good idea of where it is headed. If you know you want to be in an area for the foreseen future (say 10 or more years), the market is strong, and you've identified a building that will suit your needs for that timeframe then go for it. Ten years of equity can be substantial. If you can get a good deal on the property (at or below market value) then it certainly makes sense to buy if you'll be there for ten years. If you know the building is priced at or above the fair market value, or if you think five years may be more the length of time you'll be there then think about offering to lease.
Let's move on to the leasing process and how you can educate yourself and avoid some pitfalls.