Commercial real estate ownership – especially when it houses a business operation in which you have a stake – stabilizes your costs, provides some tax breaks and appreciates over time. The trifecta!
Here’s a breakdown of things to consider …
Cost stabilization. If you rely upon a series of 3- to 5-year leases as a location strategy, over time the rental rates will increase based on the change in the consumer price index or by a fixed annual amount. Sure, you might time a dip in the market with an expiration, but don’t count on these ends meeting very often. So, using fixed-rate debt over a 20 to 25 year amortization period can provide a level amount.
Tax breaks. Infinite are the incentives Uncle Sam provides for those who own income property. Mortgage interest, operating expenses and depreciation can all be deducted. In some cases, capital outlays, such as a new roof or parking lot, can be expensed.
Appreciation. Depreciating an appreciating asset is one of the marvels of commercial real estate investment. As an example: Say you buy a structure for $5 million. The improved portion (not the land) can be depreciated over 39 years. But at the same time, over a 10-year span, your $5 million asset could be worth double!
With these benefits, you may be wondering. Why don’t all companies own their buildings? Why would anyone lease? And what should be considered before buying?
Fluctuating space needs. Many fast-growing operations opt to lease vs. own. You see, the amount of square footage required can vary. If you own and outgrow the footprint, money is tied up in a facility that is obsolete. Conversely, a series of short-term leases and options to extend can handle the fluctuations without consuming precious capital.
Use of the down payment. Most investors finance an owner-occupied commercial real estate purchase through the Small Business Administration. Originated is a loan for 90% of the buy with the balance coming from the borrower. But 10% of a $5 million deal is still $500,000. In some instances, this capital can be better deployed in new employees, machinery or equipment.
Financeability. A lender considering making a loan will look at the creditworthiness of the borrower as well as the occupying entity. Is the business cash flow – after all the expenses are paid – sufficient to service the debt?
Company structure. As mentioned above, depreciation – for those who can benefit – is awesome. Publicly traded companies frequently avoid ownership of their buildings so that depreciation doesn’t ding their earnings.
Age of the principals. Years are an important consideration as commercial real estate ownership is a long play. Meaning: If the principals are in their 80s, chances are great they won’t live to see the appreciation. Certainly, their heirs will thank them.
Exit strategy. Owning an operation should also be considered in light of your horizon for the enterprise. Simply, if you plan to dispose of the business within the next five years, what remains is the facility. I’ve witnessed this work quite well as the acquiring group needs a place to live and signs a lease. I’ve also watched the value of the operation be diminished because duplication of addresses can occur.
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at firstname.lastname@example.org or 714.564.7104.
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