The buy/lease quandary is an old one; it’s been around since the first retail store opened. It’s a big decision for any business of any size because both buying and leasing have distinct, lasting impacts on how you operate and even how successful you will be.
It is also a question you should ask yourself periodically because the answer will likely change over time.
Rest assured, there are no real right answers. Every dealer and every business situation is different. There are major considerations on both sides of the buy/lease equation. Basically, it all boils down to this basic rule of thumb: Buy if you can plan ahead more than 10 years, lease if you can project just five years, and waffle if it’s some span in between.
Even with that guidepost, the answer still is not clear cut. Your buy/lease decision will hinge on financial, tax and personal issues as well as the sales and profits forecast for your tire business. Some of the decision boils down to your individual desires as a business owner. Some is circumstance; some is opportunity.
Regardless, do not make this decision precipitously. Bring in your attorney, financial consultant and insurance agent. Their advice will be invaluable.
Pros and Cons
First, let’s look at the pros and cons. Buying your site and building offers fixed costs, marvelous tax deductions, additional income from renting out extra space and retirement funding eventually from a sale.
On the flip side is lack of flexibility if your business grows and the shock of upfront costs, such the down payment and maintenance expenses.
For leasing, the pros and cons begin with a lower starting expense, freeing up working capital not tied up in real estate. Ownership comes with time-consuming headaches, but leasing lets you focus solely on running your business. On the other hand, leasing brings variable costs in annual rent increases and the absence of equity, leaving you nothing in accrued worth at the end of the lease.
The Buy Decision
Go ahead and buy, if you can afford it, when you want total control of the property. This allows you complete freedom to make substantial changes or renovations. You won’t have a landlord looking over your shoulder or impacting seemingly minor issues like business hours.
In most cases, buying will give you cheaper property in the long run because the cost will not include the landlord’s built-in profit. Also, you should buy, not lease, if you want to stay in the same location forever. You don’t want to lose a prime location because of a rent escalation or a landlord’s desire to take the property back.
Buy if you are in an area of appreciating land values. Otherwise, you will face continuing rent raises. If you can buy the property, the growing land values work in your favor.
A purchase may also bring you tax savings. You are allowed to recover the purchase price over time through yearly depreciation deductions. If you finance the purchase, interest-paid deductions are also available. All in all, a purchase may actually cut your tax bill when compared with a lease.
Here are the basic takes on owning. One consideration before you make the leap to buy is whether you like the general area. This is a long-term decision, so you’d better make sure that you can live with it. You don’t want later to discover that you face insufficient parking or a continuous decline in real estate property values.
Neighborhood and community stability is another key concern. You don’t want to see your customer base dwindle away as residents move to other areas. Think about such issues before signing on the dotted line.
Also consider if you’re ready to take on the additional responsibilities of being a property owner and a tire dealer. Now, instead of concentrating just on operating your business, you will be responsible for maintenance, security, remodeling and other facility and property management issues. Are you up to the task?
Consider, too, how much your business will likely grow. Will it outgrow your acquired premises, forcing you to move sooner than you might think? We all want to grow, right? So, having sufficient space to expand has to be considered.
On the plus side is asset appreciation. If you own, rather than rent, your store you will benefit, as real estate almost always appreciates in value. Also, there is the plus of fixed overhead costs. For most property mortgages, the monthly payments remain level for the life of the loan, unlike rent, which can increase annually.
Along with payroll, a mortgage is one of the highest fixed business expenses. Knowing you will have a consistent payment to make helps make planning a bit easier.
Then, there is the advantage of being able to sublet if the property proves to be too big. This will help you pay the mortgage and/or provide additional funds for your cash flow.
And, if you do outgrow your owned property, you could potentially lease it out to another firm and move to larger digs elsewhere.
Some nice tax deductions also come with ownership. The costs of both owning commercial space and running a business provide expense deductions in the form of mortgage interest, property taxes and other items.
On the other hand (and there’s always another hand), some obvious downsides to owning your quarters include lack of flexibility when it comes to meeting near-term needs and large upfront costs associated with buying the property, including real-estate brokerage fees, appraisal fees, the down payment and, possibly, property improvement outlays.
Or Maybe You Lease
Instead, should you lease? There’s a lot more to be written about leasing than about buying. A lease is much more complicated than the comparatively simple purchase document, so let’s take a detailed look at renting your premises instead of buying.
The greatest attraction of leasing, perhaps, is that it is much more affordable in the short term than buying. This frees up working capital, providing funds for your business to respond to opportunities in the market. And, you can focus more on running your business without the distraction of owning the land and building you occupy.
But, you will face the problems of potential annual rent increases and higher costs when the lease expires. Being at the whim of another also means your lease could be canceled suddenly, or your attempt to extend the lease may be rebuffed by the owner who may have his or her eye on a more lucrative option.
Also, there is no equity in leasing, so you will be funding someone else’s retirement not yours with lease payments.
The most traditional type of lease is a ‘gross lease.’ In this one, the tenant pays the rent, and the landlord pays taxes, insurance and maintenance expenses. Gross leases usually contain escalation clauses, so the rent is adjusted each year to offset increased expenses.
A ‘net lease’ transfers some of the landlord’s expenses to the tenant. With a ‘single net lease,’ the tenant pays taxes. With a ‘double net lease,’ the tenant also pays a proportional part of insurance premiums. Finally, in a ‘triple net lease’ the tenant also pays maintenance expenses. If you get to the point of carrying a triple net lease, you may want to seriously consider ownership.
Another type of lease is a ‘fixed lease,’ which requires a fixed amount of rent over a fixed rental period, with no increases during the term. A ‘step lease’ provides for set rent increases to take effect at stated times over the life of the lease. Measure those stated rent increases against historic consumer price indexes to get an idea how the anticipated hikes relate to history.
How about a ‘percentage lease?’ This one has your landlord sharing in your good or bad fortune, since the amount of rent is tied to your gross receipts or net sales. You have to ask yourself: Besides providing me with a building and, potentially, maintenance and property tax costs, how would my landlord contribute to our sales and net receipts? Unless your answer is ‘substantially,’ you may want to really, really think about entering into this type of lease.
When negotiating a lease, the lease term is very important. If you suspect you may want to stay in this location beyond the initial term, go ahead and negotiate a renewal option, entitling you to renew for a specified period at a specified rent. Make sure that your lease gives you an out that doesn’t penalize you too much. Try to maintain as much flexibility as possible.
Most leases include late payment charges. If your dealership suffers irregular sales activity, it would be smart to negotiate a flexible rent rate that corresponds to your cash flow.
Beware and closely study any escalation clauses. These provide for increases in rent over time and may include convoluted multiples. Rent increases may be linked to increases in a landlord’s operating costs, property taxes or maintenance costs, a cost index or even your gross receipts or net sales.
A maintenance clause in a lease specifies who is required to maintain which portions of the building and land. If it’s you, then you should state that you can contract with anyone of your choosing for maintenance, without landlord approval.
If you’re concerned about competition (Who isn’t?), then have the lease restrict the landlord’s right to rent to businesses similar to yours. This is particularly apropos if you are leasing in a strip mall or enclosed mall.
It may benefit you to obtain a subletting clause in your lease. This will allow you to sublease any or all of the premises to another company.
Also, the lease may cover whether you have the right to make improvements or modifications to the property. Think about how you want your store to look and what it will take to get it there including signage then work with the landlord to see how this can best be accomplished.
Taxes and insurance also should be covered in the lease, including who is responsible and how much coverage must be carried. Finally, there should be a renewal option stating terms.
‘Going dark’ is a concern if you are leasing in a mall or shopping center. What happens if a mall anchor store ‘goes dark’ and out of business? This will hurt mall/shopping center traffic and your dealership. This is a major concern in an economic climate that continues to see major department stores go belly up. One remedy is to negotiate a clause allowing you to close or get a substantial rent reduction if a major tenant closes.
You a Landlord
If you own your own space, you may consider becoming a landlord. It’s smart to charge enough to cover the whole cost of your mortgage at minimum; it may be possible to charge more and enjoy a tidy profit.
Need cash? You don’t have to borrow from the bank. Instead, sell your store property and then lease it back. Sale-leasebacks are gaining in popularity, with the market seemingly at its top.
Better read your lease closely, even though it can commonly run up to 40 pages. Unfortunately, too many sign now and read later. Before signing, ask for a few days to consult your attorney, a real estate agent who specializes in commercial property and your insurance agent. Then, make sure to consult all three they can keep you out of hot water.
And, it’s probably wise to incorporate if you haven’t already. If you lease property in your own name, rather than under a corporate name, any court judgment will be against you personally. If you are incorporated, you are not personally liable for the rent.
For the initial lease, some recommend signing on for a short, rather than long, term say three years but not five. With a business startup, you want extra flexibility. Typically, when it is about five years old, a small business begins to consider buying real estate.
Cancellation for your lease is a must if your business fails or falters. Try to negotiate a buyout clause for early cancellation, but try to not pay a penalty equal to more than four to six months’ rent.
So, that’s it for leasing vs. owning. You probably should rent with a short-term lease if you’re just starting up.
But, buy (hopefully for just 20% down) when your business is secure, and a good property ownership opportunity opens us.
Nevertheless, the best advice of all is to consult your attorney, property agent and insurance company first. The can save your a lot of headaches and dollars.