When Scott Rhodes’ father opened the family’s first tire store in 1963, he bought the real estate. Little did he know that the single purchase would eventually grow into a 59-location chain – 55 properties of which the family would also own rather than lease. With facility sizes between 4,000 and 10,000 square feet, that’s a substantial patch of soil and brick-and-mortar to be owned by a tire-dealing family.
“It was always part of our business plan to own our real estate,” says Rhodes, vice president of Plaza Tire Service Inc., based in southeast Missouri.
The decision to lease or own, however, isn’t always as clear-cut as it was for the Rhodes family. Nor does it always end up so successfully. Benefits and pitfalls exist with both options, leaving many experts to call it a case-by-case determination.
What might be the best decision in your case? Consider the opinions and experiences of these dealers and experts to help you make up your mind.
“In my opinion,” says Art Blumenthal, a Philadelphia-based business broker specializing in the automotive aftermarket, “each circumstance needs to be evaluated based upon the pros and cons of the situation and the buyers’ objectives. I don’t believe there is a rule-of-thumb that can apply to most situations.”
“Buying versus leasing is case-by-case,” agrees Chris Litzler, senior analyst at Pinnacle Financial Group, a Cleveland-based independent mortgage banking company dealing in commercial real estate. “But acquiring a property is a larger day-one investment than leasing. Most small businesses are cash-constrained so the initial upfront capital requirement of buying is often too large.”
“I’m not sure (about the problems with each option) because we’ve never owned commercial property,” explains Tracey Duke, secretary and treasurer of Duke’s Tire Pros in Wilmington, N.C. The tire and automotive service company leases one property with two buildings, at 4,000 and 4,800 square feet. “There is less of a responsibility with leasing in regard to taxes and repairs, and the responsibility for property gains or losses. There is also the freedom, when the lease is up, to be able to relocate or have the ability to choose to continue in the same location.
“Owning would definitely have its own sense of peace-of-mind, though,” Duke adds, “knowing the property is definitely in your control.”
“Leasing properties, you can exit the property when the lease is over and not have the worry about selling the property,” Rhodes concurs. “Often times maintenance expenses and issues are at the landlord’s expense. Owning, you have more control and gain equity in the property. But leasing properties, you’re always dealing with lease-compliance issues. And owning a large number of properties, there becomes a need for property management.”
Given dealers’ ability to see things both ways, what considerations can help them sort through the pros and cons of each option? Blumenthal and Litzler offer several thoughts:
As for problems when leasing, Blumenthal says, there’s “no opportunity to build long-term equity value. Rent typically increases every year, versus a fixed mortgage payment if purchased. The possibility exists of a lease not being extended and having to relocate or experience difficulty selling the business down the road. There are potential limits and difficulties in expanding or renovating the facility. And, most likely, you’ll have to give a personal guaranty on the lease and be responsible for rent for the entire term.”
“Just like with leasing a car or apartment, the tenant builds no equity in the real estate,” Litzler agrees. “Owning real estate is one of only a few main ways to create substantial net worth because mortgage payments include principal pay-down in addition to interest payments. By leasing space, the tenant receives no ownership or equity.”
And as for problems when buying, Blumenthal begins with the fact that “additional cash equity is needed to meet the down payment on financing. There’s risk in giving the bank or SBA a personal guaranty on a higher loan amount and often having to put up a personal residence as collateral. You need to conduct a thorough environmental review and potential soil and water testing to ensure that the buyer is not inheriting hazardous waste problems relating to underground tanks, lifts and drains. You also need to get a real estate appraisal to make sure you’re not overpaying for the property. Should you wish to relocate the business, it can be more complex to change locations if you own the property as compared to leasing and then waiting for the end of the term.”
“The core competency of most small businesses is not commercial real estate ownership, management or development,” Litzler summarizes. “Finding a site, arranging financing and build-outs are key aspects of owning real estate and most small business owners want to focus on growing their company, not worrying about the underlying real estate.”
With luck and successful strategizing, however, the benefits of either selected option can outweigh the pitfalls.
“It’s potentially less financial risk, depending on the terms,” Blumenthal says about the perks of leasing. “And it’s potentially easier to relocate the business if needs or demographics change.”
“The landlord is responsible for all maintenance issues,” Litzler points out. “There’s no initial capital requirement. And there is flexibility in lease terms. You’re not locked in to a site for longer than you want.”
Meanwhile, the perks of buying can be at least equally enticing.
“You build long-term equity and can own the property outright when the mortgage is paid-off,” Blumenthal says. “There’s the possibility of property-value appreciation. Monthly payments do not rise if you obtain a fixed-rate mortgage and, in most cases, mortgage payments on a bank loan are less than rent to the landlord. There is more flexibility in making improvements to the property and there’s no risk of losing a location due to lease expiration.”
Litzler notes that, besides fully controlling the site, there are tax benefits, “including but not limited to depreciation. And if purchased with all cash, there is no ongoing rent or mortgage payment so cash flow improves.”
Blumenthal also reminds dealers of two issues specific to the tire business: the aforementioned environmental assessments and the matter of specialized use. “If a tire dealer wants to sell the real estate,” he says, “it’s usually to someone who will also buy the business.”
A Few Important Details
In addition to knowing the pros and cons of leasing versus buying commercial real estate, tire dealers can take steps to ensure their satisfaction with whatever choice they make.
For those who own, Blumenthal starts with the simple matter of keeping facilities clean of environmentally hazardous materials and equipment, as well as doing everything possible to maximize the value of their business, “since they are more likely to find a buyer of the real estate and business if it’s profitable and growing.”
Litzler notes the need for awareness of legal ramifications: When buying, “you could be sued by customers for accidents on site, and you’re responsible for taxes.” When leasing, “legal action is brought on the landlord for all common-area accidents.”
Legal details also need to be addressed when structuring the real estate holdings. Blumenthal suggests that, while such issues should be reviewed with the dealer’s lawyer and accountant, “the majority of dealers will not have the business entity own the real estate, but will own it personally or through a separate limited liability company.”
Meanwhile, Litzler says the real estate can be acquired in a special purpose entity, or SPE, which constitutes a separate company and therefore can provide financial safety. “Accounting should be kept separate as well,” he suggests. Like Blumenthal, he advises that dealers consult an attorney as well as a real estate broker for acquisition and financing advice. Other possible sources of help, he says, are business consultants, marketing teams and real estate services that deal in leasing, sales and management.
“I would add that, if a tire dealer already owns the real estate and wants to retire, they need to decide whether to cash out and sell a turn-key package of business and real estate or sell the business only and lease the real estate,” Blumenthal says.
“Generally the trade-off is that retaining the real estate and collecting rent can be a good investment and long-term income stream, but the downside is that your income stream is dependent on the quality of the buyer, of the business, and on whether he’s successful and pays the rent on time. Otherwise the dealer has the burden of finding another tenant or taking over the business again.”
Real Estate in Real Life
So, how did 55-location owner Scott Rhodes and his family make Plaza Tire Service’s decision work? How did they avoid the problems and find the benefits of real estate ownership?
“By constantly talking with people that work in the real estate area,” he simply states. “Owning real estate is very capital intensive and can slow growth. But you also can gain equity and have control of your property.” Other than creating a need for property management, however, he says he sees ownership as having little impact on the day-to-day operations of his business – except perhaps for the fact that you’re more likely to continue investing in the property.”
“There’s no particular person who knows it all,” adds Rhodes, whose holdings are owned by separate entities as advised by his accountant and attorney. “I suggest that you talk to real estate brokers, property appraisers, bankers, attorneys, civil engineers, architects, local city staff and anyone that may have knowledge of the local real estate market.
“Both owning and leasing real estate can be large-dollar transactions and long-term commitments,” he says, “so you should consult the people that work in that field on a regular basis.”
As for Tracey Duke of Duke’s Tire Pros, she says “leasing will be what we continue to do, for the short term.”