Peabody Smith Realty

Leasing real estate has many advantages, as does owning. Which one is right for you depends on many factors. Some of the points to consider include:

Availability of cash for a down payment. Most banks will look for you to put down 20-25% to qualify for a commercial mortgage. In a small start up business this sometimes can place too big a burden on limited cash resources. Leasing helps preserve that cash for business operations.

Risk- As a tenant, you do not have the risk of unexpected major repairs, or market conditions changing. You are able to focus on your core business without additional worries.

Cash flow- As purchasing real estate generally requires some sort of financing, and the monthly payments include both interest and principal, the monthly payment is likely to be higher than available lease rates. Your business will be required to provide evidence of “free cash flow” (which is described as the cash flow left over after all expenses, including owners salary) of 1.25 to 1.30 times the annual debt service. For example, if the monthly payment was estimated to be $1000.00 per month, or $12,000.00 per year, the company would need to show an annual before tax cash flow of approximately $15,000.00 to qualify for the mortgage.

Flexibility- Leasing real estate may provide you with more flexibility than owning, allowing you to expand, or contract as market conditions dictate. Many leases’ can be negotiated to include clauses granting a tenant the right to expand into adjoining space if it becomes available, or even to terminate the lease if certain events take place.

Equity- As leasing a building is the same as leasing a car, what you don’t get is any ownership, the ability to build equity both from paying down the principal on a monthly basis, but also from the appreciation that you hope is happening in your market. Historically, real estate values have increase 3-5% per year, which because of leverage, can increase the owners return on investment to 15%-18%. You don’t get that benefit from renting.

So how do you decide? In some cases, the decision will be made for you. You may not have the available cash to purchase, or there just is not the right property available to purchase when you’re ready to open up. In others cases, where there is an adequate selection of real estate either for lease or for sale, the decision can be made by analyzing the total cost of after tax occupancy for each scenario, over the term of the lease or holding period (typically five years). As your lease payment has different tax consequences then your mortgage payment, and at the end of the lease, you do not have any built up equity as you would in a purchase, calculating this can be daunting task. Your accountant or commercial real estate professional should be able to help. As both a purchase and lease payments are a negative cash flow, the goal is to choose the option that has the smallest negative cash flow over the period you are looking at. Even though the purchase may have a larger monthly payment, you recoup some ( if not all) of the difference when you sell the real estate thereby minimizing the negative cash flow. One thing is for certain, and that is every situation is different. Leases will vary from landlord to landlord, and purchasing is affected by interest rates, real estate taxes, market fluctuations, and condition of the building. If you are considering a move, ask your real estate professional to perform a “Lease vs Own” analysis. The answer will make you money.

Andrew Smith, CCIM, is Owner/Broker of Peabody & Smith Realty and is licensed in both NH and VT. Smith specializes in commercial and investment real estate and holds the coveted CCIM designation. He can be reached by email at andy@peabodysmith.com.