As a small business owner, you make many crucial decisions about your company’s future every day. One of the biggest and most impactful decisions you will make is whether to lease or buy your property.
This is a multifaceted question, and there is a lot to take into consideration before reaching an answer. Let’s look at some of the disadvantages that leasing a business can present, and how to eliminate those disadvantages by buying your building.
Paying Rent Is Less Stable And Less Economically Viable
Leasing a building can be an economic challenge. There is no goal of “paying it off” to work toward: You will be paying rent for as long as you occupy the building, or at least until you get priced out by rent increases.
Additionally, commercial real estate tenants generally enjoy fewer legal protections than residential ones. For example, a commercial tenant is unlikely to have a cap set on their security deposit or rent increases, so you must rely on a negotiated lease to set the payment conditions. Depending on the market, that lease may favor the landlord heavily.
When you purchase a building with a fixed-rate mortgage loan, by contrast, your payments don’t increase with time. This is something you want to consider when you look for funding to purchase a property. Borrowers also face the question of balloon payments, which is when the final payment on a loan is much larger than the payments leading up to it.
Balloon payments can be refinanced and often are. However, by refinancing your balloon payment, you are adding a considerable amount of interest to what you pay. A loan that is fully amortized will have no balloon payment at the loan’s maturity and can offer sizable savings.
Forced Relocation Can Stunt Business Growth
Relocating because your business is thriving and expanding is an exciting undertaking! Relocating because you’ve gotten kicked out of your space by your landlord is not as exciting and can cause all kinds of setbacks and complications for your business.
Being forced to relocate has the potential to disrupt all manner of vital connections for your business. Moving is expensive. Your equipment could get damaged during the move. Customers may have trouble finding you again or be unwilling to travel to you. Employees may have a similar reaction, and even carefully planned logistical arrangements may face challenges.
According to TMC client Linda Fong with FastSigns Oakland, “moving takes easily 10% off the value of your equipment. That’s a lot of money for a small business to lose.” When you own the building you work from, the danger of having your lease end abruptly is avoided. This means that relocating will happen at the right time, when the market is right and it’s right for your business.
You Miss Out On The Economic Value of Owning Your Space
Owning property represents equity and is a valuable resource for the owner. That equity can be used to obtain credit, or it can be a nest egg for retirement when the time comes. You may love your leased facilities, but the benefit you receive from being there is limited. Leasing is not an investment in the future. It creates no equity for you and any improvements or additions you make to the property will ultimately benefit your landlord, not you.
If you own your own building, it will be your decision what you do with it, and the improvements you make to it become part of your equity. As a building owner, it is easier for you to find financing for improvements, too. There are more comprehensive, quality loans for property owners than there are for property renters.
Property ownership also has tax advantages. If you own the building under your own name, instead of that of your business, or create a limited liability company (LLC) to own the building, you can essentially rent the building to yourself. That way, your business can continue to write off rent payments, and you or your LLC can write off interest payments and depreciation.
Your Workspace Is Not Yours To Fully Customize
Everyone’s business is different and has its own specific needs. Your needs should be reflected in your premises—its size, equipment, and upkeep have to be right for you. Here are some workspace-specific questions to keep in mind when considering buying the building you are currently leasing:
- Can you expand your facility as your business grows?
- Does the building have the equipment you need?
- Are maintenance and repairs attended to promptly?
- Is your operation environmentally sustainable there?
If you own your space, you are in a much better position to see that these needs are met. While leasing, making the improvements you want may not even be an option, depending on your lease and your landlord. As the building owner, you can decide what to do with the space. In addition, as the owner of your building, you will have equity that will make it easier for you to receive funding for improvements. In addition, that equity can play a role in your future plans, such as providing a steady income after retirement.
Owning a building gives you greater freedom to use it to your best advantage. TMC Financing client, Heritage Solutions, is a good example of this. John Tatum, President of the custom packaging manufacturer, explains: “In manufacturing operations, you’re going to have tenant improvements, which means you have to invest in the building. For example, we do a lot of fulfillment for winemakers. To do that, we need a temperature-controlled facility, or we would ruin their wine. You can’t do their business if you don’t have it. And you can’t do that in a rental building.”
You Miss Out On Leasing Opportunities Of Your Own
Sometimes leased premises are too spacious. A business owner could use the square footage more efficiently and generate additional income by subdividing it and leasing out unused space. The truth of the matter is that subletting a leased space is complicated and often impossible. Even if your lease and your landlord allow it, there are risks involved. Your subletter could violate the terms of your lease, for example, which could have dire consequences for you.
The Solution: Accessible Financing Of Your Property Purchase
The Small Business Administration (SBA) understands the uphill battles that most small business owners face. Conventional financing can be hard to come by and is not ideal for most small business owners. The SBA historically has worked to make the establishment and growth of small businesses possible by providing affordable and accessible financing. For those looking to leave the leasing lifestyle behind and finance a property purchase, the SBA 504 loan is the best way to finance this crucial next step.
The 504 program helps business owners buy land or existing buildings, construct new facilities, renovate their space, or buy equipment.
A 504 loan is a partnership between a conventional lender and a Certified Development Company (CDC), which is a nonprofit organization that administers the program on behalf of the SBA. The loan has three parts:
- The first is a loan from a conventional lender for 50% of the total amount. You and that lender determine the amount and conditions of that loan, which becomes your first mortgage.
- Your CDC facilitates a separate SBA loan of up to 40% of the total, up to $5 million (or $5.5 for manufacturing and energy efficient projects), at a fixed, below-market rate. This will be your second mortgage.
- Then you, the borrower, contribute a 10% down payment. Certain types of facilities are classified as single-purpose properties by the SBA, such as hotels or car washes, and require a 15% down payment.
- 50% Conventional Lender
- 40% CDC
- 10% Borrower
A 504 loan has a maturity of 10 or 20 years and is fully amortized (so there will be no balloon payment at maturity). If you sell your property, the loan can be assumed by the buyer. You can pay the loan off early, if you wish, with a low penalty or none at all, and you can lease up to 49% of the space in a building you buy or 40% of the space in a building you build from the ground up.
Projects eligible for the SBA’s Green Energy Program can receive up to $5.5 million at a time, and you can receive an unlimited number of loans for projects of this kind.
Owning your property gives you a measure of stability that cannot be matched by leasing. It creates equity for the future and, if you have space to lease out yourself, gives you income generation opportunities in the present. As an owner, you have much broader control over the use of your property and can avoid any number of inconveniences, from forced moves to structural shortcomings in the building.
TMC Financing is one of the nation’s top-ranking CDCs and a Premier Certified Lender with the SBA. If your business is located in California or Nevada and you want to find out more about buying your own property, talk to one of our 504 loan experts. The TMC experts are happy to provide guidance through the whole loan process.