Choosing a location for your business is a huge decision. Equally important: Should you buy or rent?
In the early days of a business, this question is more easily answered: Rent.
Startups have the least amount of certainty about how their business will grow, and the least amount of knowledge about how any one location will truly affect their business.
Just as important, cash is king for any business, but especially for a startup; any capital that would be needed for a down payment should be reserved for working capital and Murphy’s Law.
However, as you and your business mature, your experiences will add clarity, and it may become easier to project your short- and long-term needs about location. It is at this point that many entrepreneurs start to consider the value of investing in their own commercial real estate.
As in your personal life, it is sometimes frustrating to pay rent, knowing you are not building any equity.
You may be tempted to look back on your years of renting and dream about how close you’d be to having your very own place paid off by now had you only purchased instead. And once it was paid off, the dream continues, you’d have better cash flow and an asset, separate from your business, that you could sell or use to generate income.
What could go wrong?
Plenty really. Managing commercial real estate is a business in and of itself, and likely not your core business or strength.
Plus, you would still need a down payment (25 per cent is typical), and that’s not always kicking around a business looking for a home. As well, shorter amortization periods on commercial real estate (such as 15 years) would make for some hefty monthly payments.
Continuing to rent leaves the leaky roof, snow clearing, property tax forms and insurance quotes as your landlord’s problems. You just keep running your business and let your landlord run his or hers.
If I haven’t yet discouraged you because you believe your business and skill set are strong enough to manage commercial real estate, then by all means, explore. Indeed, you are going to pay rent anyway and, in the right market conditions, you could always sell or rent to someone else if the need arose.
Still, be cautious about the assumptions you use in the net economic benefit analysis you do.
First, consult with your lawyer and accountant to make sure the resources you will need are available.
You need to build a financial plan for your new building that includes various scenarios. If you are building from scratch, you have land acquisition and lease, permits and suitability to consider. If you are buying an existing building, you need to budget conservatively for repairs and maintenance, and will still need permits for your business.
In both instances, you need to remind yourself that the current low-interest-rate environment will not last forever. You need to test your cash flow against interest rates that are at least twice as high as they are now, to ensure you have the resources.
If it is still looking good, then I’d be getting pretty excited if I were you. You’ll be tempted to start browsing for buildings on your own – but don’t.
Instead, you should start to talk to your bank and confirm the availability of a mortgage. Then limit your price range to the budget you created with your accountant, not the amount the bank is willing to lend.
Keep in mind that your lawyer may suggest you set up a holding company under which to buy and hold your real estate (so that your building and/or operating company are two different legal entities).
While this is common and often the right choice, it may complicate your mortgage documents, as there may need to be some guarantees from your operating company and/or you personally, and they may affect shareholders’ agreements or other covenants. In this scenario, you would own the company that owns your building and then rent it to the company you own that operates the core business.
Find a reputable real estate agent who specializes in commercial properties – not your best friend’s cousin who happens to sell houses. Don’t bother looking at places beyond your price point. Be disciplined.
Finally, as your last risk-mitigation measure, evaluate how suitable the building you are considering is to other businesses or potential buyers or renters. If the building is freakishly unique, will it be hard to rent or sell if the need arises?
Under the right circumstances, this could be a highly beneficial asset to your business and to your career – but take time to make sure the circumstances are right.
Special to The Globe and Mail
Chris Griffiths is the Toronto-based director of fine tune consulting, a boutique management consulting practice. Over the past 20 years, he has started or acquired and exited seven businesses.
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