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Nineteenth century warehouses now house art and commercial space in Red Hook, Brooklyn. (Michael Falco)
Nineteenth century warehouses now house art and commercial space in Red Hook, Brooklyn. (Michael Falco)

Location

Should I buy or should I lease? Add to ...

The question of whether to buy or lease commercial space to house a company's operations can be a dilemma. Although there may not be a one-size-fits-all answer, there are clear guide posts for entrepreneurs and small-business owners to follow to make the right decision.

Start by determining your business needs

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Customers and talent

• The location of your business will be determined by your customer and human resource needs. Do your customers come to you? If so, your location must make it easy for them to do so. Where is the best talent pool from which to draw your staff? Again, your location should make it easy for them to say "yes" to join your team.

• In the end, location will dictate the price of real estate and this reality could make your decision simple. When businesses need to locate in an area that is too costly for their stage of development, leasing is the only - and best - option.

Needs versus wants

• It's easy to loose sight of your core business needs when scouting your options. Whether you intend to purchase or lease your commercial space, start by creating a list of requirements that are essential to your operations. Once your needs are clear, stick to your list. It is easy to be distracted by quality features that in the end have little impact on success.

Operational requirement

• Finding the right commercial property is only the beginning. Consider what modifications may be required to make it fit your operational needs. Significant renovation costs will put further demands on your upfront cash requirements.

• Leasing agreements will allow you to amortize the cost of modifying the space over the length of your lease. The longer the term, the easier it will be for your business to absorb these costs.

• Be sure that operating your business does not take away time and resources that could be better directed to your core business. Consider the best option so you can achieve the right balance between operating your business versus growing your business.

Consider the financial implications

Cash outlay

• Purchasing office space requires a significant down payment, typically between 10 per cent and 25 per cent of the purchase price. While the percentage required is based on credit history and individual agreement with a lender, this cost is quite significant for many small businesses.

• The cash outlay for a commercial lease generally requires first and last months rent, provided your business has good credit. This frees up working capital, potentially allowing your business to respond to alternative opportunities or developments in the market.

Fixed versus variable costs

• A long-term mortgage allows your business predictable, clear, fixed costs.

• Leasing leaves business owners vulnerable to variable costs, including annual rent increases and potentially a more expensive lease at renewal time.

Appreciation

• Despite any short-term negatives associated with the recent downturn, a clear benefit to owning commercial property is the appreciation of land value over time. Property investment is considered stable long-term.

• On the other hand, business owners typically choose a property based on the needs of their business - not the real estate market. As a result, the best time to sell a commercial property may not be the best time to sell the business in it.

Tax considerations

• Tax implications related to leasing or buying a commercial property are individual to the owners of the business. These matters are complex and generalizations are to be avoided. Seek expert advice at the outset to determine who best to structure your transaction.

Business growth

• Business owners should consider the benefits of owning versus leasing property from a cash-flow standpoint, while taking into account long-term plans and expansion possibilities.

• New and expanding businesses often experience unexpected demands, including growing beyond what their current facilities may be able to accommodate. Selling and moving operations can be costly from both a financial and operational perspective.

• Leasing makes it is relatively easy to relocate or acquire more operating space.

Once you have made your decision, protect your interests

Protect your property

• Owning a commercial property will require commercial property insurance that protects the property owned by your business, including buildings, inventory, contents and equipment against a number of important risks such as fire, flooding and theft.

Reduce liability

• Whether leasing or purchasing a commercial property, you will require some form of general liability insurance to ensure you are covered for bodily injury or property damage done to others as a result of your operations or products.

Protect your title

For those purchasing a commercial property, title insurance ensures:

• Fast and efficient closing process - title insurance will help ensure your transaction closes on time.

• Survey coverage - protects against unmarketability (not being able to sell your property in the future or obtain financing against your property) as a result of defects that would have been disclosed on an up-to-date survey, real property report, or location certificate.

• Fraud and forgery - protection against fraudulently registered mortgages against your title.

• Duty to defend - coverage of legal fees associated with resolving insured title issues.

• Building permit coverage - coverage for renovations completed without a permit that result in a loss.

• Zoning coverage - protection should a property not meet commercial zoning requirements.

• Competing interests - protection in the case of someone claiming an interest in your land. For example, an easement for a driveway or a builder's lien.

• Problem solving/facilitates closings - often coverage for known defects such as encroachments, delays in registration and zoning violations can be secured.

Special to the Globe and Mail

John Rider is vice-president of the commercial division for First Canadian Title.

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