Everybody seems to have an opinion on whether you should buy or lease your next business facility. I have been helping companies make this decision for the last forty years, and here are the Six Questions that I ask them to help guide their decision:
1. What is your projected rate of growth as well as your estimated holding period for the real estate? For many companies, it takes between 5 and 10 years to amortize the upfront costs of a purchase. If you are a fast growing company that will outgrow your real estate in three years, you will be wise to lease. If you have a very stable need for space and foresee occupying your space for 10 years, it is likely that a purchase is your best choice.
2. What is the company’s alternate use of capital? If you are earning a 40% return by manufacturing widgets, it is best to put your capital to work in your business, not in bricks and mortar! On the other hand, many a commercial building has funded the retirement for business owners who purchased buildings personally, and then leased the same building to their business, paying down the mortgage with lease payments from the company for 20 years.
3. What is your availability of capital? Purchasing real estate generally requires a substantial upfront costs – a down-payment, soft costs (such as legal, title, and architectural), and often building improvement or renovation. Leasing preserves much of the capital if it is needed elsewhere.
4. What exit strategy is required? Fortune 500 companies prefer to lease for a variety of reasons, but this is a big one. When the lease is up, you move out. No muss, no fuss. No marketing real estate, negotiating, and being unsure of when a sale will occur. With a lease, you concentrate on your business, not the real estate business.
5. What infrastructure improvements are required? The more that you are planning to spend to upgrade or customize your facility, the more it makes sense to purchase. If you are about to invest $3 million to build a sterile manufacturing facility, as an example, it is likely that should purchase your real estate to protect your investment.
6. Are there environmental concerns with the property? This was not on my list until about 10 years ago. A client of ours wanted to make an offer on an industrial building, however, I remembered that there were some environmental problems in the immediate area. I engaged an environmental engineer to pull all the public records and give me a verbal opinion on the property before we negotiated. His comment was, “I would have no problem leasing the property, but there is no way in the world that I would put my name in the chain of title.” The property touched the edge of a superfund site, and my client could have found himself drawn into an environmental morass as a property owner. We walked away from this property and found another, but if he had desired, we could have safely leased the property.
These are the six questions that I use to start the conversation. Sometimes the answer is clear cut, and sometimes not, but at least you have covered the major benefits and pitfalls of both buying and leasing. The next step is a discounted cash-flow analysis of your real estate alternatives, and if the answers to the above questions have not been compelling, the financial analysis will help you make the final determination.