News Blog - Commercial

13 October 2017

BUYING VS LEASING COMMERCIAL PROPERTY: WHAT TO CONSIDER

An important decision that business owners need to make is whether to buy or to lease commercial property. The answer is far from black and white.

Both options bring benefits, risks and some financial and practical considerations.

Flexibility, need for control, cash flow and return on investment (ROI) are all factors that apply to businesses differently depending on maturity and stability. The decision then becomes heavily dependent on the particular company and its long-term objectives.

Real estate is no longer the only avenue for investment in Australia. So, the quality of the investment must always remain at the forefront of the decision.

YOUNG OR GROWING BUSINESSES

Start up business meeting around a table

If you’re a startup or on the cusp of your first growth phase, your best option is to lease to:

  • Free up capital
  • Reduce costs
  • Stay flexible
  • Focus on your business

Free Up Capital

The first thing you need to ask yourself is how much money you have and whether it could be better spent elsewhere, particularly if your future business needs aren’t clear.

For instance, if you’re a growing business, access to working capital can give you the ability to respond to market changes quickly. It may also mean you’re able to invest in things that can fuel business growth and may attract a higher ROI, such as:

  • Hiring the right people
  • Leasing an office in a great location
  • Equipment upgrades

And, for startups, having access to available capital may help you survive until you break even.

Upfront costs

The initial costs of buying commercial property are high. This means that you’ll probably need to secure a loan, which can be a tough ask for a growing company.

Lack of industry footing, capital and assets, typically means that your investment venture is deemed ‘too risky’ in the eyes of a lender. What’s more, you’ll need to be able to commit to a minimum mortgage term and consider acquisition costs, such as professional advisory fees and stamp duty.

Stay flexible

One of the staple understandings in business is that change is always around the corner. And this adage couldn’t be truer in today’s environment of disruptive change, increased competition, innovative business models and technological advancements. (Just think about the billion-dollar companies that did not exist a mere ten years ago, including Snapchat, Airbnb, Uber and Instagram!)

So, if you’re still a young company with an uncertain future, leasing offers you flexibility regarding:

  • Commercial stock
  • Office location
  • Securing an agreement that’s in line with the stage of your business and your goals
  • Upsizing or downsizing in response to market changes

Focus on your business

In many cases, leasing also means that you will not have to split your attention between your core business and the upkeep of a commercial property.

This is particularly relevant for growing companies whose time could be better spent defining brand, vision and purpose, hiring the right staff, listening to customers and building upon long-term business goals.

ESTABLISHED BUSINESSES

Office space full of workers

More mature companies usually have a harder choice to make when it comes to the lease versus buy conundrum. The key to making the right decision is to understand your business and your short and long-term objectives. Above all, consider the:

  • Value of the investment
  • Option to purchase through a Self-Managed Superfund (SMSF)
  • Return on Equity
  • Capital appreciation
  • Value-add
  • Need for control or flexibility
  • Risks
  • Tax advantages

Arguments for buying

The Investment

Whether you are an owner-occupier or investor, the value of the asset you plan to invest in must stack up against the return.

In general, commercial real estate is considered a safe investment with relatively stable growth and solid returns. For instance, it’s not uncommon to get between 5% and 6.5% net rental yield for commercial properties in Sydney, compared to stocks and bonds, which are traditionally more volatile and pay a lower return.

Purchasing through a self-managed super fund (SMSF)

Depending on your circumstances, you may be able to buy commercial property through your SMSF and lease it back to your business at an arm’s length.

This can be an excellent way to build your wealth and is gaining popularity among small business owners due to its tax-effective structure and the protection it offers from creditors.

Some risks come with this option, including lack of diversification and stricter lending rules. Speak with your accountant or financial advisor to determine whether this option is right for you.

Return on Equity

The return on equity is a percentage measure of the return generated on the money that you invest in a property. It increases or decreases depending on the performance of the asset.

Generally speaking, commercial real estate is associated with high return on equity because it’s more likely to be cash flow positive and increase in value over time.

Control over your property

Night time aerial view of CBD streets

If the costs involved in a specialised fit-out and equipment for your business are high, then buying a property may be a smart investment. Purchasing will guarantee you security of tenure to recoup high capital costs.

Examples of this kind of situation might be laboratories, sound studios, hotels, restaurants and other usages requiring significant capital expenditure.

It’s important to note that you’re also able to make improvements if you are leasing, provided you get your landlord’s permission. However, you will often be required to return the space to its original condition. So, you’ll need to factor in the cost of making good at the end of your lease.

Appreciation

Capital appreciation is the increase in the price or value of an asset over time. To calculate it, you simply subtract the purchase price from the sale price:

Capital Appreciation = Sale Price – Purchase Price

Commercial real estate is considered an ‘appreciating asset’, which means it is expected to increase in value over time. In fact, in 2017 alone, Australian real estate investment trusts saw commercial property values increase by more than $4.7 billion!

This is because the value of a property increases with rents, and rents increase with inflation. Therefore, if the rents double in value, so too does the worth of the asset. Inflation also pushes up the cost of constructing new properties which, in turn, increases the value of existing real estate.

Something to bear in mind though is if you make a net capital gain in an income year, you’re usually liable to pay capital gains tax (CGT). Speak to your accountant or tax advisor for more information.

Value-Add

You should strongly consider buying if the purchase means you gain a competitive advantage by:

  • Protecting the goodwill of your business
  • Securing an iconic space or an iconic location
  • Securing a site in an area that is considered a hub for your industry

Situations where this might apply include restaurants, hotels and iconic landmarks where exposure benefits the brand.

Tax deductions

As a property owner, you’re able to claim tax deductions for expenses associated with owning and operating a business.

This includes the interest on your loan, expenses incurred in the maintenance of the property and depreciation on fittings and fixtures.

Provided you meet the ATO criteria, you may also be eligible for GST credits on the GST paid as part of the purchase price, legal expenses and other costs.

Depending on how the ownership structure is arranged, it is also possible to negatively gear your property by offsetting your losses against your income.

Arguments for leasing

Return on Investment

The equity requirement needed to finance the purchase of a commercial property can be up to 30% of the purchase price, which is a significant expense no matter what your business. This requires a large amount of capital to be outlaid up front, which may cause cash flow issues or other problems.

In many cases, reinvesting this capital into other areas of your business, like marketing or talent acquisition, will yield a stronger ROI than you’re able to generate from a property.

When deciding between buying or leasing, consider first whether it’s better to have your available capital tied up in property, or reinvested back into your business.

Flexibility

Two people talking in empty creative office

Leasing is a good option for businesses that operate in a volatile industry or require the flexibility to move into new markets or expand or contract quickly.

For instance, if your firm experiences periods of rapid growth or decline, short-term leasing means you can easily upgrade or downgrade.

And, if your business relies heavily on image and branding, leasing will offer greater flexibility in terms of location, connectivity, visibility and access.

Tax advantages

Leasing also brings its share of tax benefits.

For example, the rent you pay for your property is tax deductible. And, if you make leasehold improvements to your premises to better suit your business requirements, you can claim depreciation on these modifications.

You may also be able to claim those GST credits, provided that you and the owner of the property register for GST.

Avoid ongoing property costs

Depending on how you negotiate outgoings, leasing may mean you avoid certain costs that come with owning property, including:

  • Insurance
  • General maintenance and repairs
  • Building services, such as cleaning or security
  • Council fees
  • Business rates
  • Running costs like lighting, heating and cooling

Minimise your risks

Sydney city skyline over circular quay

Though commercial real estate is widely considered a ‘safe investment’, it does come with a certain amount of risk that leasing sidesteps. For instance, commercial properties:

  • Are more sensitive to economic conditions – In a strong economy, businesses grow, prices go up, and demand for commercial property increases. But in a recession, the opposite is true – demand tends to fall, which may mean a property sits vacant for a substantial period of time.
  • Take longer to find a tenant – While commercial real estate usually attracts longer leases, once vacant, it can be harder to find a suitable tenant. And, during this time, the onus is on the property owner to cover the costs.
  • Are prone to changes in market supply – New and refurbished properties may pose a threat to existing tenancies as tenants look to upgrade or expand. High market supply can also reduce potential yields.
  • Are vulnerable to infrastructure changes – Infrastructure improvements may entice tenants to new areas and away from dated commercial premises.
  • Can fluctuate in value – if a property becomes vacant or the rent has to be lowered to attract new tenants, the value of the asset is also expected to fall.

THE RIGHT DECISION FOR YOUR BUSINESS

Whether you are a young, growing or established business, the decision to lease or buy a property can only be assessed on a case-by-case basis. The key to making this decision is to understand your current, short-term and long-term business demands, as these will steer you towards the best course of action.

With over 25 years’ experience in Sydney CBD commercial property leasing and sales, TGC is passionate about connecting people with property and working with you to secure the best property for your unique situation.

Get in touch with TGC today and discover how our experience, local knowledge and expertise can help you make the best property decision for your business.

 

Date: 13 October 2017 Author: Eric Lundberg
Commercial
Eric-Lundberg-admin

About the author:

Eric Lundberg

Eric has over 30 years experience in commercial property, and has been at the forefront of the transformation of the Sydney city fringe market, dealing with the disruptive new knowledge-based industries. Eric’s deep market knowledge, broad connections, dedication and perseverance combine to provide clients' with the best creative property solutions.

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