By Carlee McCullough, Esq., Special to The New Tri-State Defender
Real estate has traditionally been used as a means to increase wealth. A first step may include first-time homeownership. The next step may be multifamily purchases. But another option along the wealth-building spectrum includes adding commercial real estate to the investment portfolio. Commercial property usually encompasses apartment, office, retail, warehouses, and/or industrial buildings.
Business owners at some point and time have to determine whether renting or owning their space is in their best interest. Initially, when the business is a startup and uncertain, a lease may be more appropriate. However, as the business grows and becomes more established and financially stable, a purchase of commercial property may appear to be more suitable for the business model. When making this decision, there are a number of factors that need to be considered, including the cash flow of the business.
Advantages to owning Commercial Real Estate
As an owner-occupant of the property, the business owner is not subject to market rent increases by the landlord or manager. Commercial leases tend to run longer than normal residential leases and as a result, at the end of the commercial term, the rent may increase depending on the supply and demand of space at the time. If the business owner has been in the location for a long period of time, moving may not be an option. This may force the business owner to accept the higher rent for a longer period of time. However, if the business owner purchased their space, there is less exposure to uncertainty in monthly rent expenses. Hopefully the monthly mortgage rate is fixed by the bank and there is certainty for a long period of time.
Over time the property should appreciate in value – meaning it is worth more today than it was yesterday. This usually occurs if the real estate market is strong and not on the decline or experiencing a market correction. Secondly, paying the mortgage down is like placing money in the bank if the property maintains its value. Unlike paying rent, the real estate owner should gain equity in the property with each payment made unless the loan payments are interest only. Ideally, after paying the mortgage off, the business owner has a property worth more than what it was purchased for years ago and this contributes to the owner’s overall wealth. But if the business owner had rented for years, there would be no equity and no overall increase in wealth from a real estate perspective.
A brighter side of owning real estate is apparent when there is an owner-occupant who has tenants as well. The tenants help pay the mortgage and the business owner has an additional source of income and cash flow. Dependable, stable paying tenants are key to success in commercial real estate. An unstable tenant can be the sole cause of a real estate owner losing the property if there is a dependence on the rent payments.
From capital gains to depreciation and interest to repairs, there are tax benefits that help to lower income for tax purposes. A good accountant is a must to take advantage of all of the benefits available. The earlier the accountant is engaged the better.
Location. Location. Location. In some businesses image is everything. The location of the business can say a lot about the business. Traffic, accessibility and visibility can tremendously and positively impact a business. Ownership of the real estate makes a statement of independence, strength and stability.
Operating expenses and maintenance
In certain situations, the owner of the real estate is responsible for the maintenance of the property, although there are times in a commercial setting where maintenance costs are passed on to the tenant. However, if the owner is responsible for maintenance, the owner determines when to repair, who is going to repair it, and how it is going to be repaired. If the maintenance needs to be deferred temporarily for cash flow purposes, it is the owner’s prerogative. Ownership has its privileges.
There are a thousand stories floating around about nightmare residential tenants that destroyed the property. Commercial tenants tend to be just the opposite in that they maintain the property because it is a reflection of their business and ability to earn a living. So the tenants in a commercial setting usually take better care of the facility than residential tenants.
Overall, the decision to rent or own is one that has to be evaluated by the business owner to determine what is in the best interest of the business.
(Contact Carlee M. McCullough, Esq. at 901-795-0050; email – firstname.lastname@example.org.)