The question of buying versus leasing involves not only the same items you would consider for Process Equipment, Vehicles or Computers but also a few that are specific to Real Estate.

In general there are 5 factors to consider.

1/ You’ll first want to look at Cash Flow. Many elements of your outflow……. Property Taxes, Insurance, Routine Maintenance, and Utilities will be the same under either scenario. So will initial renovations or improvements and GST ( an outflow on commercial purchases or leases but claimable as an ‘input credit’ like the GST on your other business expenditures ) so all of these items can be largely ignored for purposes of comparison.

A Purchase will typically involve a higher initial outflow when you compare the down payment, Land Transfer Tax ( approx 1% of value) and  higher Legal & Mortgage costs for a Purchase against  the typically lower Legal costs plus a couple of months’ rent ( perhaps 2% of Capital Value ) for a Lease.

After the initial outlay a Purchase will lower ongoing monthly costs and will not be subject to annual escalation clauses or to base cost increases on each renewal term .

Up to this point, the decision is quite like the decision whether to buy or rent a house so the first question is “ Can you afford to commit the upfront costs in order to reduce your ongoing monthly costs, forestall escalation in the future lease rate and benefit from the appreciation of the property ?”

The follow up question is  “ Is this the best use of cash resources or would I get a better rate of return investing the funds elsewhere ?”

2/ The next consideration  is Tax Deductibility. The Lease payment is a straightforward operating expense while the Purchase involves both an Interest expense and a capital cost/depreciation allowance. The latter is typically based on the value of the structures, excluding the value of the land. Your accountant can show you how to maximize the deductibility  of your purchase costs and you should remember the old maxim “ never do anything for tax reasons that doesn’t make good business sense anyway”

3/ Specific to Real Estate are the questions of how much customization or “leasehold improvements” the premises will require and how much will it cost to install equipment in terms of mechanical, plumbing, electrical, heating, ventilation and air systems and other “sunk costs” that will not be recoverable if you relocate ? Further, will you incur costs at the end of the lease to remove custom installations, remediate any environmental issues and restore the site to its original condition. Clearly,the more costly and disruptive that a relocation would be, the more attractive it becomes to purchase rather than lease. Naturally you can protect your business by means of a very long term fixed-rate lease but in essence you will pay the same financing costs that you would pay to purchase plus a premium for the owner’s profit and perceived risk. A shorter lease term with renewal options leaves you in a weak negotiating position for renewal when it is evident that a move would be costly and disruptive to you. For these reasons the conventional wisdom used to be that a manufacturing facility should be owned while a warehouse could often be leased. There is still some merit to this approach however many of today’s distribution facilities are sufficiently  complex and sophisticated that the costs and disruption of relocation are comparable to moving a plant, while some ‘light assembly only’ manufacturers can move as readily as a conventional warehouse.

4/ What will be the future availability of suitable alternative sites if you have to move ? This must be addressed on several levels. First, if you have a skilled workforce you need to consider whether suitable options will be sufficiently close to the present location to retain your skills. Second, if proximity to specific highways, rail spurs or other facilities is vital, will alternate sites be suitable? Third, are there zoning or regulatory issues that will limit your choice of sites and are these likely to become more restrictive ? if so it will be a lot more difficult to obtain a variance on a new site than to continue an existing one. This issue will be a major consideration for food, chemical or auto businesses and for anyone with requirements such as floor drains or outside storage. Again the ‘rule of thumb’ would be

“the more difficult it would be to find an alternate site, the stronger the case for buying versus leasing”

5/ What are the extreme highs and lows of your volume projections over the forseeable future and how might these affect your space requirements ? Whether you buy or lease you generally have 2 main options for dealing with significantly lower-than-planned space requirements, i.e rent out the excess or relocate. If you lease you should ensure that you include specific wording to allow a full or partial sub-lease. Unlike residential leases for commercial leases this is not an automatic right unless negotiated.

Similarly, if space requirements are higher than planned you have the options of finding additional off-site space or relocating. However, if you purchase a free-standing building on a site where total coverage is less than permitted, you have the further option of adding space without relocating. In  a mature industry where the range of possible volumes is predictable you can make a fully informed decision. If you are in a new sector where volumes are more volatile you may want to consider a relatively short-term lease that includes both an option to renew at a pre-determined rate and an option to purchase. Your Realtor can advise you of properties where the owner is amenable to this type of arrangement.

Paul Graham is the owner and Broker of Record for BUYERS REALTY INC.  Please direct your questions to paul@buyerscall.com or to his direct line, 905-607-4400