Real Estate is an essential part in business operations of corporations, not just as usage of the facility, but as a major investment vehicle. There is a strong believe that due to general scarcity of land (especially in the Golden Triangle) that real estate values can be maintained, if not appreciated, in the medium to long term. Notwithstanding this notion, the values can oscillate beyond reason, as we have seen in the last six years since the 1997 Asian Economic Crisis, and also due to external factors such as slowing global economies or unexpected events like the 9-11 incident. As a result, Companies need to deliberate the question of whether to buy or lease real estate, especially if real estate is not the core business of these companies.
We are going to explore on when buying or leasing makes more economical sense.
When Leasing is a Preferred Option
The following factors may lead a company to conclude that it should lease, rather than purchase, its business facility.
- The current cash flow is of vital importance - particularly in these hard times, a lease may be better than a purchase from a cash flow perspective. This is because up-front outlays associated with a lease are usually less than those required with a property purchase. With a lease, your main initial cash expense may well be limited to your security deposits, utilities deposits, plus first rent payment. With a purchase, you have to have the lump-sum purchase price, or at least a down payment on a loan.
- The Company does not want involvement in property management and maintenance.
- The Company wants to retain its mobility. Maybe the company is not sure that the facility selected now will serve its needs several years in the future. The company may need more or less space, the target market may have moved elsewhere, or better-suited properties may later be built.
- The Company's credit rating may not support a loan/financial facility - if the business is rather new, or has experienced some financial difficulties, lenders may not be willing to extend it sufficient credit for a loan on the facility. With the same financial situation, however, a property owner may well be willing to rent a property to the company.
- The Company has not found a suitable property to buy - It may want to buy, but have found that all properties that would be suitable for it needs have been offered only on a lease basis.
- The facility may be in an area of declining real estate values - The Company may find a facility that meets its needs, but are concerned that the real estate values in the area are stagnate, or may actually drop in value. In this case, leasing makes sense: let the landlord suffer the effect of the declining values, not you!
When Purchasing is Preferred Option
The following factors may lead a company to conclude that it should purchase, rather than lease, its business facility.
- The Company wants control of the property. The Company intends to make substantial additions or renovations to the property. Or it decides to change the business hours or change something else about the way it is doing business. If the company rents the facility, it may have to get your landlord's permission to make these changes. If, however, the Company owns the property, there will be no one question your moves and answer to.
- The Company is in strong cash flow positions and can seriously consider the long-term cost. A lease of course beats out a purchase in terms of cash flow, particularly in the early years. But over the long haul, a purchase is usually cheaper because a landlord, in addition to paying all of the costs associated with purchasing and maintaining the property, will attempt to build in a profit for himself. The Company avoids paying this profit premium by buying, rather than renting, the property, with the 'rental' payment going towards the payment of the mortgage, if applicable.
Moreover, whether the property is purchased for occupation or investment, there is potential for an upside in capital values. In addition, there could be annual yields earned from the properties held for rental income. Leasing, on the other hand, does not give any returns at all as rental expenditure is essentially an expense.
- The Company wants to stay at the same location - for some businesses, the location is of utmost importance. If the Company has established a winning business location, it will not want to lose it because of increase in rentals or because the owners wants the property for another use. If the Company owns the facility, it won't have these worries.
- The Company is in an area of appreciating real estate values - In event the Company locates itself in an area where the real estate values will continue to increase, it would be better to own the property (and thereby get the benefit of this appreciation) rather than to lease it.
- The Company wants to Enjoy the Tax/Depreciation Shelter. Owners of real estate actually enjoy tax and depreciation shelter besides the other benefits of ownership. Interest paid on a loan for a property is considered an expense, and thus can reduce the taxable income. Depreciation is also used to reduce income that is taxable. Therefore, both the interest expense and depreciation can reduce the taxable income, thus providing a tax and depreciation shelter for Company whilst such a shelter is not available for leases.
If a company is considering whether to acquire a facility (office, factory, warehouse etc) by purchase or by lease, it may have a tendency to concentrate on the short-term, such as the forthcoming years' cash flow projections that would result for each of the alternatives. This is natural, and probably altogether necessary: If things don't go well enough in the next few years of the business's operation, it may not be around to see how a particular decision would have benefited it 10 years down the road. But having said this, it's still worthwhile to consider how a lease or rental could affect a corporations business in the future. Will it be important for the business to be able to stay at the location for as long as you want? Do you foresee the need to modify the facility in a way that a landlord may not agree to?
Let's say you look at the short-term and long-term implications of the rent-or-buy decision, and conclude that it's in the long-term best interests of your business to buy the property. If your rent-or-buy question is otherwise a close call, this long-term consideration may lead you in one direction. If, however, buying the facility is out of the question, at least you'll know that you should be thinking about how you can accomplish these long-term goals by other means.
This major decision on whether to buy or lease should finally be based on financial foresight, as you would not want to be caught in a situation of a credit crunch. Factors such as the interest rates, cash flow projections, values & affordability level and the cash available for deposits have to be carefully weighed before making the commitment.