Friday, April 3, 2015

Should I OWN or LEASE my Commercial Real Estate?

Image Attribution: www.wsj.com
Commercial real estate comes in many, many flavors. There are warehouses and manufacturing buildings, commonly known as industrial buildings.

Office buildings are built as two story walk-ups, high rises, mid rises or if you add a bit of warehouse or manufacturing space to an office building it becomes flex space.

Retail spaces are located in neighborhood shopping centers, malls, power centers, or strips.

Institutional campuses such as colleges, hospitals and government buildings are classified as commercial real estate. 

Don't forget hotels, resorts, and motels, commonly known as hospitality. Have I forgotten any? I hope not.

As there are many types of commercial real estate, your occupancy of the real estate a bit simpler. You as an occupant of commercial real estate either own it or you lease it. Easy, right? Not so fast.

Some classes of commercial real estate lend themselves more toward tenants (leasing). As an example, few, if any regional mall occupants own their space, because the spaces are difficult to divide into smaller ownership interests. In order to own commercial real estate, the property must have a separate definable, transferable parcel. An easy rule is this. If the space has its own tax bill, it can generally be leased or owned by the occupant. 

If you occupy commercial real estate, how do you determine whether to own or to lease your space? As industrial real estate is my specialty, I will advise accordingly. However, the general rules cross all classes of commercial real estate (industrial, office, flex, retail, institutional, or hospitality) and are somewhat interchangeable. Your specific situation may vary so it is always a good idea to consult professionals before choosing an occupancy type.

In my experience, owners of commercial real estate generally have one or more of the following characteristics in common:

Closely held entity. Sometimes know as "mom and pop" companies, a closely held entity is a small C Corp, S corp or LLC that can benefit from the depreciation on the real property. Frequently, the owner of the business that occupies the building is also the owner of the building. The decision to own vs lease for a closely held entity revolves around paying rent to a third party or paying rent to yourself. Assuming the other factors below, align, ownership can be awesome! 

Stable space needs: owned real estate is more difficult to unravel if a company's space needs fluctuate  constantly. With a lease, if you outgrow the space, you sublease the space or wait for your lease to expire and walk away. If you own the building and owe a mortgage monthly, you are forced to sell or find a tenant that can pay you rent. 

Super specific facility needs: companies that must make large investments in their commercial real estate, such as heavy power distribution, dense office buildout, food processing equipment, freezer or cooler space, etc, will opt to own vs lease. To relocate these specific improvements is extremely costly! 

On the other hand, occupants that lease their commercial real estate would have in common:

Publicly traded companies: ownership and depreciation of commercial real estate lowers earnings and thus many publicly traded companies would prefer to lease their locations. 

Widely fluctuating space needs: as discussed above, moving is expensive, disruptive, and rarely achieves a speedy payback. To couple those reasons with an obligation to service a mortgage on a building you've outgrown, hampers the expansion of a fast growing company. 

Space that is a bit of a commodity. Logistics providers (warehousers and distributors) have many choices for buildings that suit their needs. Space is plentiful and interchangeable. Consequently, the space is a commodity vs a rarity. When their options are plentiful and interchangeable, a decision is made to lease.