Learn about the various strategies involved in leasing vs buying and evaluate which option works better for you.
When it comes to deciding between leasing vs buying industrial space, there is no right or wrong answer. The decision comes down to business type and priorities, your company’s rate of growth, cash flow, tax considerations, comfort with debt, along with future plans.
We also highly recommend that your accountant or financial advisor conduct a financial review to assess either option’s impact on your business needs.
- Your company is fairly new
Businesses just starting out typically do not have the same level of capital or fiscal certainty that long-standing businesses do. These companies may not be able to pinpoint rate of growth, profitability, and/or space needs, in which case leasing may be the better solution as it offers financial flexibility to adjust to varying business demands.
- Your company is expanding or downsizing– and fast
Companies growing or downsizing quickly, and showing no signs of slowing down, are better off leasing as it offers the option to move should they need more or less space.
- Your business involves warehousing
It’s a fact – you cannot simply create space. So when you require more warehouse space than what your current location offers, you need to find a bigger building. If you’re leasing, you can more readily move to a bigger space at the end of your term versus if you own, in which case you would need to sell the building as part of your relocation process.
- You’d rather invest your money in the company than in real estate
If you see more value in investing in your company than in real estate, leasing is for you. Having readily available capital will put you in a position to grow and expand your business as opposed to locking capital into a single asset.
- Your business works on a client contract basis
Automotive and logistics companies typically engage in client contracts with a set end date. An advantage leasing provides is the ability to match lease terms with the duration of client engagements. Should clients shorten, extend or cease engagements, depending on the terms of your lease, you may be able to re-negotiate your lease agreement to accommodate your requirements.
- You want to own an asset
Owning an asset can build equity, which in turn can help strengthen your balance sheet. Although purchasing does entail a large amount of capital on the outset, some buyers view ownership as a major upside as it provides the option of becoming a landlord and earning rent income from tenants. The bottom line is that despite financial setbacks your business may encounter, you have the worth of your building as leverage.
- You need to customize your space – permanently
When you own your building, you can tailor it and install equipment to suit your business needs – without worrying about putting the space back to its original condition at the completion of a lease.
- Your business has reached maximum growth
When you know your company has reached its growth potential, you are well-positioned to purchase a building. In this case, you are certain you won’t undergo an aggressive hiring phase, invest in more heavy machinery, and/or require extra (or less) space in the future – so buying a building could be a viable option.
- You don’t want to pay higher rent
Tenants are susceptible to rent increases; by contrast, owners, depending on the terms of their mortgage, can fairly predict, and plan for, their monthly payments. This can produce more reliable financial projections and allow the business to make sound, longer-term decisions.
- You anticipate growth in the near future
Another approach is buying bigger than your current needs, and leasing the balance of space to offset carrying costs. Sign tenants to short-to-medium term leases, providing the flexibility to take over space if/when necessary.
Why do both?
Another approach is to do both: own core, long-term sites and lease satellite locations. This strategy allows for flexibility in geographic growth or contraction, and ownership of stable assets.
There is also the scenario of leasing with the option to purchase the building – a growing trend. The advantage? You have a say in the building you’re occupying while being able to generate rent income from fellow tenants.
Forecasting and certainty play a key role in deciding between leasing vs buying industrial space. If your business is in its early stages, your ability to predict its growth and space needs will help you determine whether being an owner or tenant is the more sensible option. If you are an owner of a long-standing business, knowing your company’s expansion/downsizing and relocation history, as well as succession plan, is important to making the ultimate choice. The process truly is a matter of evaluating which route better complements your business’ situation, and your personal and professional goals.
Case study #1
“Manage your working capital before you buy…”
Hypothetical company “Eagle Manufacturing” has current assets listed at $1.5 million, which includes cash and accounts receivable. Their current liabilities are listed at $1 million, which includes short-term debt and accounts payable. When the decision-makers at Eagle Manufacturing discussed purchasing an industrial property, they agreed to take $1 million from their cash reserves (current assets) to use as a down payment.
Unfortunately, as the company purchased the property, a major vendor requested a significant payment for a recent raw material purchase. Since the current liabilities exceeded the current assets, the decision to purchase industrial real estate created a cash-flow crunch that pushed Eagle Manufacturing into insolvency.
While this specific situation is hypothetical, it is very much a reality for some businesses. Before deciding to purchase, we recommend that you review and project your working capital needs to ensure you have the ability to make the property acquisition without negatively impacting the operations of your core business.
Case study #2
“Unknown future lease increases can impact the accuracy of financial projections…”
Hypothetical company “Pulp & Paper Distribution” is entering the sixth year of a seven-year lease. The projections for next year estimate $500,000 in net income with the current lease, but with a pre-approved mortgage, next year’s net income projections are estimated at around $300,000. As the lease is coming up for renewal and relocation is deemed far too expensive, the landlord substantially increases the rent. The $500,000 net income projection must now be significantly adjusted as a result of the higher rent payments. Whereas if Paper & Pulp Distribution were to purchase, assuming they met the financial requirements, the fixed cost of a mortgage would allow for a more stable projection in the coming fiscal year’s operating results.
Although this situation is strictly an example, it is very much a concern for some businesses. Before deciding to continue a lease, it is important to understand the implications a rent increase can have on cash flow, income projections and business endeavours, and to fully comprehend the benefits of a fixed cost mortgage to financial projections and business continuity.
We understand that every business has unique needs, and our professionals at Colliers are here to give you that advice. Give us a call.