It may seem a bit odd to think of the building you pay for each month as a source of profit for your company. After all, the cost of occupancy, whether you lease or own your building, is probably one of the biggest expenses your business faces each month.
In the past few years, rents and sales prices have risen dramatically, sending occupancy cost even higher. So, how can it be said that such a major cost item could give a boost to profitability?
The answer starts with your decision: to lease…or to buy?
Lease It Or Own It?
Leasing requires less of an up-front investment, allows you to move when a lease expires no matter what the market conditions are, and landlords may front some of the cost of building improvements to suit the unique needs of your business as an inducement to sign a lease. So, in the near term, less capital is diverted to real estate leaving more to invest in growing your business to become more profitable.
However, almost all leases contain substantial annual rent increases, which, when compounded, drive the cost of leasing up significantly over time. Given today’s market conditions, those increases can run as high as 5% per year, over and above lease rates that are already running at record levels. Every extra dollar in rent paid is one less dollar of profit realized.
And, if changes in your business model require further building improvements during your lease, those are costs that will fall to you. When the lease expires, the return on that additional investment comes to an abrupt halt, and you may have to spend that money again to properly configure your next leased building. The impact on profitability is clear.
On the other hand, purchasing a building for your own use presents another set of variables that need to be considered carefully. The down payment for a purchase is a significant outlay of capital that could be invested in your business. Fortunately, in today’s financing environment, business owners can pay as little as 10% of the purchase price as a down payment, and finance the balance at low fixed rates for up to 25 years.
Up to 90% of the cost of capital improvements can also be rolled up in the loan and paid for over the same time period, preserving working capital for use in business operations.
Currently, interest rates for SBA 504 and 7A loans are running as low as 4.2% on a fully amortized basis. This equates to monthly mortgage payments similar to the cost of leasing the same space, except for the fact that the mortgage payment is flat for up to 25 years, while the lease rate moves up every year. The potential long-term savings on occupancy cost is astronomical when looked at from a longer term perspective. If you are looking for even lower monthly payments, you can choose the 10 year “call date” option, which fixes the interest rate on the first 120 payments at 3.5%.
Think of the advantage you can gain over competitors who are paying more rent each year for their space while you pay the same each year for yours. Then consider the fact that with each mortgage payment, you are building equity in your own property by reducing the principal balance of the loan, rather than doing the same for your landlord for the entire term of your lease. Building equity means a bigger payout for you personally or for your company when the property is sold. And, then there is the tax benefits of owning real estate, which include depreciation, interest write-off and capital gains tax treatment vs. ordinary income tax rates when the property is sold. You can even exchange your property and defer all or a portion of your tax liability at the point of sale.
There are some risks associated with owning that should be taken seriously. In a lease situation, you can walk away without cost when your lease expires. But, if you need to sell your building to find a more functional home for your business, you must do so under the market conditions that exist at the time. Timing market cycles is far from an exact science and the typical range in price from the top to the bottom of a market cycle can be significant. So, it is generally recommended that your need for space be relatively constant over the long term to avoid being forced to sell at any given point in time.
Cost of occupancy is just one aspect of making your building a source of future profits. The other big one has to do with functionality and physical condition. Not all buildings are the same and no two businesses are exactly alike. Location, building specifications and physical condition all play a role in maximizing profitability.
Location is important to your customers in terms of their ability to find and access your products and services.
Thus, the right building in the wrong location can put you at a disadvantage relative to your competitors. If your business is hard to get to or just too far away, your customers may look to more conveniently located competitors to fulfill their needs. The same may be the case when comes to your employees.
Longer commute times and distances may make it more difficult for you to attract and retain the good people you need to run your business at peak profitability. We often see business owners locate their businesses near their own homes for their own convenience, but that can backfire if it makes it harder for their workers to arrive on time, in a reasonable amount of time, ready to work hard each day.
The old real estate mantra of location, location, location didn’t just come out of nowhere.
Functionality is another key ingredient to maximizing profit.
Buying or leasing a building that doesn’t fit your operational needs can have disastrous consequences. Too often we see business owners get target-fixed on the sales price or the lease rate without giving full consideration to the impact the layout is likely to have on the operation itself. For example, a distributor paying less per square foot for a building with low ceiling height may have to take more space than if he paid more per square foot for a smaller, high-clearance building and invested in a new racking system.
Likewise, having the right number of loading doors and good truck-turning radius could help move more product, improving profitability via increased efficiency. As the most active industrial real estate team in our market, we see the consequences of good and bad real estate decisions every day. Making sure you see the whole picture in terms of functionality is vital to increasing profitability.
Physical condition is also an important aspect of choosing the right building for your business.
If projecting an image of quality is important to your brand, then a poorly maintained property that lacks curb appeal will definitely impact your probability. Conversely, if you don’t deal with your customers face to face and desire to offer good products and services at a more competitive price, then an older property in a secondary location that costs less may be just what you need.
A poorly maintained building can also cut into your profits in terms of the time and money it costs to keep it operational.
As a tenant, you have the responsibility to maintain and repair the building as if you owned it. HVAC, sprinkler systems, power panels, roof structures and other systems are expensive to fix and even more expensive to replace.
It is imperative that you fully inspect the property you lease or buy before you pull the trigger, or you could be spending the hard-earned profits from your business on your building. Given the low supply of available buildings, the aging of the industrial base and the lack of new inventory being built to meet current demand, this issue is now front and center on many of the transactions we complete for our clients.
We Can Help
Running a profitable business is difficult enough without operating out of building that costs more than it needs to. Every dollar saved on your facility goes to your bottom line.
So, it is important for you to look at all aspects of occupancy before you decide where to locate your business. After completing over 4,000 lease and sale transactions over the course of several market cycles, we have developed the expertise and created the tools to help you take a comprehensive look at all your options before you make your decision.
Give us a call.