Eric Joo, Chief Operating Officer, Schueler Group
Almost every business is confronted with this dilemma at some time, and it’s amazing how many times I’m asked to perform a financial analysis to determine the best course of action. Ironically, we all also get pulled into conversations discussing whether it’s best to own or lease a car, purchase a home or rent an apartment, and even what stocks to buy. Hmmm…
After 25 years in the commercial real estate industry spending too much time working on spreadsheets, the analysis has become easy – the actual decision is a little harder. What I have learned over the years is that the business decision to purchase or lease its real estate is more of a qualitative decision than a quantitative one. Yes, we can perform an after-tax cash-flow comparison and corresponding net present value incorporating the loan terms, cost of capital, lease terms, appreciation, depreciation, opportunity cost, your incremental tax rate, and even the price of tea in China.
However, the real question is how the decision impacts and advances the strategic goals of the company. Consider the home purchase or apartment rental analogy. Imagine a recent college accounting graduate (unmarried) starting his first career position in a CPA firm located in a relatively slow growth city. He (or she) sees themselves gaining some knowledge in the firm for a few years, but someday, becoming a CFO in a cutting edge high-tech industry. Most of us would advise him to rent instead of buy for all the obvious reasons. Now, let’s assume he is a pretty good handyman and stumbles upon a duplex at an estate sale in a decent neighborhood for a great price and likes the entrepreneurial idea of leasing the other half of the duplex to cover the mortgage. Some now might advise him to buy, while others might still say to focus on your career at this early stage and not get distracted with managing a tenant. Hmmm… we didn’t even perform an analysis.
Consider just a couple of thoughts before sending your CFO off to create a spreadsheet.
First and foremost, what do you imagine your company to be like in 5 or 10 years?
Will your future business be twice its current size with twice its employees? Will your current facility suffice? Will your business require significant capital or investments? Are you preparing to sell the business and will the added cost of real estate help or hinder the marketability of your business? I’ve talked to many owners whose real estate ownership has become a liability – not an asset.
After thinking critically about the future (you), if the decision to lease or buy isn’t already clearer, consider the current condition of your company.
What lifecycle stage is your business in? What is your credit? Is capital currently plentiful or scarce? Since businesses and buildings are valued differently, will a capital infusion in your business generate more cash flow than investing in real estate might save you in higher lease payments? What is your current risk tolerance? I’m assuming you’re an expert in your industry. How well do you know the real estate industry?
Now, if you’re still uncertain, think about the current market condition or economic environment.
What is the general economy like? Are you in a stable, growing or declining economy? What real estate cycle are we in? What is the existing building inventory (for lease and sale) and planned new construction? What are the demographics of your city? Is it growing, stable or losing population?
Finally, discuss your vision, current condition and the market with your CFO and a trusted, local real estate professional who can help you critically evaluate the advantages and disadvantages of owning or leasing real estate, selecting a location, designing a new building or purchasing an existing one, crafting lease terms congruent with your business plan, negotiating municipal financial incentives, and other real estate considerations.
Now, you can send your CFO off to create a spreadsheet and analyze your alternatives within the guidelines of your business plan.