When economic conditions cause sellers of commercial real estate to drop their prices, it presents an opportunity for your business. Owning your business location might be superior to renting. However, ownership of real estate has risks that are distinctive from owning a business.
Owning a commercial building provides a permanent arrangement for the business. That’s why the location is so important. You have to decide if the location will be optimal for your business in the future. Because you own the building, there’s no risk of having the rent cost skyrocket or not having a lease renewed. But you also cannot easily relocate if the neighborhood declines or better facilities arise in the future.
Building ownership also creates a fixed cost. Future escalation of rent is no longer a worry. However, prospective increases in property taxes and maintenance costs are still a reality. Plus, as a building owner, you can no longer reduce your rent expense by simply moving. Your cost of acquiring and maintaining the building are permanent until you sell.
You therefore have some detailed financial calculations before deciding on a building purchase for your business. The basic process involves identifying the costs you will incur and the expenses of renting that you eliminate. To benefit from owning your business location, the present value of your ownership costs should be less than the present value of expense for continuing to rent. That’s a complicated calculation since you cannot be certain of future rental expense. However, you can simply compare the present costs of building ownership to present rental costs.
Chances are, the initial monthly costs of ownership are going to exceed your rent expense. As long as the present ownership costs are not too much higher, the real estate purchase makes sense. That’s because the fixed cost of acquiring the building is not incurred again, but rent expense is perpetual. Another way to look at this is by realizing that the mortgage for buying the building may be a little higher than your present rent expense; but eventually the mortgage is repaid and you still have a building to occupy. If you can convince yourself of the economic feasibility of owning your business location, you can likely illustrate the scenario to a lender.
Business locations that are owner-occupied often have different ownership structure than the business itself but control by the same individual. For example, the owner of a small business corporation may personally own the commercial building where the company operates. The corporation does not own the real estate. Also, a business owner might create a different entity—such as an LLC—to own the real estate that is leased to the business operation. This doesn’t change the financial calculation because rent paid by the business entity must be sufficient to cover the ownership costs of the building-owning entity.
There are various reasons for creating a different entity to own the commercial building. One possibility is legal liability. A distinctive legal owner of the business location separates risks of building ownership and the business itself. For example, the value of a building may be insulated from unusual risks attached to certain professions—such as medical services. Another financial aspect of holding title to a building by a different owner than the business is that it permits a sale of the business and retention of the building for lease.