A big question that comes up when I’m hanging out with other business owners is whether it’s better to buy or lease an office or warehouse space. I’m going to be honest here, I have always rented and I have always thought that others who would brag about buying the office space were doing just that, bragging. I never really stopped to do the math and weigh out the pros and cons of buying versus leasing. Until now.
During a recent visit with a good friend of mine, the light bulb finally went off for me. Mike Spears is a commercial real estate broker in Houston, Texas. He’s always ranked as a top 10 broker in Houston, and I generally respect him for his attitude and business acumen. As usual, Mike started pressing me about buying my own building. Mike knows that I lease several spaces around town for various companies that I have equity in, but he’s alway pushed me to look at purchase options. Again, I was focused on my business from an operational standpoint and wasn’t thinking much about buying a space. So after some push back, Mike finally said “follow me” and headed towards his conference room where he picked up a marker and began writing out the pros and cons on a white board.
Here is what he came up with:
The first thing Mike asked me was, “What is your financial exposure when leasing?” “The term of the lease” I answered. “Okay, so let’s say it’s a $5k per month lease for 5 years. If you just take the monthly rent amount, not including the additional fees such as CAM, you are committed to $300,000. Let’s say, worse case scenario, you can’t afford the lease payment after 12 months. Do you just walk away? NO! the landlord is going to come after you for the full lease commitment. So you will be on the hook for the remaining balance of the lease of $240,000.” He had a good point.
Mike then went on to explain the buying scenario: “When you’re buying a building, there is a lot to take into consideration aside from just the costs. For the sake of this example, let’s assume you’ve found the perfect building at $500,000. You won’t have to sign a long term lease, but you will need to put down or pay upfront somewhere around $100,000, leaving you a balance of $400,000. The note on that would probably be somewhere in the neighborhood of around $4,000 per month. So let’s say the same worse case scenario happens here. After 12 months, you have to shut your business down. You’ve invested a $100,000 down payment and $48,000 in monthly payments, leaving you a balanced owed at $350,000. Now, right off the bat, that $350,000 seems higher and potentially more dangerous than the balance of the lease.But now that own this building, you can either rent it to someone else or sell it. Even in a fast sell scenario, assuming the real estate market didn’t crash over the past twelve months, you should be able to recoup a lot of your investment into the building, even if the bank foreclosed on you. The bank would then try to sell the building and you would be responsible for the balance. So let’s say they sold the building cheap at $300,000. Remember you paid $500,000 just 12 months earlier. Your balance owed to the bank was $350,00 plus probably another $20,000 in fees. That leaves a difference of $70,000 that the bank is going to hold you accountable for paying, far less than the landlord’s $240,000 lawsuit.”
When Mike broke it down for me this way, it showed me the power of leveraging real estate has as an asset; it’s not just a line item on the monthly expense.
Now, Mike’s reasoning doesn’t mean everyone should run out and buy a building. I mean, for one you have to have the upfront money to put down on the purchase price, and that amount of money might put unnecessary financial stress on your business.
Bottom line is that as you grow your business, I encourage you to surround yourself with real estate minded people. The more I dug into this topic the more I realized that everyone around me who has significant wealth also has a real estate portfolio or real estate experience no matter what industry they apply their focus to.
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