The question for businesses on whether to buy or lease commercial real estate is one that seems a long way from being answered. It is a known fact that both buying and leasing have their own pros and cons, and that they tend to be most suited to different situations and business set ups. Where an investor, for instance, will always purchase commercial real estate, a startup business will almost always lease it. But what about for those in between? What is the better option for them?
We know that the value of a business can be positively affected by owning real estate, as it is an impressive asset. However, many businesses fail to look beyond that, and don’t investigate whether purchasing commercial real estate could stop their company from expanding and growing. There are three key factors to take into consideration: your working capital, how much physical space you have, and the liquidity. Let’s take a closer look at how these three elements affect business growth.
1. Working Capital
First of all, you need to know what your personal working capital needs actually are.
Working capital is one of the most difficult financial concepts for the small-business owner to understand. […] Most businesses cannot finance the operating cycle (accounts receivable days + inventory days) with accounts payable financing alone. Consequently, working capital financing is needed. This shortfall is typically covered by the net profits generated internally or by externally borrowed funds or by a combination of the two.
In simple terms, you need to have money available to purchase your materials, equipment, and processes, pay your employees, and pay for your facility. If your business is growing, for instance because you acquire new competitors or because you have gained organic new business, you need to make sure that every last cent of your operating capital is used in an efficient manner. If you own commercial real estate, however, this could stand in the way of growth. This is because you will have less money available. If you want to expand your operations (hire new employees, automate a manufacturing line, or fund a new marketing campaign, for instance), you will also need the space to do that, but you may not have enough money for both. If you predict that your company will experience growth quite soon, therefore, it is generally best to lease, at least until you have stabilized. Once you have done that, then you may want to consider buying instead.
2. Physical Space
The first element is related to the second one, which is that of physical space. It is vital that the space you have available is suitable to the growth of your company. For example, if your customers demand that certain products arrive at their place within a certain period of time, yet you do not have staging areas, loading docks, or warehouse space, then they will not trust that you can deliver. Similarly, if you have a tiny space where everybody is cramped together, you are unlikely to attract top talent.
Clutter can actually distract employees and impede efficiencies because no one knows where to find things. Better organization doesn’t require much money, if any, but it does require a plan and commitment.
Similarly, if your business is hidden in a huge row of other businesses, all with the exact same exterior, then customers may simply pass by. If you have leased a building and it has some problems, such as the ones described above, you are within your rights to speak to the property owner to make the necessary changes, or you will not renew your lease contract. Interestingly, in most cases, the owner will have to pay for these upgrades and refurbishments as well. Should you own the building, on the other hand, those costs will all be yours, if it is possible at all to change the property. If not, you may have to find somewhere else to conduct business from, leaving you with a useless property.
Finally, there is the issue of liquidity, which is quite similar to that of working capital.
Liquidity refers to a company’s ability to pay its bills from cash or from assets that can be turned into cash very quickly. The quick ratio, also known as the acid-test ratio, is an indicator of a company’s liquidity.
While similar to working capital, there are also some significant differences. Your liquidity demonstrates how quickly you could, if need be, raise more cash. As such, it takes into consideration the value of your assets (notes, receivables, bonds, stocks, and real estate), as well as how quickly you could potentially sell them. Your liquidity is then transformed into working capital, for it to be used in other ways. For instance, if you have bonds and stocks, which are traded daily, you could raise instant cash by selling your stocks and bonds, immediately increasing your working capital. You can, in other words, raise cash by factoring your receivables. However, this is a very costly issue.
One of the reasons why it can be costly is because it is highly complex to convert commercial real estate equity. Usually, you have two options available to you: sell it, or have it refinanced. By refinancing the equity in your commercial real estate, you should be able to raise cash. However, you don’t know who much you will get, as it depends on how much positive equity you have in your building and how much it is worth. Furthermore, you will have to pay a variety of fees and it can take as long as three months before you see any money.
If you have a desperate need for cash, you will be forced to sell it. In that case, you have two new problems. First, you may run a loss on the property if there isn’t a seller’s market. Second, it means you can no longer stay in your building to operate your business.
So is owning commercial real estate bad for business? It all depends on how aware you are of potential risks.