There are many reasons why someone would prefer to lease a commercial property versus buying. However, a lease can be just as complex as a purchase and it’s important to know what a commercial real estate lease agreement entails. Here are a few differences to consider when deciding between leasing or buying.
- More liquidity
- Leasing commercial real estate requires less money upfront. Common items you may need to cover when leasing are security deposits, attorney fees, and inspections. This is significantly lower than the amount you would need for a purchase thus less of your liquid capital is being utilized in acquiring the property.
- Potential tax benefits
- Purchases and leases both have potential tax benefits so be sure to consult your tax professional for more detailed information. Some benefits to discuss are deducting lease payments, utilities, maintenance, property insurance, and property taxes.
- Higher flexibility
- Businesses ebb and flow and a benefit to leasing is the flexibility you have to move into another space that better fits your needs. The length of a commercial lease can have a large range so be sure to consider how much time you’d like to spend there when beginning your search. If your goal is to purchase but you can’t find the right space or need more funds, leasing also allows you the ability to continue your day to day business while you save and wait for a property you’d like to purchase.
- Cheaper and easier to get into an existing development
- If you are hoping to move into a specific building, location or area of town and there aren’t any spaces available for purchase leasing may be your only option.
- No investment potential
- When owning a building you are able to build equity and benefit from the appreciation if it sells. As a renter you don’t receive these benefits which can hurt your income potential.
- Higher monthly payments
- Mortgages can be spread out up to 30 years so your monthly lease payment could be higher than your payment if you owned. Also, some lease agreements require a tenant to pay more than just rent. For example, a triple net lease requires tenants to pay monthly property taxes, utilities, maintenance costs, and retail insurance. These can increase the cost of a lease compared to a mortgage.
- No property control
- A landlord has the control to make vital decisions about the property that can affect your business. Also, there are such things as clauses in your lease agreement that can trigger a termination or increases in rent based on certain criteria should be well understood and thought through prior to signing. These things add a level of uncertainty then an outright purchase would.
- Renewals can lead to cost increases
- The end of the lease comes with a high level of uncertainty. A landlord could decide to significantly increase the monthly payments or decide not to renew your lease at all which could leave you hurrying to find a new space.
- Earning equity in the property
- There are a few ways to earn equity after purchasing a property. If you took out a loan the property will earn equity as you repay the loan. You can also increase the value of your property with improvements such as renovations or expansions.
- Asset appreciation
- Over time the property can increase in value by general appreciation. An increase can occur for a multitude of reasons including low supply, increased demand, or as a result of changes in inflation or interest rates.
- Rental potential
- If you do not plan to occupy the entire property you could choose to rent out the vacant space to a tenant. This will bring in rental income but you’ll also be responsible for the tenants in a landlord capacity unless you decide to hire a property management company.
- Potential tax benefits
- Consult with your tax professional for more detailed information but potential benefits could include deductions for interest expense, depreciation expense, and other non-mortgage related expenses.
- Higher upfront costs
- When purchasing real estate you’ll come across many things that will add up to higher upfront costs than you would see if leasing. Things like your downpayment, closing costs, inspections, and due diligence can add up quickly requiring .
- Increased liability
- As an owner you’re responsible for the safety of those who utilize the space. You’re responsible for any maintenance or repairs on the property as well. If you are renting out space there are additional insurance policies you’ll need to have in place for your protection.
- Risk of property depreciation
- You are at the will of the real estate market so there is always a risk of your property losing value just based on those conditions. Your property can depreciate regardless of what condition you’ve kept it in.
- Lack of flexibility to move your business
- If you find the property you are in doesn’t fit your needs anymore you can’t just leave at the end of your lease. You will need to either sell or rent the space which could be difficult depending on various circumstances. A lease of a few years provides a much greater flexibility than a 15-30 year mortgage.
Common Types of Commercial Leases
The simplest type of commercial lease is a full-service gross lease, or gross lease. It is structured so a tenant is charged a gross lump sum each month. This rate includes all the operating costs related to running the property such as property taxes, insurance, maintenance, and common area maintenance fees or CAMs. Since all of these fees are included in the rate a gross lease option will be higher than comparable properties that are using a different structure.
Gross leases can be adjusted to exclude certain expenses like utilities a tenant can pay on their own which would then be called a modified gross lease. Often times to avoid unlimited expenses an expense cap will be written into a gross lease which means the landlord will pay for a certain amount but anything exceeding is considered the tenants responsibility.
Letter of Intent
In commercial real estate a letter of intent (LOI) outlines the basic terms and conditions the tenant is prepared to offer in consideration of a lease. It’s a way to open dialogue between both parties and come together before formalizing a contract. This eliminates surprises and the need for multiple revisions on a contract. Below is a list of items you will be addressing in an LOI.
- Leased Premises
- Use of the Premises
- Initial Lease Term
- Option to Renew
- Tenant Improvements
- Landlord Improvements
- Additional Charges (NNN)
- Tenant Expenses
- Landlord Expenses
- Security Deposit
- Exclusive Use
- Early Occupancy
- Additional Terms
- Response Date