When is the right time to buy your office space instead of lease it?

This is a question I have heard many times from clients over my career, typically when lease rates are at historical highs or property values drop and begin to look attractive. I think economic and real estate market conditions in the past couple of years have created opportunities for corporate users to acquire properties for their operational use with attractive financial terms.

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The idea of owning your business real estate for companies that never have seems like a great idea. For major corporate users with multiple locations that typically both lease and own key facilities, there is less emotional appeal, and it is strictly a financial decision as they understand the implications of owning real estate and whether it’s a viable operational choice for a particular space requirement.

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Most companies are in the real estate business by default since it serves as an operational need to produce products or provide services. The decision to buy versus lease corporate real estate is not a consideration that should be based solely on the financial considerations but should include evaluation of a more comprehensive set of decision drivers. Corporate real estate decisions are not only about the financial implications but also managing the risk associated with that decision.

Many internal and external factors affect such decisions and their eventual outcomes. These factors have to be carefully evaluated in order to make the decision that best complements the overall business objectives of your organization.

Weighing the benefits and the risks

An attractive financial transaction does not always translate into the best real estate decision. The benefits and risks of each option have to be weighed carefully.

Leasing benefits

• Lower upfront capital requirements
• The availability of various lease term choices (length) that best fit your companies’ projected operational requirements
• More flexibility for growth and contraction both short and long term
• Ease of disposition at the end of the lease term

Leasing risks

• Exposure to fluctuations in market rents and landlord-provided concession packages and incentives
• Potential for missed option and notice dates
• Disposition prior to end of term can be challenging, depending on market conditions and other factors
• Typically dependent on third-party property management and service providers for quality of life and service issues
• Building ownership can change hands

Ownership benefits

• Property value appreciation
• At some point with continued occupancy, ownership becomes less expensive each year on an actual cash basis
• Realization of residual value of tenant improvement costs
• Depreciation for some entities
• Tax benefits (income and property if municipality offers incentives)
• Control of quality of life and property management vendors

Ownership risks

• Ownership of real estate is a separate non-core business that requires time, real estate expertise and resources
• Less flexibility than leasing particularly in growth and contraction
• Potential loss in asset value
• Economic and interest rate risk
• Risk associated with change in demographics, transportation issues and perceived neighborhood quality

Decision drivers

• Required capital outlay (including retrofit costs)
• Required return on investment
• Internal competition for capital
• Short vs. long-term plans impacted by other large capital investment initiatives
• Projection of required employee headcount based on revenue, product or service demand (static or rapid changes)
• Projected market conditions
• Demographic and labor force shifts
• Neighborhood stability
• Capital appreciation
• Income tax implications
• Financial reporting
• Perception of stability as a result of ownership
• Exit strategy

The decision to buy or lease includes a myriad of financial and operational factors that extend beyond the real estate asset and its projected occupancy cost. There should be an equal consideration given to business needs and expectations.

Owning is typically more advantageous as a long-term decision, but keep the end in mind

Purchasing a facility can certainly be a prudent long-term occupancy decision with significant financial reward and operational advantages. The real questions in my mind — assuming the economics are attractive – are: How much or how likely will your business or space requirement change and will owning a building create significant challenges in managing those changes? Owning versus buying is not only a financial decision but also a risk and operational decision.

You have to consider not only how attractive ownership might be going in but also what will be different if you own and how you will meet unexpected changing space needs. Can the building or site be expanded? Is leasing additional space at nearby buildings viable? Is excess space marketable to third-party tenants if staff reductions are necessary? And what is the exit strategy and projected value of the asset if required?

During my career, I have helped users lease, purchase, build, sell/lease back, sublet and dispose of office and industrial space. A trusted professional will help you make and execute a prudent decision.

Coy Davidson is Senior Vice President of Colliers International in Houston. He publishes The Tenant Advisor blog.