Your business needs a home too, right? Why not start leveraging this fact to buy commercial real estate?
With the right strategy in place, investing in commercial real estate can be a smart business move.
The movie “The Founder” underscores just how transformative owning commercial real estate can be in building an empire like McDonald's. Although the scene above may be an exaggeration, it poses a question that every company founder must face: Should I own commercial real estate for my business to occupy?
The Benefits of Owning Your Office Space
The process of buying an office for your business to use is referred to as an owner/user transaction. Typically, a business owner purchases a property and leases it back to the business on terms optimized for both the owner and user.
Let’s take a look at the benefits of building ownership when you own the business and the real estate.
1. Build Equity for Yourself
Chances are, a good chunk of the rent you pay to your current landlord goes toward paying down their loan.
In an owner/user transaction, you are the landlord, so your company writes that rent check to you so that you can pay down the balance of your loan. It’s like taking money out of one pocket and putting it right back in the other.
Many business owners think that beats handing their hard-earned cash to a stranger on the first of each month. Add the increase in your property’s value to the reduction of your mortgage balance over time, and your pile of equity is constantly growing.
2. Diversify Your Portfolio
Entrepreneurs build their wealth, mainly by growing their businesses. As a result, their net worth is concentrated in the value of the business itself along with the owner’s personal residence.
By acquiring commercial buildings to create a home for your business, you diversify your personal portfolio and create a new income stream at the same time. Why pay rent to a landlord when you can pay it to yourself instead?
When the property no longer suits the space needs of your business, you can keep the property and rent it to a new tenant, exchange it into another home for your business or sell it and use the profits for whatever else you want.
3. Receive Tax Benefits of Ownership
While there were some concerns that the recent tax reform legislation (passed in December of 2017) would limit or disallow mortgage interest deductions, the final bill left the traditional tax benefits of real property ownership intact.
Property investors continue to enjoy the full deductibility of mortgage interest and the benefits of IRC Section 1031 to execute tax-deferred exchanges of real property (buildings, land and the like).
The economic life for depreciation moved up from 39 to 40 years for non-residential investment properties.
The Tax Cuts and Jobs Act also created two new property designations, Qualified Improvement Property and Qualified Real Property, which offer the owners of commercial properties bonus depreciation for leasehold improvements and designated capital expenditures. These include roof and HVAC replacement, which were previously depreciated over their designated useful life.
Buyers of commercial properties now also have access to component depreciation, also known as cost segregation, which allows for accelerated depreciation of separate building components designated as having a useful life of fewer than 20 years.
4. Control Occupancy Costs
One of the most important drivers behind the owner/user decision is the desire to control long-term occupancy costs.
Many tenants have grown weary of paying rent and operating expense increases year after year and getting nothing in return. Commercial property rents have risen dramatically during this economic recovery, and landlords have gained the upper hand in lease negotiations.
The truth is that tenant improvement allowances have dwindled alongside rent abatement while operating expenses and rents have risen. The availability of low interest rates and fixed-term financing (for up to 25 years) has allowed many tenants the opportunity to stabilize occupancy costs by buying their commercial buildings. Typically, the owner/user matches the lease rate to the mortgage payment for the property, but you can also build in your desired return. Either way, you have control on both sides, as landlord and tenant.
4 Considerations for Purchasing Office Space to Use
At WindWater Real Estate, many of our clients have executed the owner/user strategy with great success. Purchasing commercial property with your business as your anchor tenant is a very effective way to build a commercial real estate portfolio.
We’ve touched on some of the benefits of becoming an owner/user, but this decision must be carefully considered based on your unique circumstances.
- Evaluate your space needs: The owner/user dynamic works best for owners with businesses that have relatively stable, predictable space needs. It probably isn’t practical to move your business every couple of years because it has outgrown your building.
- Consider the leasing potential of the property: Buying quality buildings that can be quickly and effectively re-leased to other businesses is a must.
- Compare the cost of owning versus leasing: You should be comparing the cost of owning a building to the cost of leasing the same (or a very similar) building. If the numbers are telling you that leasing is more cost effective, being an owner/user may not be the right move.
- Evaluate the tax benefits: As mentioned above, tax laws favor property owners. Before determining whether to lease or own office space for your business, consult your tax professional regarding the tax benefits of owning.
Unsure whether your business should own or lease its office space? WindWater Real Estate is here to help.
Our team of experienced commercial real estate brokers can help understand your goals and guide you toward the most lucrative opportunity for your business.