Owning Vs leasing your premises

Alchemy Corporate Advisors -

"It all depends"....

Right now it's a tantalizing idea to own the premises you operate from - the listed property sector showed median returns of 50% during 2005, with Redefine generating a breathtaking return of over 90%, so doesn't it make sense to buy your own building, rather than let the landlord get rich off your rental? As the enigmatic cliche goes: "Ja nee", or in English "It all depends".... Lets have a look at the pro's and con's of buying your premises, rather than following the traditional route of leasing them.

Buying your premises

+ Certainty via fixed costs and automatic renewals: Locking in your bond long-term can give your business clear, fixed costs and in addition, your “landlord” is unlikely to kick you out upon lease expiry! Over the longer term, say in years 10-20 of ownership, occupancy costs for the business can approach zero given that the initial bond would’ve been paid off.

+ Tax Deductions: The costs of owning and running a commercial property can provide expense deductions in the form of bond interest, property taxes and other items.

± Additional income, additional headaches: Owning your premises means you’re in the property “game”. On the upside is the opportunity of renting out extra space to 3rd party tenants adding another source of income. However, being a reluctant landlord has it’s own costs – the hassle of managing leases, collecting the rent, replacing tenancies etc, fairly straightforward tasks when handled by a dedicated property management firm, but tricky to extract maximum value from when its not your core business. Also, until you have a substantial portfolio in place, its relatively cost inefficient to appoint expert property management staff to your payroll.

± Retirement fund: The prospect of owning commercial space and having the property appreciate over time, though almost certainly not at the extraordinary rates seen in the last few years, allows the owners of many smaller firms to sell out and fund their retirement. In the short term, any equity that has built up is an asset which can be used as collateral.

However, corporate governance issues rear their heads when the property is owned in a separate entity by one or more directors of a public firm – is the branch still in the right location? Is the firm paying a fair market related rental? These questions have to be transparently answered to prevent management time from being wasted in review meeting after review meeting to justify leasing premises from a director.

- Lack of Flexibility: A new or growing business may experience unexpected needs in the future. If your business continues growing, your owned premises may become inadequate forcing a sale of the property, which can be tricky, in particular if you’ve customised it in a way that narrows its appeal to the general market.

- Upfront Costs: Buying commercial property will initially cost far more upfront. There are the building, transfer, appraisal and on-going maintenance costs along with a typically substantial down payment (10-20% of the value if the building) and possible property improvement costs.

- Not a realistic option: occupiers needing high profile premises in specific locations, e.g. a regional shopping centre, generally aren’t in a position to own their trading environments. With the exception of perhaps the Shoprite group, retailers in SA don’t have significant property holdings, as many American and British retailers do. So it would seem that pragmatism and culture combine in SA to make leasing the favoured option, for retailers at least.

- Working capital: money not tied up in property can be used to respond quickly to opportunities in the market. In addition, your ability to borrow funds will not be as limited as with buying your space.

- Lack of focus: Lastly, and in my mind most critically, is the question of focusing on one’s core business. A ‘widget’ company should by rights generate significantly higher ROI from manufacturing and marketing widgets, than it does from property investment (notwithstanding the current bull market in property, which has made accidental property gurus of us all). So applying resources (capital + time) to managing property investments can be a costly distraction. And if the firm does in fact become world-class at property investment, it should sell out of the original widget business and re-focus on property – it’s practically impossible to ride two horses at once.

A few pluses, lot’s of minuses, so you can see my bias in answering the “lease Vs buy?” question.
“The truth is out there”, as Sculley used to say, so let’s defer to what the academics have 'proven'.
In a UK study done by Cass Business School in London, it found that listed companies which leased 60-80% of their premises achieved a 71% better return over the 14 years to Dec 2002. Their conclusion was that where companies lease their premises, they seem to manage it more effectively than when they own it, and this efficiency is rewarded by the markets.

This is confirmed by the Gerald Eve/RICS 2003 study showing that UK firms used 17.6sqm of office space per person in their owned buildings and only 15.5sqm per person in leased premises, a significant difference of 13.5%.

In summary: stick to your knitting and focus on your core business. Do not get distracted by property ownership and, as a rough guide, lease from 60-80% of the portfolio you occupy.

Article from: www.eprop.co.za