COMPARISON BASICS
Some of the basic pros and cons to consider in the decision making process are as follows:
A. Lease Benefits
(i) Provides short-term flexibility with greater ability to move to a new location, which may be a bigger or smaller facility depending upon the growth of business; (ii) credit rating and financial statement are not as significant a factor in leasing as is the case with buying a property with financing; (iii) as there is no down payment in the equity, and lease security deposits are typically limited to one to two months base rent, less cash is tied up in leasing the real property which in turn allows use of the saved cash for other business purposes; (iv) the monthly rent can be deducted from taxable income as a business expense; (v) the monthly and annual cost of leasing is primarily limited to the amount of the agreed upon rent and is therefore more predictable than the cost of ownership; (vi) if there is a need to move before the end of the lease term, subletting or other transfer of the lease interest is generally available; and (vii) there is no loss in a declining market, and rents/cost of leasing will typically decline with the property’s market value.
B. Lease Disadvantages
(i) Rental rates and annual escalations are based on current market conditions and can result in a significant increase at the time of lease renewal; (ii) there is no equity appreciation for the benefit of the tenant, and in an appreciating market, rents will also generally rise; (iii) unless there is an express right to extend the lease, the tenant could be forced to move at the end of the term if the owner desires to put the space to different use or lease to a different party – this can be particularly devastating to a retail or service business dependent upon location; and (iv) any capital invested into the leased property by the tenant (such as tenant improvements) will generally remain with the real property and be lost at lease expiration.
C. Ownership Benefits
(i) If part of the price is financed, the interest on the loan is deductible from taxable income; (ii) the owner has (subject to applicable laws) complete control over the property such that it can be used and improved without third party landlord approvals; (iii) property taxes and other property expenses are generally deductible from taxable income; (iv) annual depreciation of improvements on the real property is available for deduction from taxable income; (v) there is no risk of increase in rent; (vi) any space not used by the owner may be leased to third parties, thereby generating income; (vii) there is no lease term limiting the time that the property may be used or the period over which the improvements made can be enjoyed; (vii) as owner, equity build-up from market appreciation over time may be realized at the time of sale; (viii) capital gain tax resulting from sale of the real estate may be deferred by acquiring another property in accordance with Section 1031 of the Internal Revenue Code; and (ix) there are certain state (and federal) tax incentive programs for certain types of property uses, and properties located and redeveloped within certain designated areas.
D. Ownership Disadvantages
(i) The initial cash outlay to purchase is significantly greater, and even with use of acquisition financing the owner is typically required to make a 30% to 40% equity down payment (or more); (ii) the risk of a declining market resides with the owner; (iii) owning real property subjects the owner to various legal and regulatory risks and reporting obligations not associated with leasing (some of which are noted below); (iv) unless owning and investing in real estate is the company’s primary business, owning requires the investment of much more human management time in areas that are not part of the core business, and can therefore distract from the central business purpose of the company (such as ongoing maintenance and compliance with laws); (v) upon sale of the asset, prior depreciation deductions taken for tax purposes can be recaptured and taxed at regular income levels instead of lower capital gain levels; (vi) the risk of changing laws, including environmental, land use and building/fire code and taxation laws, are primarily on the owner; and (vii) while insurance can mitigate risk, an owner is potentially liable to third parties for any injury occurring on or about the property, whereas a tenant’s liability is generally limited to the portion of the property it leases.
A. Lease Benefits
(i) Provides short-term flexibility with greater ability to move to a new location, which may be a bigger or smaller facility depending upon the growth of business; (ii) credit rating and financial statement are not as significant a factor in leasing as is the case with buying a property with financing; (iii) as there is no down payment in the equity, and lease security deposits are typically limited to one to two months base rent, less cash is tied up in leasing the real property which in turn allows use of the saved cash for other business purposes; (iv) the monthly rent can be deducted from taxable income as a business expense; (v) the monthly and annual cost of leasing is primarily limited to the amount of the agreed upon rent and is therefore more predictable than the cost of ownership; (vi) if there is a need to move before the end of the lease term, subletting or other transfer of the lease interest is generally available; and (vii) there is no loss in a declining market, and rents/cost of leasing will typically decline with the property’s market value.
B. Lease Disadvantages
(i) Rental rates and annual escalations are based on current market conditions and can result in a significant increase at the time of lease renewal; (ii) there is no equity appreciation for the benefit of the tenant, and in an appreciating market, rents will also generally rise; (iii) unless there is an express right to extend the lease, the tenant could be forced to move at the end of the term if the owner desires to put the space to different use or lease to a different party – this can be particularly devastating to a retail or service business dependent upon location; and (iv) any capital invested into the leased property by the tenant (such as tenant improvements) will generally remain with the real property and be lost at lease expiration.
C. Ownership Benefits
(i) If part of the price is financed, the interest on the loan is deductible from taxable income; (ii) the owner has (subject to applicable laws) complete control over the property such that it can be used and improved without third party landlord approvals; (iii) property taxes and other property expenses are generally deductible from taxable income; (iv) annual depreciation of improvements on the real property is available for deduction from taxable income; (v) there is no risk of increase in rent; (vi) any space not used by the owner may be leased to third parties, thereby generating income; (vii) there is no lease term limiting the time that the property may be used or the period over which the improvements made can be enjoyed; (vii) as owner, equity build-up from market appreciation over time may be realized at the time of sale; (viii) capital gain tax resulting from sale of the real estate may be deferred by acquiring another property in accordance with Section 1031 of the Internal Revenue Code; and (ix) there are certain state (and federal) tax incentive programs for certain types of property uses, and properties located and redeveloped within certain designated areas.
D. Ownership Disadvantages
(i) The initial cash outlay to purchase is significantly greater, and even with use of acquisition financing the owner is typically required to make a 30% to 40% equity down payment (or more); (ii) the risk of a declining market resides with the owner; (iii) owning real property subjects the owner to various legal and regulatory risks and reporting obligations not associated with leasing (some of which are noted below); (iv) unless owning and investing in real estate is the company’s primary business, owning requires the investment of much more human management time in areas that are not part of the core business, and can therefore distract from the central business purpose of the company (such as ongoing maintenance and compliance with laws); (v) upon sale of the asset, prior depreciation deductions taken for tax purposes can be recaptured and taxed at regular income levels instead of lower capital gain levels; (vi) the risk of changing laws, including environmental, land use and building/fire code and taxation laws, are primarily on the owner; and (vii) while insurance can mitigate risk, an owner is potentially liable to third parties for any injury occurring on or about the property, whereas a tenant’s liability is generally limited to the portion of the property it leases.