ADVANTAGES OF LEASING
Location– Leasing can allow a user to occupy space at a premier location, or in a synergistic multi-tenant environment, that the user otherwise couldn’t afford.
Flexibility & Mobility– Leasing can provide greater flexibility to a user who many need to expand or contract, and can provide mobility if a user needs or wants to relocate.
Availability of Cash– Leasing typically requires less cash out of pocket than ownership alternatives, leaving more capital to invest in the user’s products and services or to establish additional locations
Source of Financing– Leasing can be viewed as a source of financing, since many small or marginally profitable firms may find traditional financing difficult to obtain.
Stability of Costs- The long-term occupancy costs of leasing, when viewed from the user’s perspective, are generally simple to estimate and typically include base rent (pure net, pure gross, or hybrid), operating expenses pass-throughs, amortized tenant improvements, percentage rent (retail), and the like. Although some leases may expose a user to certain capital expenditures, tenants are generally insulated from unforeseen capital costs such as the replacement of mechanical systems, structural repairs, and roof or parking lot replacement.
Tax Benefits– Unlike ownership, the occupancy costs of leasing are fully deductible, including that portion of rent attributable to the value of the land.
Focus– Leasing space allows the user to concentrate on its primary business without the distractions of management.
DISADVANTAGES OF LEASING
Cost– For a firm with a strong earnings record, ready to access to capital, and the ability to take advantage of tax benefits from ownership, leasing is often the more expensive alternative.
Loss of Appreciation– Leasing means the tenant does not benefit from property appreciation.
Contractual Penalties- If leased property becomes obsolete or the business occupying the space becomes unprofitable, the tenant must continue paying rent or face penalties for default.
Loss of Salvage Value– Most leases provide that any improvements made by the tenant become the property of the landlord at the end of the lease term, or the landlord may require that the tenant remove any improvements made to the premises at the tenant’s expense.
Control– When leasing, a user located in a building with other tenants has little or no control over the types of the other tenants placed in the building. These other tenants can have an adverse impact on parking, hours of operation, use or compatibility, or building services.
ADVANTAGES OF OWNING
Appreciation– An owner enjoys the benefit of capital appreciation over time
Debt Reduction & Equity Build-Up– Assuming conventional financing, an owner enjoys debt reduction and equity build-up through amortization of the original loan amount, since both interest and principal are included in every mortgage payment.
Control– Within certain legal limits, a user who owns a building enjoys the opportunity to
operate the building as they see fit.
Income– If a portion of the property is rented, income from other tenants can be used to pay
the mortgage on the property or for other business or investment purposes.
Tax Advantages- An owner enjoys the benefit of interest and cost recovery deductions that
reduce the annual tax liability from real estate operations. The accumulated cost recovery
deductions, although taxed at the time of sale, are currently taxed at 25 percent, which is
typically less than the user’s marginal tax rate applied to ordinary income and the user enjoys
the benefit of those untaxed dollars until the property is sold. The capital gain from
appreciation, while currently taxed at 15 percent, is often 87 to 133 percent less than the user’s
ordinary income tax rate.
DISADVANTAGES OF OWNING
Time Frame– The decision to purchase should be made with a holding period in mind of at
least five years. Although historically commercial properties tend to appreciate in value, the
costs of acquisition and disposition may offset or eliminate the benefits of appreciation over a
short-term holding period.
Inflexibility– Often, owned facilities do not lend themselves to the expansion or contraction of
Initial Capital Outlay– Most commercial lenders require equity at closing of 20-30 percent of
the cost of the property acquired. This equity requirement ties up capital that could otherwise
be deployed to grow the user’s business.
Management– The management of commercial property can absorb manpower and require an
owner to focus on building management issues such as legal compliance, health and safety
issues, contractor management, and other issues not related to the user’s primary business.
Financing. The sources and availability of debt may be limited in times of economic recession
or depression, and rising interest rates may make refinancing difficult or impossible.
Financial Liability– Although equity financing & investment capital may be readily available,
a commitment to long-term debt financing often involves a 20-30 yr amortization &
possible loan provisions that mandate pre-payment penalties if a loan is paid off prematurely.
Risks. There are numerous risks to ownership, including internal and external obsolescence,
market risks, financing risks, and unforeseen capital requirements for repairs & maintenance.