Business owners must constantly weigh risks versus rewards when evaluating growth strategies. An example is owning commercial property, which involves more responsibilities and expenses than leasing a space. However, over the long term and in the right circumstances, commercial real estate may be a smart investment with a high upside.
Buying a business property is a different process from buying a home, and it involves different considerations. Before buying property for your business, it is important to engage an attorney who is experienced in handling commercial real estate transactions.
Pros of Buying a Commercial Property
Volatility in the commercial real estate market adds risk for small businesses that want to expand their physical footprint.
Further, increasing interest rates result in higher borrowing costs for small business owners; however, a mortgage may be refinanced in the future. In addition, a higher monthly payment may be balanced by the following benefits of owning a business property:
- Fixed payment. Fixed-rate loans protect borrowers from future rate increases. In contrast, rent may increase in a competitive rental market.
- Build equity. The average annual commercial real estate return on investment is nearly 10 percent. Businesses that own property may take steps to enhance their value over time. As a result, buying property may make owners wealthier, and the added business value can provide greater borrowing power for the future expansion of the business.
- Generate additional income. If a business buys a commercial property but does not need all of the space, they can rent out the unused space to tenants for a secondary income stream. Additional income can also be generated by selling advertising space on the property if permitted under local law.
- Tax advantages. There is no guarantee that a business owner will profit from commercial real estate, but their ability to deduct mortgage interest, property taxes, property depreciation, and other expenses may provide tax benefits.
- Control. While renters must defer to their landlords regarding building repairs, maintenance, and upgrades, owners have more control over their property. As long as they comply with zoning requirements, owners are free to make renovations that align with their goals and business culture. Another important benefit is that a business that owns the property where their business is located is not subject to the risk that a landlord will sell a property and displace the business.
Downsides of Owning Commercial Property
Like many business decisions, buying commercial property is a risk–reward proposition. The benefits of owning must be weighed alongside the disadvantages, which may include the following:
- Down payment. Small business owners can expect to need a down payment of 10 to 40 percent. For example, if a commercial building costs $1 million, the down payment needed will be $100,000 to $400,000. Many businesses simply cannot afford this expenditure, or they will need to prioritize other capital investments.
- Financing. The down payment is not the only affordability consideration involved in buying commercial property. The business will need to qualify for a loan with an affordable interest rate. Commercial loans may also impose prepayment penalties if a business owner repays the loan early.
- Maintenance cost. Depending on the lease terms, a tenant may be responsible for limited repairs and maintenance. In contrast, when a business owns a commercial property, all maintenance responsibilities fall on the business, leading to unexpected costs and disruptions.
- Bad investment. Business owners who purchase commercial properties may have to deal with the impacts of overpaying, bad locations, depreciation, or market crashes. These factors could make leasing a commercial space look good in retrospect.
- Legal exposure. Property owners sometimes have more legal responsibilities than tenants under premises liability law. If a person is injured due to a dangerous condition on a property, they can sue the owner. Moreover, obtaining adequate insurance coverage imposes additional costs on a business.
An Experienced Attorney Is an Important Part of the Equation
Real estate may be the largest investment your business ever makes. In addition to consulting an accountant who can help you crunch the numbers associated with owning a commercial property, there are legal aspects to commercial real estate that demand a lawyer’s expertise.
Our attorneys can advise you about local building and zoning rules, landlord-tenant statutes, and other legal considerations associated with owning commercial property, such as the type of legal entity to choose for your business and whether the business entity should own the property or a separate company should be established to own the property. We can also help you negotiate with the seller, prepare paperwork, navigate environmental and title issues, and complete the purchase. Call us today to schedule an appointment.
Mia Taylor, 2023 real estate return on investment, Bankrate (Oct. 14, 2022), https://www.bankrate.com/real-estate/roi-on-real-estate/#average.