When it comes to buying a business, real estate often doesn’t get a lot of attention. But it should. Whether a business owns or leases its property impacts the business and its value. And if the business leases, prospective buyers need to understand the type of lease and its terms. Here are the basics.
Lease vs. own
Owning a home as an individual is usually a no-brainer value proposition. But for a business, there are definite pros and cons to owning real estate.
The benefits of owning are pretty clear-cut. The business has more collateral to support the borrowing capacity of the business. As it pays down the mortgage, it builds equity. Owning also allows the business to customize or even add on to the space without getting approval from a landlord.
The downside of owning is, of course, capital. Owning a property requires additional equity capital for an asset that has a lower internal rate of return (IRR) than the business. That lowers the overall IRR of the investment. Owning can also come with future complications. The business may outgrow the space, the location may be inconvenient, or a future buyer may not want to purchase real estate. It’s a lot to consider.
Leasing has its own pros and cons. A big benefit is flexibility. The business isn’t tied to the facility long term. Plus, the business has limited liability for capital expenditures related to normal wear and tear on the building.
The problem with leasing is that the business is somewhat at the mercy of the landlord. The owner could decide not to renew the lease or to increase the rent. Moving a business is expensive and time-consuming under the best of circumstances. When it’s not necessarily your choice, it’s even worse.
Kinds of leases
There are three main types of leases:
- Non-triple net (or gross) – In this agreement, all costs and expenses of the lease are included in the monthly base rent. The lessee pays the rent – and nothing more of the landlord’s costs. Rent under this kind of lease is generally higher than rent under a triple net lease.
- Triple net – This lease requires the lessee to pay the base rent and a proportionate share of other expenses. These include real estate taxes, building insurance, and basic maintenance. Rent is typically lower than under a non-triple net (gross) lease but you have other expenses which can increase if they go up.
- Absolute triple net – This agreement is similar to a triple net lease, with one big exception. The lessee is responsible for almost all repairs to the property. If there’s a problem with the foundation, a busted sewer line, or a roof that needs to be replaced, it is the responsibility of the lessee. This type of lease is common when the parties are related or if there’s been a sale-leaseback transaction.
Every business is unique, so there’s no one-size-fits-all answer to the buy vs. lease quandary. But what you can do is gather all the information and determine what works best for your business.
If you’re concerned with how real estate is going to work in your transaction, O’Keeffe & O’Malley can help. Call us at 913-648-1085 for a confidential meeting.