The decision to buy or lease your office space can, and should, be made on properly
based economic principles.
The early 1990s will be remembered for the crashing of commercial property values and
the people, and institutions, who were humbled. It had looked easy. Come up with a
small down-payment. Mortgage payments had been easy to afford because of inflation.
Lenders were eager to lend more based on the increased value of the property. Finally,
the property could be flipped at a large profit after a very short period of ownership.
Unfortunately, the economy did not continue in the same manner. Property value
increases of 20 percent, 30 percent, or even 50 percent per year are sometimes
sustainable over the short term, but in the long term, prices inevitably stabilize and
readjust. Reality and sensibility has returned to property values.
There are both psychological and economic reasons for deciding between leasing and
buying.
Pride and distinction are intangible elements that come from owning your own office
building. Even if it is just a converted home off Main Street, it is still yours. Some would
rather own than be in debt. Others may be looking for a place to invest and diversify
assets. Leasing allows the flexibility of choice to change in the future, and it puts the
burden of maintenance on someone else’s shoulders. These are the non-quantifiable
reasons for owning rather than leasing.
The economic reality of owning must also be considered - the impacts of tax treatments,
cashflow, and financial statements.
The tax code requires buildings to be depreciated on a straight-line basis. The land is not
depreciable. Building contents (equipment, furniture, air conditioners, water heaters, etc.)
are depreciated at a different rate than the building. As a private company, accounting for
depreciation decreases taxable income (as a non-cash expense) but not take-home
income.
Leases and mortgages are treated differently from an accounting perspective. A lease is a
payable only, having no effect on the net worth of your company. A mortgage is both a
payable and a liability, reducing your net worth. The down-payment must be treated as a
long term (illiquid) asset. The annual gain in the value of the property is not taxable as
income but as capital gain at the time of ultimate sale. If the property is owned within a
corporation company, sale of the property can possibly be facilitated through sale of
shares, avoiding recapture of depreciation.
Lease and mortgage costs are frequently similar amounts. The difference is whether it is
yours or the leasing company’s capital tied up in the down-payment.
For the same outlay the agent in a large market will make to rent space, the agent in a
smaller center could buy the building. This is the same approach that a doctor or dentist
would take.
Kinds Of Lease Arrangements
GROSS is a fixed amount of rent which represents the capital cost for the owner and the
current level of operating expense. Future increases in operating expenses are added in
subsequent years. This is an older form of lease. It is good for the tenant because of the
predictability of costs over the term.
NET/NET is a fixed amount of rent which represents the capital cost for the owner. All
other costs (taxes, caretaking, security, utilities, etc.) are passed on — proportionately —
to tenants.
Lease Terms & Clauses
There are certain clauses in the normal boiler-plate of lease agreements that can lead to
problems if not understood beforehand:
• Renovation clauses. Costs for capital improvements (new roof,
elevators) made by the owner can be passed on to the tenant.
• Restoration clauses. You may be required to restore your space to the condition it was in
before your lease began.
• Liability clauses. These cannot be modified but be sure the implications and
exposures are understood and properly and fully insured against.
Always try and negotiate a “fairness” provision. The landlord always takes the position
that he is not responsible for anything. At the places in the lease agreement where this is
addressed, a suggested alternative wording could be“unless it is due to the negligence of
the landlord or those for whom, in law, he is responsible”.
No matter how much space is being rented, always consult a leasing expert and/or a
lawyer. Changes are not always permitted in the boiler-plate of a lease. Even trying,
unsuccessfully, to renegotiate has its positives — you are more aware of the lease
provisions, and the landlord will have more respect for your asking. The worst outcome
will be that your request is denied.
As well, check out the landlord. How do current tenants feel they have been treated? Are
there any municipal work orders against this or other buildings owned by the landlord?
Check with the Better Business Bureau about the landlord. Ask Dun & Bradstreet for a
credit report — does he need you more than you need him? Compare what the landlord is
offering versus what else might be available in the local market.
Renting space in a building is not just obtaining four walls. The space rented by a
previous tenant may be acceptable as is, with just some redecorating. The cost of creating
the internal space was borne by the previous tenant, and amortized over the term of the
lease. The cost of creating a new office can be handled in two ways but your rent will
always include the cost. The landlord may provide an upgrade allowance leaving design
and construction contracting to you - subject to landlord approval. Any savings are yours,
and cost over-runs are your responsibility. Alternatively, the landlord would provide, and
control, a design service, taking care of the construction — with extras being your
responsibilities. If you have a choice, it will be the balance of convenience over control
of the event. If the rental market is depressed in your area, it may be possible to negotiate
significant savings in moving costs, improvements or even in a period of free rent.
