There are many factors for end users to consider in determining when to buy or lease commercial real estate. One of the most important aspects for users is to look at their business plan. The business plan should make provisions for long term growth and space requirements. High growth companies usually do not build or purchase real estate. In the early 90’s Dell Computer was leasing space in Breaker Center as fast as the buildings became available. Dell could not build or purchase buildings quick enough to keep up with their growth. I remember seeing the breaker Center leasing agent with a two way radio that Dell required he carry at all times. There space needs changed minute by minute and In the short term leasing was the only option. Leasing provides more flexibility for companies that fluctuate in size. Other factors include specialization.

In 1999 I was involved in the construction and sale of a warehouse for Ashland Chemical. Ashland was providing chemicals for the semi-conductor industry. The chemicals were both flammable and corrosive. The specialized building needed just didn’t exist. They decided to build and own this facility. Still another factor is cost of capital. Many companies need to put all their resources into growing their business. Why tie up funds in a building and maintenance staff when those funds can be used for generating revenue. Market factors are also very important. Today lease rates are well below the cost on some office properties due to an oversupply of space. Combine this with the poor performance of the stock market in the past years and what you find is a high demand for investors to purchase real estate. This demand has pushed prices up. During the early 90’s there was a fairly ready supply of buildings that were selling below replacement cost. Buying at the low point in the market cycle provided low cost alternatives to leasing for some companies. The market factor is extremely important in the decision making process.

Dr Steve Sherwood at left and Attorney Rick Whitley right are happy to have completed the paperwork for the purchase of Dr. Sherwoods new Medical Condo.

We all have worked with companies that say we really want to buy rather than lease. There is just something about owning real estate and many decision makers are sometimes blinded by the American dream. However buying is not right for everyone and a detailed analysis is needed to help with this decision.

One of the tools that the CCIM institute uses is Net Present Value (NPV). In the simplest terms net present value looks at which investment option (purchase or sale) requires less money at time period "0" to make the needed payments over time. The Net Present Value discounts all the cash flows back to a start point at a given discount rate (purchaser’s safe rate). That amount is then compared for both the sale and lease options. Another way of looking at is if I were to purchase a building and use it for 10 years (hold period), how much money do I need to have in the bank today and at what rate does it need to be invested for me to make the needed withdraws (payments) over the10 year estimated hold. The option that has the lowest net present value is the less costly option

A small accounting firm was looking for new office space along Bee Caves Road. They company liked the look of one complex in particular and wanted to purchase one of the office condominiums. In the complex there were both units for sale and lease. Which options is best? The following tables will take you through a simplified analysis:

There are many factors to look at when determining if it is best buy or lease commercial real estate. One of the decision making factors is to look at the financial data.

One of the tools that the CCIM institute uses is Net Present Value. In the simplest terms net present value looks at which investment option (purchase or sale) requires less money at time period "0" when the time value of money is considered for the investments. For example, if I were to purchase a building and use it for 15 years (hold period), how much money do I need to have in the bank today and at what interest rate does it need to be invested for me to make the needed withdraws over the15 years estimated hold period. In the same way the Leasing option looks at it the same way even though the cash flows are a little different. The question is in calculated the Net Present Value is how much money do I need to have in an interest bearing account and at what rate should it be invested so that I can go to that account and withdraw the funds needed each period over the 15 year lease.

For our example two identical 2,000 square foot units were found. One was for sale at $195.00 per square foot the other for lease at a market rental rate. A banker specializing in SBA loans agreed to loan 90% of the purchase price at fixed rate of 6.5% on an amortization schedule of 25 years. In the 10^th year the building was sold at $240.00 a square foot less a 7% cost of sale. This produced the cash flows listed in the table. Note that the expenses are identical for both the purchase and lease options (convenient for this example).

For the lease option the schedule below shows the rent, expenses and cash flows. In this example note the total dollars spent over the 10 years. If you compare $269,198.97 for the sale and $380,300.70 for the lease most of us would pick the sale. When you look at the Net Present Value a slightly different picture appears. As long as the rate is 3% or 7% the NPV for the sale is less, an easy decision. But when we increase the rate to 10% the NPV is less for the lease. This is true because in the Lease example the user is able to invest the money (down payment and higher payments in the first years) at a rate higher than the return produced from the amortization and appreciation in the sale.

In conclusion there are many factors in making the decision as well as thorough understanding of your business. Hiring a skilled knowledgeable commercial broker is one way to insure that you have looked at every aspect of the buy verse Sale question.