We often have company owners in Fort Bend seek our advice when weighing the advantages and disadvantages of leasing versus purchasing the commercial space needed to operate their businesses. Those of you who have followed my column over the last few years know that a number of factors other than equity accumulation can make the financial benefits of owning significantly more attractive.
The recent tightening of available credit in the commercial mortgage markets and the predictions of a recession by a number of financial gurus will persuade a number of these owners to determine that their reaction should be to wait for these conditions to stabilize before investing in real estate. In many cases they will be making a costly mistake.
Financial advisers universally advise their clients to avoid attempting to predict the timing of the financial markets. They encourage dollar cost averaging and investment strategies that are designed for the long term (typically five (5) years or more). They counsel that investment portfolios typically realize their strongest growth as a result of the investment activity during market lows. Similarly, real estate opportunities are often maximized during periods of slowed activity.
Before starting a business in Fort Bend, I was employed by a leading national real estate investment trust (REIT). Although it was rare when the company decided to dispose of one of their commercial properties, when they did decide to sell, it was always when the real estate market was healthy and capitalization rates dictated the highest prices. Likewise, the company’s acquisition efforts always took place when conditions were weak. We would buy shopping centers when vacancy rates and capitalization rates in the commercial market were high and the rents generated in projects were low. Although we knew that it might be difficult to generate a favorable return on the investment under the then existing market conditions, we knew that when those conditions improved and we were able to fully lease the project, the value added to the property would easily generate our desired long term return.
For businesses that know they will be operating in Fort Bend over the foreseeable future, the reasons for investing in a property rather than leasing are compelling. The tax benefits alone that are afforded to commercial property owners are reason enough to make purchasing a better alternative than leasing. The savings generated by 1) the tax deductions for mortgage interest payments 2) depreciation of the improvements on the property and 3) operating expenses, the occupancy cost will be significantly lower when owning rather than leasing.
The after tax difference, however, between the occupancy costs for the two alternatives is significant. If a business 1) generates sufficient income to take advantage of the tax deductions, and 2) knows that it will be conducting business in the property long enough to derive the benefits from the tax deductions, purchasing is a better alternative from a financial standpoint. Note that I qualified the above by saying that purchasing is a better “financial” alternative. Oftentimes a business will still elect to lease even though it is more costly. Leasing may allow the business to secure a location that would have been unattainable when purchasing (i.e. a retail space in Sugar Land Town Square). Business owners that make the decision to lease rather than purchase, even though more costly, do this because they have determined that the leased location will offer their company the opportunity to generate higher sales.
Up and down cycles in both the financial and real estate markets are inevitable. For savvy investors, however, these periods can offer some of the best opportunities.