When building and growing a business, buying the business premises is often not on the priority list. But once you get to a place where you’ve created a solid financial position, purchasing and building out your own space is a business milestone that can pay long-term dividends. It can lower monthly costs, be tax-efficient, and eventually provide a source of low-cost funding for future growth.
It can also increase the value of your business and diversify your risk profile. Not to mention allowing you to create a custom-built space that exactly meets your needs, whether that’s enhancing efficiency or building out a statement of what your business presents to the world.
In this week’s Inside Look at Building Towards Wealth, we break down exactly why owning your building can provide significant upside.
The Advantages of Owning Over Leasing
With a growing business, your needs change over time, and a lack of customization can limit your ability to grow and meet those needs. The ability to customize a facility that works for your vision can increase your growth trajectory, enhance efficiency on all fronts, and be meaningful to your bottom line.
While you may be allowed some customization to leased property, not being the owner puts you at the mercy of existing and new limits imposed by landlords, zoning rules, and environmental regulations. As an owner, you can petition for zoning variances and work with authorities to create solutions that comply with environmental standards.
Leasing a property usually means that you must continually account for an increased monthly cash outflow. Rents increase over time – one reason commercial real estate is considered a good investment.
Clarion Partners reports that since 1994, commercial real estate rents outpaced inflation in 19 of the past 27 years. The average annual growth rate is 2.1% over the same period. In addition to increased leasing costs, getting additional concessions to upgrade or update space can become more difficult as the landlord realizes the cost of moving may be greater than accepting less-than-advantageous terms.
Deciding to buy means allocating upfront cash to real estate instead of using the funds for other purposes – either business or personal – but it can put you in a position to lower monthly costs and lock them in. This creates a more solid balance sheet, which in turn can help you tap other sources of funding. And when you’ve built equity in the property, that can become a low-cost source of financing as well.
Owning Equals Equity (And Tax Advantages)
When you may already have loans for business capital, taking on debt to purchase a building can initially seem like an increase of risk. In reality, you are building equity and diversifying your risk profile – as well as potentially lowering and smoothing your monthly outflows. Over time, you’ll build equity in the property, and your initial liability slowly evolves into an asset.
As you build equity through paying down debt and potential appreciation, the property can become a source of low-cost capital that can replace other debt as you continue to expand and grow. You’ll have a more diversified portfolio while you own the business, and it will add to the overall value when it becomes time to exit in retirement.
Aside from the ownership aspect, you also receive favorable tax benefits that aren’t available when renting or leasing, including:
- When you’re making loan payments, you can generally write off the interest paid as well as take advantage of depreciation deductions.
- The IRS allows depreciation of commercial buildings over 39 years, which means you can deduct a portion of the building’s cost from the business’s taxable income every year when using the straight-line method
- Maintenance work to the building, such as renovations and upgrades, can qualify as deductions.
It’s More Affordable Than You Think
Depending on your business, you may be eligible for low-cost funding sources. To help business owners with real estate purchases, the Small Business Administration created 504 loans. With SBA 504 loans, borrowers pay fixed interest rates on fixed assets with longer terms, generally 10 to 25 years. This helps owners of small and mid-sized businesses hold on to more of their cash in the short term while consistently growing their equity in the property.
To qualify for a 504 loan, the business must have a net worth of less than $15 million, and the average net income must be under $5 million for the prior two years. There are restrictions on the types of businesses allowed to use SBA loans, but most for-profit companies that fall under the income thresholds can qualify.
Also, if you plan to make your property more energy-efficient, you may qualify for the green provision, which allows business owners to for higher lending amounts. To qualify, you must show how planned renovations will reduce energy costs by at least 10%, including energy-efficient lighting or better-insulated buildings to reduce heating costs.
If you’re in a robust financial position, it’s worth looking into buying a building. Financing costs are still relatively inexpensive, and the investment can lower costs and create an additional asset.
However, the decision to purchase a property isn’t always straightforward, and a financial advisor can help determine the best route to take concerning your overall financial picture and business goals.
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