I am the owner of a construction services firm that I founded more than 10 years ago. We have always rented office space and will soon complete the third year of a five-year lease. I'm wondering if I should consider purchasing a building when our lease expires. What factors should I consider? Is there a mathematical formula someone can use to figure out whether to buy or rent office space?
-- Bill Ericson, president
National Project Management, St. Louis
There are no formulas in business that can substitute for good judgment, and so the answer to Bill's second question was easy: no. That said, there are some undeniable advantages to owning the space that your business occupies. For one thing, you can't be thrown out by your landlord. Then, too, you have the satisfaction of knowing that your company's monthly rental payments are coming back to you, rather than going to someone else. Under the right circumstances, moreover, commercial real estate can become a sort of piggy bank you can draw on for as long as you own it.
Suppose, for example, that you buy a property for $1 million. These days, banks will typically give you a 20-year mortgage if you put down 30 percent of the purchase price -- in this case, $300,000. And let's say that, by the time you pay off the mortgage, the property has doubled in value to $2 million. You can then take out another mortgage, and the taxes due on the proceeds will be deferred until you sell the property. If banks are still insisting on a 30 percent down payment at that time, you wind up with $1.4 million in cash. Assuming you're around long enough to pay off that mortgage, you can then do the same thing all over again.
To be sure, there are risks. You could lose the property and your investment if you run into trouble and don't have enough cash flow to keep making your mortgage payments. And there is no guarantee that the property's value will increase. If you buy at the top of the market or while prices are still falling, the value will obviously go down before it comes back up.
From that perspective, however, Bill's timing is pretty good. I expect that the commercial real estate market will bottom out in 18 months to 24 months -- right about the time his current lease ends. So I suggested he start looking around right now. He can use the time he has left on his lease to become familiar with the state of the market and scout out opportunities. That way, if he eventually does decide to buy rather than lease, he'll be ready to take advantage of the bargains that are sure to be available. Of course, every situation is different. So Bill should talk to his accountant and his lawyer before taking the plunge.