Pros and Cons of Owning Your Business Property

Ownership is attractive for reasons that go beyond the monthly number. CDC Small Business Finance, a lender to owner-occupants, names four common motives: control, more predictable long-term costs, the ability to customize the property, and equity.

• Control. You decide on renovations and additions, subject to zoning, codes and your lender’s terms. A tenant usually needs the landlord’s approval.
• No landlord at renewal. Nobody can decline to renew your lease, redevelop the property or raise your rent when your move would be most disruptive.
• More predictable debt payments. A fixed-rate loan keeps principal and interest steady. Taxes, insurance and repairs can still rise.
• Equity. Part of each loan payment reduces the balance, and once the loan is fully repaid you own the building free of that debt.
• Possible appreciation. If values rise, the gain belongs to you. Truist notes that the rate of appreciation varies with inflation, local supply and demand, interest rates and other factors.
• Possible rental income. Space you do not need can sometimes be leased, within your lender’s limits.
• Tax deductions. Business interest, real estate taxes and depreciation on the building may be deductible, as rent may be for a tenant. IRS Publication 946 says land itself cannot be depreciated. Ask your CPA how the two paths compare for your company.

• Capital tied up. The down payment and upfront costs leave the business. Truist’s comparison puts a down payment often at 20 percent of the purchase price. Programs and lenders differ, so get your own figure, and add closing costs, reports and renovation.
• Every repair is yours. Truist lists the kinds of items involved: foundation, roof, walls, HVAC, electrical, plumbing, sidewalks and parking lots. Repairs come on their own schedule, not yours.
• Management time. Someone has to run contractors, insurance and compliance, and that person is usually pulled from another job.
• Harder exit. A tenant can leave when a lease ends. An owner has to find a buyer or tenant, and Truist observes that a buyout or sublease could be easier than selling in a down market.
• Less room to adapt. A growing company can outgrow a building. A shrinking one can be stuck with too much of it.
• Loan terms. Financing may require a personal guarantee, according to Truist, and loans may carry prepayment penalties, which can make an early sale or refinance more expensive.
• Compliance. The ADA Title III regulations apply to a private entity that owns, leases or operates a place of public accommodation. As an owner-occupant you may have no landlord to share that obligation with. Ask your attorney what applies to your use.

Most of the items above are costs you can estimate. Concentration risk is different. It means more of your wealth, your income and your company’s survival now depend on the same thing.

If the local economy turns or your industry weakens, your revenue can fall at the same time as your building’s value. The company may then be least able to carry the loan just when the building is hardest to sell. Lenders are aware of this: the OCC’s handbook for bank examiners says the primary repayment source for an owner-occupied loan is usually the occupying business, and that owner-occupants with uneven earnings may warrant a higher coverage ratio.

Equity magnifies the effect. Here is a hypothetical, for illustration. A company buys a building for $2,000,000 with $400,000 down and a $1,600,000 loan. If the value falls 10 percent, to $1,800,000, the equity falls to $200,000 before any loan paydown. A 10 percent drop in value has cut the company’s stake in half.

Specialized buildings add to this risk. The OCC handbook points out that highly specialized improvements can cost more than the value supported by leasing to another user. Money you spend tailoring a building to your process may not come back at sale.

Ask this before you buy: if the business had to close or move in three years, what would we do with this building, and who would pay for it in the meantime?

Cash in a building is not available to hire, buy equipment or carry the company through a slow year. Equity can often be reached later, but only by refinancing or selling, which takes time and depends on conditions at that moment. A building can have value on paper while your bank account is empty.

So compare the return on the building with the return your business earns on the same cash. If the company has high-return uses for its capital, or expects to need money soon, owning may slow it down. If it generates more cash than it can use and its plans are stable, a building can be a reasonable place for that cash. This comparison is specific to your company, and only your own numbers can make it.

Leasing is not free of balance sheet effects either. RSM’s overview of ASC 842 explains that lessees recognize right-of-use assets and lease liabilities for most leases, so have your CPA show how each path changes your statements and any loan covenants.

• ✓Which of the advantages above would change how we operate, and which are only nice to have?
• ✓Could we fund a major unplanned repair without touching payroll?
• ✓What share of the owners’ total wealth would be tied to the company and this building together?
• ✓What happens to the building if the company is sold, or a founder retires?
• ✓Would the building be easy to lease or sell to another type of business?
• ✓Who will manage the property, and what will that person stop doing?

If the concentration worries you but ownership still appeals, there are partial answers: buy a more general-purpose building, hold more cash in reserve, keep a longer loan amortization if your lender offers it, or hold the property in a separate company if your attorney and CPA advise it. A sale-leaseback later can also free up equity, though it comes with its own trade-offs.

Tenant Advisory Group represents occupiers on both purchases and leases, so we can set out the pros and cons against an actual lease alternative and not a hypothetical one, leaving the final call on tax and structure to your CPA and attorney.