The subject to lease or purchase a building has been a matter of much discussion for the 40 years that I have been in the commercial real estate business. My recommendation to clients more often has been to lease rather than to purchase a commercial or industrial building.
The only reason to purchase a building is due to the high cost of moving and expensive improvements that will be installed in the building. Leasing a building provides much greater flexibility for growth compared to purchasing a building which requires a great deal of capital. Furthermore, owning the building does not provide immediate liquidity when an investor needs to sell the property.
I have been extremely careful in my selection of commercial real estate properties as an investor in the business. That is not to say that I didn’t make mistakes; however, the mistakes were minor, and at the worst I broke even.
In 2000 I invested in a 60,000-square-foot warehouse in the South Bay area of Los Angeles. The building was a good building, but it is certainly not a Class A property. I was fortunate to lease the building immediately at a rate of .48 cents per square foot triple net. The tenant was a Fortune 500 company, and I enjoyed 15 years of good cash flow from the property.
The tenant recently notified me that they will be vacating the building in the second quarter of 2015. I am aware of current rental rates as a commercial real estate expert in the area. As a result, I have just placed the building on the market at .54 cents triple net. This rental rate is consistent with the marketplace, but it only represents a 12.5% increase in the rent in 15 years.
This is typical with rental rates for warehouses generally in the Los Angeles County area unless the building is relatively new or in a high rent location. Therefore, considering modest inflation, commercial real estate rents have actually decreased. Fortunately my tenant incurred all of the expense of maintaining the building or it would have been even worse. A client I represent leasing her buildings recently said that rental rates have not increased since the 1980’s.
Here is the kicker! The building mentioned above has more than tripled in value since the purchase of the property 15 years ago. That is great appreciation in value but only if I intend to sell the building.
I mentioned that it was better to lease than to purchase a commercial real estate building in the beginning of the story. Let’s take the value of the 60,000-square-foot building today which is roughly $7,000,000. If an individual were to purchase this building today, they would probably need a down payment of 30% or $2,100,000 and finance the balance at 5% interest. The payment for a mortgage of $4,900,000 would be $28,644 or about .50 cents per square foot. The current asking price on a lease is .54 cents per square foot. Therefore, the real cost of the building is $2,100,000 since the mortgage payment and the rent are practically the same.
In conclusion, leasing is still the best opportunity provided the lease is negotiated by a skilled broker who protects your best interests. However if you are a long term user of the property that requires installation of costly capital equipment, you should strongly consider a purchase.