Lease or buy? How to choose
By Jenny C. McCune • Bankrate.com

Every business needs a roof over its head, but it's up to the small-business owner whether to own that roof or rent it.

For 15 years, Tyler and Carla Hill rented space on the ground floor of a historic building on Main Street in Bozeman, Mont., for their restaurant, John Bozeman's Bistro. "It was a great lease for us," Tyler Hill says. "We only had to pay a (yearly) cost-of-living increase and it was a great location."

But then the lease came up for renewal. In the 15 years that the Bistro had resided on Main Street, Bozeman had evolved into a boomtown and commercial rents had soared. Hill's landlord wanted to quadruple the rent. Meanwhile, another historic building had been for sale for some time and its owner had just decreased the price tag. The Hills stepped up and became owners rather than renters. "It worked out great for us," Tyler Hill says.

Whether your company rents or owns, like the Bistro's decision, depends on the local market, your line of business and your company's long-term business goals. There are pros and cons for both. Below we list the advantages and disadvantages for both and give you some ground rules to help you decide.

Leasing, renting: Advantages
Being a tenant gives a business several advantages:

• Flexibility. It's easier to exit a lease than to sell a property.
• Less initial outlay. Your company pays a monthly rent and doesn't have to come up with a huge down payment. "It's a little less painful," says Mike Howard, a sales associate for the investment property group at Colliers Commerce CRG in Salt Lake City.
• Leasing also evens out expenses, says Jeremy Willits, a commercial agent specializing in office property sales at BarkleyFraser.com, a commercial real estate firm serving the Charleston, S.C., area. A business pays a monthly rent and doesn't have to worry about unexpected expenses such as repairing a roof.
• Tax deductible. Lease payments are a deductible business expense, notes Willits. When you deduct lease payments, "you are in effect depreciating the value of both the building and the land," he says.

Leasing, renting: Disadvantages
Of course, there are downsides to renting. These include:

• Less control. Your company doesn't own the building. In the case of Tyler Hill and the Bistro, all repairs had to be done by the landlord. Toward the end of the lease, the building needed some sprucing up, but Hill was loath to do it since he wouldn't reap the benefits if he moved.
• The space isn't tailor-made for you. The Bistro's kitchen wasn't as large, nor set up exactly as Hill would have liked, but that's the way it came, so he went with it. If he had made improvements he probably would have needed the landlord's permission and, depending on the lease, might have been forced to return the property to its original condition upon vacating the space.
• While rent payments are deductible, they usually aren't as high as those for outright ownership.

Ownership: Advantages
Ownership carries with it certain privileges. These include:

• More control. It's your space, you can do what you want with it. In the case of Tyler Hill, he completely renovated his building and built the kitchen of his dreams.
• Equity builds in property as you pay down the note, make improvements and as the building appreciates in value. "That's one of the major benefits as far as I'm concerned," Tyler Hill says.
• No unexpected rent increases.
• Tax deductions. A business can deduct improvement costs and its mortgage payments.

Ownership: Disadvantages
Of course, as any homeowner knows, there are disadvantages to owning your own place. These include:

• Large initial capital outlay. "The down payment required will vary between 15 percent to 25 percent of the sales price," says Barkley Fraser's Jeremy Willits. "For many business owners this capital is better spent fueling the business rather than acquiring property."
• You own it, you repair it. When you don't have a landlord, it's up to you to make any repairs. That can be expensive and unpredictable, two things that many small businesses can't afford, says Mike Howard of Colliers Commerce. "You can end up having to fix a roof or repaving your parking lot, something that tenants don't have to worry about," Howard says.

What's right for your business
When a company needs a new space and is trying to decide whether to rent or buy, it should start with an overall assessment of its business, Mike Howard says. "We sit people down and talk about their business plan for the next five to 10 years. We look at their employee needs and what type of space they need," Howard says.

Some geographic locations preclude ownership. Hot real estate markets in urban areas such as San Francisco, Dallas, Atlanta or New York generally will put real estate out of sight for most small firms.

According to Willits, the bottom line is whether your company's capital would be better spent in another investment (including putting money back into the business) or in real estate. "If the return on your money is higher in real estate, then you should buy," he says. "If you can make more by putting it back in the business, then you should rent."

A small-business owner can crunch the numbers -- as Tyler Hill of the Bistro did -- or get help from a real estate broker. "There are a number of software programs on the market that can work the numbers for you," explains Colliers' Howard.

Whether you crunch the numbers yourself or have someone else do it, you'll need to know -- or make real-world assumptions about -- the details of both the lease and the purchase. You'll need to know:

• Lease terms, including cost and length;
• Your combined federal and state tax rates;
• Purchase terms;
• Closing costs;
• Expected life of the building;
• Expected residual or resale value;
• Your cost of borrowing; and
• The cost of maintenance.

Most importantly, small-business owners must take a hard look at what's best for their company. Sure, having the "Your Company Name" building sounds nice, but can your firm afford it? Does it make sense? Answer those questions before you buy or rent and your company will find there's no place like home, whether the business abode is rented or owned.

Jenny C. McCune is a contributing editor based in Montana
To comment on this story, please e-mail the Bankrate.com editors

-- Posted: June 5, 2000