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When you’re starting your business, it’s okay to first start in your home office, basement, or garage, but you will need more space over time. If you’ve never signed commercial leases before or purchased commercial property, you may easily get overwhelmed with deciding what is best for you.
You may even struggle with the terms and conditions, especially if you aren’t sure what is best for you and your business. If this sounds anything like you, you came to the right place. This brief article will go over what is in a commercial real estate agreement and who you can contact for more clarity.
When to Consider Buying Commercial Real Estate
Purchasing commercial real estate gives you the opportunity to own the property outright, whether you finance the purchase or pay with cash upfront. If you wish to finance the purchase, you can obtain a commercial real estate loan.
Advantages of Buying Commercial Real Estate
When you purchase a commercial property, you can earn equity in many different ways. If you bought the property with a commercial real estate loan, your property would earn equity as you make your payments on the loan.
Another way to earn equity in your building is to renovate or expand it, increasing the property’s value. If you lease the building instead, you lose all chances of building equity.
Asset Appreciation
As mentioned above, improving the property increases its equity and its value. Asset appreciation of the commercial real estate market also helps your property increase in value. Over the past twelve months, commercial real estate property values have increased by 21%!
Renting Out Your Property
Businesses that purchase real estate usually only occupy about 50% of the property, and they rent out the other half. When you rent out a portion of your building, you can easily bring in rental income, but you will also be responsible for your new tenants. If you don’t want to do it yourself, you can always reach out and hire a property management company, but it will cut into your potential profits.
Tax Benefits
You can deduct non-mortgage-related expenses, depreciation expenses, and interest expenses from your tax bill. Of course, you may have other tax-related deductions, but it is best to reach out to your tax advisor or business lawyer for more information.
Disadvantages of Buying Commercial Real Estate
One of the most significant disadvantages of buying commercial real estate is the lack of flexibility. Once you buy the building, it’s yours, and you may have a more challenging time selling it for what you paid. You can lease the building to another company, but you will be responsible for their actions unless you sell it completely to them.
Risk of Depreciation
While the increase in commercial real estate can provide an increase in value and equity, it may not always trend upward. The real estate market in general changes often, so there is a chance that your building may actually start to depreciate instead of appreciating.
Increased Liability
When you purchase a building, you are the listed owner. In the event that something happens to the people inside of the building, they will look to you for answers and compensation if they sustain injuries. If you rent out the building, you are also liable for your tenants, and you may need to purchase additional insurance to cover your bases.
When to Consider Commercial Leases
Depending on the needs of your business, it may be better for you to lease a building instead of buying one. For example, if you only plan on being in an area for a year or two, you may want to lease space instead of purchasing a building.
Advantages of Leasing Commercial Real Estate
One of the most significant advantages of leasing space is having more liquidity. You generally need a large down payment when you purchase commercial real estate. Leasing does not require as much money upfront.
Common things you must pay upfront with a lease:
- Pre-lease inspection
- Attorney fees
- Security deposit
Those combined costs are typically less than what you would need to purchase commercial real estate. This means that you have less liquid capital tied up in buying property.
Potential Tax Benefits
Regardless of whether you decide to buy or rent commercial real estate, they both come with potential tax benefits. When you lease a building, you have the opportunity to write off lease payments, property insurance, property taxes, maintenance, and utilities. Again, it is best to reach out to your tax professional to see what you can or cannot deduct from your tax liability bill.
Easier and Cheaper
If you want to move into a building that is a part of already existing development, it will be easier to lease space instead of buying your own. With these types of developments, they most likely already have plumbing lines complete and electricity wired throughout the building. If you buy a building on your own, you have to consider the wiring and plumbing in addition to other things if they aren’t already complete.
Greater Flexibility
Most commercial real estate mortgages are between 15 to 30 years. Lease terms typically only last between three to ten years, and they are negotiable. This allows you to move your business to a new location to accommodate your needs.
Disadvantages of Leasing Real Estate
A significant disadvantage that most companies face when leasing buildings is the higher monthly payments. Of course, the higher monthly payments compensate for the convenience of renting someone else’s space. You won’t have to front large upfront payments, but you may have higher monthly payments than you would if you had a mortgage on the building.
Costs Can Increase
When leasing someone else’s building, they may increase your monthly payments at the end of your lease agreement. The new amount can significantly cut into your rent budget. On the other hand, if the owner decides they don’t want to renew your lease, you will have to scramble to find somewhere else to house your business.
No Property Control
Because you don’t own the building, you technically don’t have a say in anything if your landlord decides to make significant changes to it. This may or may not affect your business. Your agreement may have an escalator clause that triggers increased lease payments each year of your lease.
There also could be another clause in your agreement that can trigger a lease termination. For example, if the landlord has an anchor tenant that decides to leave, they may terminate your contract, forcing you to go with short notice. This can cause a lot of uncertainty to your business.
Questions to Ask Yourself Before Signing
Once you weigh your pros and cons, you will want to ask yourself a few critical questions before you sign a lease or mortgage loan. One main question you should ask is if the location makes sense for your industry.
Does This Location Make Sense?
This question is honestly one of the most important questions to ask yourself. Does this location make sense for your business?
Can all your employees commute to the site within a reasonable time? Is the area safe? Is it close enough for your customers?
How Long Is My Lease?
If you purchase a building outright, you will want to ask yourself how long the mortgage is. As mentioned earlier, you may be tied to a location for up to 30 years, depending on your mortgage agreement.
With leasing, you will need to choose a place that offers negotiation and flexibility for how long you must stay at that location. Some leases require ten years and others give you the option to choose between one to five years.
What Do You Get for the Price?
Most reputable and logical commercial leases will offer you more than just the space, especially if you pay a high premium. When reaching out to potential places to lease, ask if they include any janitorial services, garbage disposal, or maintenance in your monthly payment.
Ask them about on-site parking and if you have to pay more for more parking spaces. It is imperative that you know exactly what you are paying for.
Should I Have a Lawyer Help Me?
Enlisting the help of a business lawyer to help you negotiate and obtain space for your business is an excellent idea. These attorneys are very knowledgeable about contracts, and they will help you better understand the terms and agreements.
Navigating the financial and legal aspects on your own is not an easy feat. The last thing you want to do is sign a contract just to obtain space for your business, just for you not to know what you agreed to.
Verbal Assurances in Writing
When speaking with a landlord, either over the phone or in person, they may make promises to you verbally. In the event that something happens and the landlord does not hold up their end of the bargain, they may argue that the promise was never in writing; therefore, it is not valid. When you partner with an attorney, they will ensure that the verbal assurance gets written into the agreement so that both parties are satisfied and held responsible if they don’t live up to the agreement.
Other Benefits of an Attorney
As a business, you want to be able to put up signage and advertise to bring in new customers. If you don’t look over your lease carefully, you may find a clause stating you cannot put certain signs or that you must use certain contractors to do so.
Portions of the lease govern any rules and restrictions for both you and your landlord. If you are unaware of them, you may have a rude awakening. Your attorney will look over the lease to inform you of what you can and cannot do while leasing a space before you even sign the contract.
Repairs and Improvements
It is always good to negotiate terms that don’t dip too much into your personal finances in your commercial lease. If you don’t review your terms and conditions properly, you may find that you are on the hook for any HVAC, electrical, and plumbing repairs.
Your attorney can sit with you and help you negotiate more favorable terms. Before you move it, it is also best to make it clear who pays for any construction.
Rent
You will want to know how your rent is calculated. With commercial leases, you must be aware of different types of rent payments. For example, there is usually a base rent in addition to other fees. Those additional fees may have you paying a portion of the property taxes, property maintenance costs, and property insurance.
You will want to carefully read and review the rent section of your contract to ensure that you understand how the landlord calculates your rent. Pay close attention to any language that states the landlord may increase your rent in the future. It is not bad if your landlord increases your rent; they may have that in there to help keep up with inflation and rising living costs.
Protect Your Business Interests
Regardless of whether you decide to purchase commercial real estate or sign a commercial lease, it is best to have a local attorney help you work through the contract. The last thing you want is to sign a contract just to find out that you are responsible for something you thought the landlord would handle.
As a business owner, your primary focus should be taking care of your business operations and tending to your clients, not if you have to repair the HVAC system if it decides to break down. If you are looking for commercial leases and need someone to protect your interest before you sign any contracts, contact us now!
