The activity level in the owner/user commercial real estate segment of the market is very robust for office and industrial properties. This level of activity is in large part being driven by historically low interest rates. In the current environment, for comparable properties the monthly debt payments are generally less than rent payments.
The primary economic consideration for any user evaluating whether to own vs lease is to determine whether the return on the investment in a property is greater than the return on the investment in the business. Real Estate Advisors has created a back of the napkin Own vs Lease Comparison Analysis for users of commercial real estate along with a handout comparing some the most common pro’s vs con’s factors to consider when evaluating purchasing a property. These tools are available on our website below.
Own_vs_Lease_Analysis_12.14.21.xslx
The example of the economic comparison at the bottom of the Own vs Lease handout assumes that a user is considering purchasing a 10,000 square foot building for $2,000,00 that will require an additional $500,000 of tenant improvements for their specific use, for an all-in cost of $2,500,000. The financing assumptions are 10% down ($250,000.00) and the balance on a 25-year loan at an interest rate of 4.5%. This equates to an annual debt payment of $150,075 per year.
The hypothetical lease alternative is that the user can lease a comparable space where the landlord provides all the improvements for a lease rate of $17.50 per square foot. This equates to an annual rent payment of $175,000 per year.
Based on the above assumptions, the annual loan payment is $24,925 less than the annual rent payment. However, since the Ownership option requires a $250,000 down payment, it is necessary to calculate the annual return on the Down Payment to determine if the user is better off investing in the property or in their business. In this example the annual return on the investment is approximately 10% ($24,925 / $250,000). Therefore, if the user can achieve a greater than 10% return on investing the money in their business, they are probably better off leasing.
We have also found this Own vs Lease Financial Comparison Tool beneficial in positioning properties for sale and for landlords in lease negotiations with a user that is competing with a purchase alternative. An example of how a property owner can apply this tool is the current average capitalization rate is approximately 8.5%. By multiplying this capitalization rate by the $17.50 rental rate, the improved value of the building to property owner is $205 per square foot or $2,050,000. Whereas the all-in value to the user is $2,500,000. Therefore, it may be an ideal time for the property owner to cash in on the 20%-30% delta of the owner’s value versus the value to an end user. It is for this reason that in the market end users are outbidding investors for vacant properties.
If you are a user evaluating whether to lease or purchase a property or a property owner wanting to position your property to maximize your sales price, please do not hesitate to contact REA/Real Estate Advisors where Your Success is Our Focus.