Your business needs a new property, but should you buy or rent commercial premises? There are many factors which impact on this decision and should be considered before determining which is the right approach.
When you decide to buy or rent commercial premises, you are potentially making a long-term commitment and, unless your business has a lot of capital, the purchase will likely require finance and, therefore, come with the liability of a commercial loan secured by a mortgage. A lease, on the other hand, may be either a short-term or long-term arrangement and your rights and obligations can vary significantly depending on the terms of the lease.
In this article we consider some of the factors (including some of the key pros and cons) that determine the right approach for your business in whether to buy or rent commercial premises.
Specifically, we cover the following:
A general note on your industry/sector
It goes without saying that not all businesses are the same. Each business will have its own unique requirements, even when compared with those that operate within the same industry sector. The industry or sector in which your business is involved can, however, play a crucial part in determining whether to buy or rent commercial premises. For example, a tech start-up may benefit strongly from working in shared office space with other similar fledgling businesses. This type of property is more likely to be available to rent than to purchase. A manufacturing organisation, however, may require a facility that is particularly bespoke and not readily available in the leasehold market. Equally, retail outlets might find it attractive to be located within a retail park or shopping centre as part of a functional zone and such properties are not available for sale. Understanding your sector, what your priorities are and what is available in the market are critical first steps to determining the path forward.
Overview of pros and cons relating to key factors of renting and buying
– Potentially more freedom to alter the property. Possibility to
use without landlord consent.
Con – usually less flexible as it requires capital investment and ability to exit is dependent upon ability to sell and market conditions.
– If structured correctly lease can provide tenant with long
term opportunity but with ability to exit at key
Con – long term leases may be harder to exit than selling freehold. Changes usually require landlord’s consent.
– Have equity in the property and a potentially appreciating
Con – Buying usually requires a large up-front payment and potentially need to involve lenders. Any decrease in the property market could cause losses. Property purchase prices may be very high and unaffordable in the desired location.
be possible to avoid any up-front payments. Indeed, a rent-free
period could be negotiated for an initial period. There may be
certain tax advantages to renting.
Con – Lack of equity means less likely to be treated as an asset, but instead a liability. Rent payments are ‘spent’ as opposed to paying down debt. Lending may still be required if there is a lease premium payable up front. Can be more difficult to raise financing on leasehold interest. May be subject to rent reviews which increase the rent during the term of the lease.
|Usage|| Pro – Subject to planning laws, use of the property can be self-determined (without the need for landlord permission). Making changes to the property can be much easier. May be possible to share the property / let parts of the property to third parties to generate revenue. |
Con – If the business grows or shrinks, it may be more difficult to respond without disposing of the property or making large capital investments.
| Pro – Potentially greater flexibility to expand to other premises. |
Con – Any change of use will likely not only require compliance with planning laws, but also landlord’s consent. Such consent may not be forthcoming or may be time consuming and costly to obtain. Usually any transferring, sub-letting or sharing of the property will require landlord’s consent.
a property has been acquired, other than meeting loan repayments
(if finance has been raised,) there are fewer ongoing obligations
when compared with a leasehold interest.
Con – Although not strictly speaking obligations, the owner of the property will need to bear the full cost of upkeep and any unexpected repair costs which could be significant.
| Pro – Depending up on the nature of the lease (short term / long term) it may be possible to share some of the responsibilities associated with maintaining the property with the landlord. |
Con – Ongoing obligation to pay rent and potentially significant repairing obligations.
Other factors to consider
Obtaining planning for the necessary use for your business is critical. For both buying and renting, it is important to understand what the current planning permissions are and whether this is suitable for the type of activity that you plan to carry out.
If the property requires a change or addition to existing provisions, then consideration should be given to whether this can be obtained prior to or as a condition of the purchase or lease. This may involve a level of complexity when compared to a straight-forward purchase or lease. However, if it is not a condition of the purchase, then as a buyer or tenant, clearly a risk exists if such permission cannot be granted and you are already committed to the property.
As an owner of a property it is normal (and indeed often a requirement of a lender) to have in place buildings insurance. Appropriate advice should be sought from an insurance broker. The cost of such insurance will naturally be borne by you as the owner of the property. Premiums can be elevated if the property is considered to be at a higher degree of risk (such as flood risk areas), and this should, therefore, be determined at an early stage of due diligence, to ensure that there are no surprises.
In a leasehold arrangement, the landlord will ordinarily be responsible for insuring the building. That said, it is also common that any costs associated with the insurance will be passed on to the tenant either as a specific insurance rent or as part of a service charge. Therefore, a prudent tenant should enquire as to the level of the insurance premium and the amount the landlord plans to attribute to the property. A tenant should also ensure that the lease provides clearly that the proceeds of any such insurance will be used appropriately in reinstating the property.
It is important to consider all costs associated with buying or leasing a property. There may be certain costs that are not immediately apparent. Enquiries should be undertaken to understand whether cost might arise in areas such as:
- Tax (stamp duty land tax, VAT, others)
- Service charges
- Maintenance charges
- Obligations to contribute to the upkeep of third-party buildings in the vicinity (for example chancel repair)
- Legal costs – often a landlord will require a tenant to cover or contribute towards their legal costs
- Finance costs
- Agent fees
The location of a property, or indeed the location in which a business needs to operate, can impact on the decision of whether to buy or lease. The need to operate on a particular, retail park or industrial estate to be proximate to customers or suppliers, may dictate the type of property required. It may be the case that the market provides that such properties are only available on leasehold interests. This may also apply in city locations where office space in particular zones are located in high rise where it is not practical or possible to acquire all or part of the building.
Conversely, particular property types, such as manufacturing facilities or agricultural land may not have a mature rental market and may, therefore, necessitate freehold purchase.