Good morning and happy Monday! I hope everyone had a great weekend. Mine was filled with time in the gym, laundry and a walk around the Fort. Plus lots of reading and the occasional show on Netflix. A very nice weekend indeed.
For small business owners, there is one part of the own versus rent conversation that concerns them; and it has to do with their business property. I share their concern. On the one hand, it can be cheaper than leasing and you build equity, on the other, it potentially ties up a huge chunk of liquidity. Lets dig into this a little bit.
On the use of the property, most business owners swear they use the property 24×7. But do they really? Even if your hours are 6am to 6pm M-S, that is only 72 hours a week out of a possible 168. I know, the business parks the fleet there, has tools, etc. in the building that need to be protected 24×7. It doesn’t really meet the 80% test, but it does fall squarely into the lease category. If you still feel it best to consider buying the property, there are other things to be aware of.
The bigger concern is how to pay for the purchase of the property. With a lease/rental situation, you may have to leave a deposit, perhaps first and last months rent plus $1,000. For this conversation, lets say the rent is $5,000 per month so your initial out-of-pocket to move in is $10,000. Coming up with $10,000 is not a real challenge for most small businesses looking for property.
To buy that same property though, you may need a lot more than $10,000. Let’s say the building is worth $500,000. If you are fortunate, you may be able to put a down-payment of 3% (assuming you qualify for some sort of SBA guaranteed loan). Most typically, plan for a 10% down payment. That is $50,000 of liquidity you must have available to buy the property. It is also liquidity you can’t get back quickly or easily.
But you cannot forget the other costs of ownership. Remember, you still have property taxes which say runs about 1.5% of the value of the property. And don’t forget, now that you own the building, you are responsible for its upkeep and maintenance.
If you have talked to some professionals about this (which I very strongly encourage), you set the building up in an LLC and are now renting it to your business. Your business rents from you at $5,000 per month, which is what you were going to pay in rents to begin with.
I know that there are tax benefits from the ability to take depreciation, but your business doesn’t see that, you do. Don’t get me wrong, you may have other forms of income where having rental losses can be very helpful. But if you are a typical small business owner, you have your income from the business and that is pretty much it.
I also realize that there is the potential for the gain on the investment. But the net gain after realtor fees, lawyers and taxes might not be as great as you imagined.
There is nothing wrong with owning your business property and renting it to your business. Remember though, it can suck down your liquidity and possibly slow your business growth. Really analyze your current and future cash position and ask yourself if tying up your cash in real estate is the right investment. If you need help or want to understand the impact of owning versus renting commercial property, talk with your accounting professional and ask her advice. If you are not working with an accounting professional or are interested in a second opinion, feel free to contact me and enjoy a free no obligation consultation.
Accounting Clarity 