In these situations, the question is usually ‘should I own or lease?’
There are three criteria that affect the decision: the first is the risk factor, the second is the finance available and the third relates to the needs of the business.
There is a different exposure to risk depending on whether a business owns or leases a property. Owning a property is inflexible in that it cannot be easily sold or let if surplus to requirements but it may achieve capital growth. Leasing has less exposure to risk unless a business is tied into a long lease, because it could at some point need to get out of this quickly.
The cash flow for any business is crucial. The greatest failure for any business is to run out of money. Owning property requires funding. Whilst borrowing may be possible, this is likely to be about 60-65% of the valuation of the property to be purchased and there is a need to find the balance as a deposit. It’s vital to establish whether this is possible without denuding the business of essential cash flow by which to operate effectively.
Shortage of cash slows business growth so getting the balance right is essential. If the preference is to lease and the business has no trading history, the securing of a lease may be problematic unless there is a personal guarantee or deposit.
Before agreeing to the lease, the landlord will research the trading, credit rating and capitalisation of the business to assess the risk. They will want to identify whether the business will be able to pay the amount of rent required on time throughout the length of the lease. The value of the landlord’s investment in the property will be severely diminished if the tenant defaults in paying the rent and the property becomes vacant.
Where property values are expected to move rapidly or rents are expected to increase quickly, the best thing is to buy. Except in London, this is unlikely to be the case at the moment due to the economy and low demand for property (although some growth is apparent where space is being taken up due to a lack of new development).
Some larger businesses prefer to rent. Where they have existing premises they may sell and take a leaseback - this is where the business is sold to an investor but remains in the property and pays rent. This can be a way of injecting capital into the business.
If the property increases in value as an asset it may be possible to borrow against this to increase the investment in the business or have a more ready supply of cash to hand.
Sometimes in selling the business the property can be retained as an investment and let to produce a rental income. This could be handy where the owner of the business wishes to retire yet keep a secure and regular flow of income, or where the sale of the business is challenging because the asset value of the property is combined with the value of the assets and goodwill of the business too.
Although often the last to be considered, the needs of the business are the most important. It’s imperative to ask whether the business needs to be near its customers or whether it is better located near to the materials used in manufacture or to a good supply of labour. For example, I recently helped to locate a low carbon energy company to a city where there is a ready availability of highly trained design engineers, which was critical to success.
Consider whether the business needs a high profile by which to retail the stock or whether a warehouse would be more appropriate with a higher advertising and marketing budget to attract customers, either physically or online. If to be leased and the business is relatively young, a short term lease to allow the closure of the business without too much exposure to rent and empty property rates and other charges could be useful.
Help can be found by talking to the Economic Development Department of your local council to see what support is available for start up and small businesses. There can be remissions from Business Rates during start up periods. Also speak to the local office of Business Innovation and Skills Department to see what government and European support there might be because often there is plenty out there if you know where to look.
Finally, please remember you should always discuss your decisions with your accountant to consider any impact of investment and borrowing, as well as taxation matters before a final decision is made. If you’re still uncertain, a chartered surveyor will definitely be able to signpost the way and can probably save you money in the long run.
Kevan Carrick is a Chartered Surveyor and principal of JK Property Consultants LLP, a mentor to small businesses and a mediator: firstname.lastname@example.org