An important decision in the course of running a successful business is whether it is better to buy or to rent a property. To start off, there is no single right answer which applies to all businesses. Making the right decision involves understanding the numbers, as well as having a strong business plan as well as an understanding of your economic environment.
In order to understand whether to buy or to rent, you need to analyse the following criteria.
Cash flow determines how and when your expenditure takes place. If you have a negative cash flow you need to make up for it with savings or lines of credit. Generally, you should always seek to maintain a positive flow. Indeed, this is sometimes much easier than said, especially when clients take longer to pay you or you foresee a lucrative investment opportunity.
Cash flow projections can help you determine whether your business will have the necessary outlay necessary to give you the choice to buy or to rent. Naturally, if you cannot afford one or the other, it’s not really a choice anyway.
How cash flow affects your decision
When you buy a property outright, with your own cash reserves, the return on investment will be much quicker. Fees will be lower and, in the long term, you end up paying less than you would had you rented a premises. This statement comes with a few conditions. It is only correct if there is no economic shake-up, your business survives over the long term, and rental and sale prices are within the normal property range, meaning there is no impending property bubble.
In such situations, your property will probably appreciate in value and, since your cash flow won’t be affected, might result in fewer overheads. Nevertheless, you need to consider maintenance costs and other fees which you would need to account for.
If your business does not have the necessary funds to buy a property outright, you will probably rely on a loan. In such a situation the decision to buy or rent becomes less clear. Taking out a loan requires you to put down up to 25% deposit, or sometimes more. Furthermore, you have to factor in additional bank fees and charges.
After you purchase the property you need to continue to pay interests and the capital until the loan is fully paid up. This could have a devastating effect on your cash flow.
In such a case, the option to rent may make more sense. Renting doesn’t require any upfront costs, except, perhaps, a couple of months worth of rent. Renting provides less strain on a business’ cash flow, by requiring steady monthly instalments. Furthermore, depending on your agreement with the renting party, you may be exempt from maintenance or repair costs.
A potential opportunity
A common mistake made by many entrepreneurs is to only think in the short term. Whether you are growing your business quickly or struggling to increase business, your short term goals need to be matched by long term vision.
Consider the amount you would allocate for the property’s deposit. Could this amount be better spent, providing you with faster returns? Let’s take a retail business as an example. You could potentially invest this deposit amount into additional stock, which would result in a return much faster than purchasing a business property could. The challenge is that often such opportunities come at the worst moments.
Consider also the possibility, or reality, that your business could struggle, either currently or sometime in the future. If you paid up the deposit, would you have the necessary reserves to weather such an economic storm? Understandably, it is difficult to answer this question with certainty. A simple rule of thumb is to carry out a stress test, slashing revenues by half for 1 – 3 years whilst maintaining existing overheads.
Depending on the nature of your business, your existing market might one day disappear. New or existing competition might also drive you out of your established region. If you are renting a property, the move to greener pastures is logistically simpler than if you own the property. You might be liable to fees relating to early-cancellation of your rental agreement. Other than that, you should be free to move location.
Now, imagine you bought a property but your business demands that you relocate your operations. Unless you have the comfort which comes with strong capital reserves, you will probably need to sell your property quickly. As a seller, you have very limited control over the speed of this process. It could take months or even longer for the sale to go through. In the meantime, your business is probably suffering. It might experience loss of sales or be charged interests on an overdraft used to cover rental expenses in a new market.
To make matters even worse, selling your property might result in you losing money. Consider that the money you are left with is the net difference between purchase and sale price, with associated fees, and interest deducted. Things could be even worse if the property market is in decline. In such a situation you might end up selling the property at a lower cost than you initially purchased it.
Generally, businesses, especially startups, should always seek to rent rather than buy a property. Doing this does not only support the business’ cash flow, but it also keeps the operations nimble. It is able to be flexible in case it needs to move to bigger or smaller premises or move location altogether. In fact, baring certain limited exceptions, the option to rent is always better than the option to buy. Nevertheless, this logical basis is often overlooked by ambitious entrepreneurs. Many often seek to make a name for themselves or make their business appear bigger than it actually is.