When it comes to securing a commercial property, you can either lease it or build it. We take you through the considerations and practicalities of both, assessing the cost of leasing vs building so that you can make an informed decision.
What Does Building vs. Leasing Mean for Your Business?
Building a property for business use versus leasing one each have different implications for your business. They each have advantages and disadvantages. The option that you choose should reflect your risk appetite, as well as your business requirements, and what you are aiming to achieve from the transaction.
Building a commercial building for your business
If you are interested in commercial real estate investing through building a premises for your business, there are some things to consider. You need to be clear on the ownership structure and control of the building, as well as factoring in how you’re going to build equity and maintain long-term value.
You will also need to consider maintenance and responsibility.
Ownership structure & control
When buying or building a commercial property, especially for your business to operate from, the ownership structure you choose is paramount, as it has implications for both asset protection and tax liability.
There are several ownership structures you can use, including individual joint ownership, a Pty Ltd company structure, or a discretionary trust. You could also own and operate as a Self-Managed Super Fund (SMSF).
Building equity and long-term value
One of the advantages of building an office space, rather than the leasing of commercial property from somebody else, is the chance to build equity. Over time, commercial properties, particularly in high-demand areas tend to increase in value. Instead of making rent payments, you can pay down your mortgage and build further equity in your building.
You can also add long term value by making improvements or redeveloping parts of the property to increase its value.
Leasing commercial property
Leasing commercial property for your business in Perth (or anywhere in Australia) involves a formal arrangement where you, as the lessee (tenant), rent a property from the lessor (landlord) for a specified period. This is governed by a legally binding document called a Commercial Lease Agreement.
This Commercial Lease Agreement can take several different forms. It’s definitely worth having a lawyer review the lease terms before you sign. You should also ask an accountant or financial advisor to review the financial implications of the lease.
Common lease styles
The most common type of lease is a net lease, under which the tenant pays some or all of the property’s operating expenses, as well as their rent. There are different versions of a common lease, such as single net lease, double net lease and triple net lease, which specify which proportion of costs the tenant has to pay.
There’s also a gross or full-service lease, which means the landlord is responsible for paying the property’s operating expenses out of the tenant or lessee’s rent.
There are also ground leases and percentage leases, as well as further modifications of existing lease templates.
Flexibility and short-term commitment
The main advantage to leasing a commercial property rather than building or buying one is the flexibility it offers. It is also a significantly shorter term commitment than building your own building.
It’s worth remembering that while it’s possible to sign a short-term lease for less than 12 months (or even a pop-up lease), traditional commercial leases in Australia are typically 3-5 years, with options for renewal. Make sure you are clear what type of lease period you are signing up for.
Strategic considerations
In addition to your personal risk appetite and financial circumstances, there are strategic considerations involved in commercial property buying and leasing.
Scalability requirements
You need to understand your business growth trajectory and how you plan to scale it when considering commercial real estate. Are you expecting to grow rapidly? If so, you need to make sure the premises have space to accommodate you or grow with you.
Business maturity and long-term goals
If you have a business with long-term growth goals, make sure your premises have fit out flexibility so that you can reconfigure the space, as your team changes.
If you opt to lease, you could ask your landlord for the right of first refusal for adjacent spaces if your business continues to grow. Conversely, you should ask for the right to sublet internal space in case your business contracts.
Cost comparison
We’ve laid out the different options. Before making a decision, it’s also worth making a cost comparison.
Monthly lease payments vs mortgage payments
While comparing a monthly lease payment with a mortgage payment does have a value, there are other costs involved.
If you’re considering building, the cost of the land acquisition requires significant upfront cost, as do the construction costs. Ongoing costs include mortgage repayments, property taxes, land tax and insurance.
Leasing a commercial property comes with its own price tag. You will need a security bond and usually 12 months’ rent in advance, as well as ongoing rent. You should also include fit-out costs into your calculations.
Both scenarios will involve legal fees.
Commercial real estate depreciation and tax considerations
Commercial real estate depreciation is a significant tax benefit for property owners in Australia. Through it you can claim deductions for the "wear and tear" of the building's structure and its fixtures and fittings over time. This reduces your taxable income, ultimately improving your cash flow.
If you borrowed money to finance your build, the interest on your loan is tax deductible, as is the borrowing expenses incurred in arranging the loan. Several property operating expenses are also tax deductible.
Is commercial property a good investment?
Investing in commercial property can be a very good investment, provided you get it right. Leases tend to be longer than residential properties and usually the landlord has fewer financial obligations under the terms of the lease, as we have seen above.
It can be more precarious, however, with commercial tenants more likely to go broke and need to move out than residential tenants.
Insights
If you choose the right location, and create a versatile building that appeals to multiple businesses, your commercial development has every chance of being successful.
Commercial properties typically offer higher annual rental yields, with greater stability, due to the length of commercial leases.
Commercial leases are structured more favourably towards landlords, with fewer landlord outgoings and reduced costs. There are also tax advantages. The interest you pay on commercial property loans is counted as a tax deductible business expense. Many operating expenses, like council rates, water, insurance and property tax, are also tax deductible.
Risks
Commercial property developments are not risk-free, which is why it’s important to partner with a developer who knows exactly what they are doing.
Often, commercial property has a higher vacancy rate, with longer periods between tenants. Initial investment is likely to be high and commercial property is subject to market fluctuations and economic downturns.
Let’s talk: invest in commercial real estate with confidence
Novus Projects is an experienced commercial property developer, with over 30 years of industry experience. We offered a bespoke approach, tailored to you and your project. We can be as involved as you want us to be, guiding you through the process from the outset.
We can help with site selection, feasibility studies, planning, design and construction to help you bring your vision to life. Contact us today to discuss your next project and see how we can help.