Greater Reston Chamber of Commerce-Commercial Real Estate 101: Buy vs Lease
THE STRATEGIC REALESTATE ADVANTAGE™ANALYSIS OF BUY VS. LEASE
REAL ESTATE IS MORE THAN A TRANSACTIONCommercial real estate can be complex and confusingfor even the savviest of business professionals.Without the proper knowledge, systems and processes, it’seasy to make decisions that cost you money and restrictyour ability to control the business, creating a negativeimpact on the value of your enterprise, and impeding growthopportunities and wealth creation.
THE STRATEGIC REAL ESTATE MAPTM • Leverage Wealth Creation / Business Enterprise Value • Business AdvantageDesiredResults • The Right Place • Economical • Minimal Disruption/Maximum Ease Barriers Understanding The Real Transaction Focus Direct vs. Total Costs Estate Ecosystem ActionsOutcomesExpected
PURCHASE VS. LEASE THE ECOSYSTEM1. Cash Outlay2. Opportunity Cost3. Direct vs. Total Costs4. Growth Considerations5. Property Management6. Appreciation7. Tax Factors8. Cash Flow Analysis a. Investment View b. Occupancy View9. Market10. Other factors to Consider
THE ECOSYSTEM CASH OUTLAY• Purchase • Lease – 10% to 20% of Project Cost – 1-2 Month’s Rent – Improvements – Improvements – Closing Costs – Security Deposit Scenario Scenario – 5,000 SF @ $340/PSF Project – 5,000 SF @ $30/PSF Cost (incl. TI’s) – $50,000 in TI’s & Costs – $25,000 transaction costs $150,000 to $250,000 $45,000 to $75,000
THE ECOSYSTEM OPPORTUNITY COSTS• What Does Opportunity Cost Mean? 1. The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action. 2. The difference in return between a chosen investment and one that is necessarily passed up. Say you invest in a stock and it returns a paltry 2% over the year. In placing your money in the stock, you gave up the opportunity of another investment - say, a risk-free government bond yielding 6%. In this situation, your opportunity costs are 4% (6% - 2%). Source: Investopedia
THE ECOSYSTEM DIRECT VS. TOTAL COSTS• Purchase • Lease – Payment – Rent • Fixed for Term of Loan • Typically Escalates • Financing Vehicle Driven • Market Driven – Expenses – Expenses • Actual Each Year • Increase Over BY – Improvements – Improvements – Transaction Costs – Transaction Costs
THE ECOSYSTEM GROWTH CONSIDERATIONS• Questions to Ask and Consider? – How stable is your business? • Is your business in growth mode or retraction? • History – What are your options and associated risks in different company life cycles and each decision?
THE ECOSYSTEM PROPERTY MANAGEMENT Function Owner Landlord Tenant Maintenance X X X Asset Value X X• Time is Money – Employ or not to Employ – Association’s
THE ECOSYSTEM TAX FACTORS• Purchase • Lease – What Can Be Deductable?* – What Can Be Deductable?* • Interest Payment’s • Lease Payments • Depreciation of • Depreciation of Improvements* Improvements?* – 39 years (some less) – Cost Recovery (25%) – Capital Gains Treatment* *Disclaimer- Consult your tax advisor for the impact of taxation
THE ECOSYSTEM CASH FLOW ANALYSIS• When Does it Make Sense? – In order to understand the financial impact of purchasing and the economic viability of the decision you must prepare a detailed Net Present Value (NPV) cash flow projection. – NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account.
THE ECOSYSTEM CASH FLOW ANALYSIS• Inputs to Analyzing Cash Flows. – Holding Period / Lease Term – Discount Rate – Anticipated Appreciation – Loan Terms – Rental Terms – All Cash Outlays
THE ECOSYSTEM CASH FLOW ANALYSIS• Steps to Evaluating Cash Flows 1. Determine the After Tax Cash Flows • Purchased Property • Leased Property 2. Calculate the PV’s of Future Cash Flows • Purchased Property • Leased Property 3. Compare the PV of the Future Cash Flows • Differential 4. Determine the IRR of the Differential of Cash Flows
THE ECOSYSTEM CASH FLOW ANALYSISIf Opportunity Cost is 12%, Does it Make Sense to Purchase?