Buy or Lease a Business Premises?

For many established business owners, there comes a point where paying rent starts to raise the question of whether owning the property would be a better option.

Buying your business premises can give you greater control and allow you to build an asset alongside the business. But it can also tie up a significant amount of capital that might otherwise be used to grow the business.

Leasing offers flexibility and usually requires less capital upfront, but you remain exposed to rent increases, lease negotiations and decisions made by the property owner.

There is no universally better option. The right decision depends on your business, your financial position and what you want the next five, ten or twenty years to look like.

When buying your business premises can make sense

Buying can become attractive when a business is established, profitable and reasonably confident about where it will operate over the longer term.

Instead of rent being an ongoing operating cost, purchasing premises allows you to acquire an asset that may appreciate over time.

It can also provide greater certainty. You aren't relying on a landlord to renew your lease and you have more control over improvements, fit-outs and how the property is used.

For some business owners, particularly where the property is held separately from the trading business, the premises can eventually become an important asset in its own right. You may be able to sell the business in the future but retain the property and lease it to the new owner, creating another source of income after you step away from day-to-day operations.

But property ownership comes with a much larger financial commitment.

The real cost of buying isn't just the loan repayment

One of the biggest mistakes when comparing buying and leasing is simply comparing monthly loan repayments and monthly rent. The decision is more complicated than that.

Purchasing commercial property can require a substantial deposit as well as transaction costs, professional fees and potentially fit-out or improvement costs. Then there are ongoing expenses such as rates, insurance, repairs and maintenance.

More importantly, consider what happens to the capital used for the purchase. If buying a property requires you to put $300,000 or $500,000 into the transaction, what could that money have achieved if it remained available to the business? Could it have funded additional staff, equipment, inventory, another location or an acquisition? Could maintaining a larger cash reserve allow the business to respond more easily to an unexpected opportunity or downturn?

Property may prove to be an excellent investment, but the opportunity cost of the capital should form part of the decision.

When leasing may be the better option

Leasing can be particularly valuable when flexibility matters. If the business is growing rapidly, changing its operating model or isn't yet certain how much space it will need in five years, buying can potentially lock it into a property that no longer suits.

Leasing may make it easier to:

• move as the business grows
• access a better location
• increase or reduce the amount of space you occupy
• preserve capital for other investments
• avoid taking on substantial property debt.

For a business with strong opportunities to reinvest capital at a high return, retaining that capital inside the business can sometimes be more valuable than putting it into commercial property.

That is why “rent is dead money” isn't always a particularly useful way to look at the decision. Rent may be purchasing flexibility, location and access to capital that can be deployed elsewhere.

But leasing has its own long-term costs

The trade-off is that you don't own the underlying property. Commercial rent is generally deductible where premises are rented for business purposes, and GST-registered businesses may generally be entitled to GST credits on eligible commercial leasing costs. But after ten or twenty years of leasing, the business has not accumulated a property asset from those payments.

You may also face rent reviews and lease renegotiations, and there is always the possibility that the premises may not remain available indefinitely.

For a business that relies heavily on its location or has invested substantially in specialised facilities, that lack of control can become increasingly important.

Think about what your business is likely to look like in five or ten years

The decision becomes easier when you stop looking only at today's numbers. Consider where the business is heading.

If your current premises are already becoming too small, buying them simply because they have become available may not make sense.

Likewise, if you're approaching retirement or thinking about selling the business within the next few years, the decision needs to be considered alongside your exit plan.

Ask yourself:

• Do we expect to operate from this location for the long term?
• How much more space might we need?
• Could our business model change?
• Would owning the property make the business easier or harder to eventually sell?
• Would we want to keep the property after selling the business?

Those questions can matter just as much as the purchase price.

Consider what buying could mean for your personal wealth

For many successful business owners, their business is already their largest financial asset.

Buying commercial premises can provide an opportunity to build wealth outside the operating business, depending on how the purchase is structured.

Over time, a business owner could potentially have two valuable assets; the business itself and the property it operates from. That can create more options later. However, it also means committing more of your overall wealth to the business and property.

If most of your net worth already consists of your business, home and investment properties, another substantial property purchase may increase that concentration further.

The question is therefore not simply whether commercial property is a good investment, but whether it is the right investment for you given the rest of your wealth, assets and financial priorities.

What about tax?

Tax should not be the sole reason to buy or lease your business premises, but it can materially change the numbers.

This is also where involving your accountant before you make a decision can be particularly valuable.

If you continue to lease

For a business leasing commercial premises, rent is generally deductible where the property is used to run the business. If GST is included in the rent and the business is registered for GST, it may also be able to claim the relevant GST credits.

An accountant can also help you look beyond the headline rent and understand the full financial impact of the lease, including outgoings, fit-out costs, incentives and future rent increases.

That becomes important when comparing leasing with buying. A lower monthly property repayment does not necessarily mean buying will produce a better financial outcome once all of the additional costs of ownership are taken into account.

If you buy, there are more moving parts

Commercial property ownership creates a different set of tax considerations.

Depending on the transaction, GST may be included in the purchase price and an eligible GST-registered purchaser may be able to claim GST credits. In some circumstances, such as the sale of a leased commercial property or an operating business together with its premises, the transaction may qualify as a GST-free sale of a going concern where the relevant requirements are met.

There are also upfront transaction costs to model. For example, in Queensland, transfer duty applies to purchases of commercial and investment property.

Once you own the property, an accountant can help determine which costs can be deducted immediately and which need to be claimed over time.

Depending on the circumstances, this may include:

• interest on money borrowed to acquire the property
• depreciation on eligible plant and equipment
• capital works deductions for qualifying construction expenditure
• repairs and maintenance
• property-related expenses incurred in earning business or rental income.

The distinction matters. Spending $100,000 improving a property does not necessarily mean receiving a $100,000 tax deduction that year.

Who owns the property can be just as important as whether you buy it

If the decision is to purchase, the next question is who should own the premises?

It could potentially be held by:

• the trading company
• the business owners personally
• a separate company or trust
• an SMSF, where the property and arrangement satisfy the relevant superannuation rules.

Each option can produce a very different long-term outcome. For example, holding the property separately from the trading business may allow an owner to eventually sell the business while retaining the premises and receiving rent from the new operator.

On the other hand, different ownership structures can produce different income tax, CGT and state tax outcomes. In Queensland, for example, land tax rates and thresholds differ depending on whether land is owned by an individual, company or trustee.

Changing the ownership structure after a property has already been purchased can also trigger additional tax and transaction costs, which is why this conversation is best had before signing the contract.

Could the property be purchased through super?

For some established business owners, an SMSF may also form part of the discussion.

There are restrictions on SMSFs acquiring assets from and leasing assets to related parties, but specific rules exist for qualifying business real property. This can, in some circumstances, allow an SMSF to own commercial premises used by a related business, provided the arrangement complies with the relevant superannuation requirements and is conducted on commercial terms.

That can make the premises part of the owner's broader retirement strategy rather than simply an asset of the operating business.

However, buying through super introduces its own issues around contributions, liquidity, borrowing, compliance and retirement planning. It needs to make sense for the owner's overall position, not simply because an SMSF is able to purchase the property.

Consider what happens when you eventually sell

The tax consequences at the other end of the investment deserve just as much attention. If the property increases in value, selling it may create a capital gain. The ownership structure can affect how that gain is taxed and which concessions may be available.

For eligible business owners, property used in carrying on a business may also potentially interact with the small business CGT concessions, depending on the ownership, use of the property and whether the relevant eligibility requirements are satisfied. This becomes particularly important when planning an eventual business exit.

You may want to sell the business and the premises together. You may prefer to sell the business but keep the property as an investment. Or you may want to sell the property separately at another point in time.

Those decisions could be ten or twenty years away, but how you structure the property purchase today can influence the options available to you later.

An accountant can help model the real comparison

The tax question is therefore much broader than “Can I deduct the rent?” or “Can I claim the interest?”

A good buy-versus-lease analysis should consider the after-tax cost of each option, the cash required upfront, available deductions, GST, duty and ongoing property taxes, ownership structure, financing, the potential tax position on an eventual sale and how the property fits with your broader business and personal wealth strategy.

That can give you a much clearer picture of whether buying your premises genuinely puts you in a stronger financial position than continuing to lease.

Run the numbers beyond the first year

If you're seriously considering buying, a proper comparison should look further ahead than the immediate monthly cost.

Model what buying and leasing could look like over five, ten and potentially twenty years.

Consider:

• the deposit and upfront capital required
• loan repayments and interest
• current rent and expected rent increases
• rates, insurance and maintenance
• potential property growth
• the return you could generate by leaving the deposit invested elsewhere
• the effect of either option on business cash flow
• tax consequences
• your plans for the business and property longer term.

It is the combination of these factors that determines which option makes more sense.

So, should you buy or lease?

Buying may make sense if your business is established, you expect to remain in the property for a long period, you have the capital available without compromising the business and property ownership fits with your broader wealth strategy.

Leasing may make more sense if flexibility is important, your requirements are likely to change or your capital can be put to better use elsewhere in the business.

The important thing is not to make the decision based solely on the belief that owning must be better than renting.

For a business owner, every dollar committed to property is a dollar that cannot be used somewhere else.

Before purchasing your business premises, understand both sides of that equation.

At Bonerath & Co., we can help you model the financial and tax implications of buying versus leasing, consider how the decision fits with your business plans and determine the most appropriate ownership structure if you decide to buy.

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