Many types of businesses require commercial real estate from which to operate. From office spaces to warehouses, these spaces provide a brick-and-mortar place of operations for many entrepreneurs. In general, there are two means of securing commercial real estate: leasing and buying outright. There are pros and cons to each, which we will discuss further in this article. Let’s take a closer look at things to consider before you buy commercial real estate, as well as financing options for small business owners.
Reasons to Buy Commercial Real Estate
When you buy a commercial building or space, you may pay in cash upfront or finance the purchase with a loan. This is not unlike a traditional mortgage, and it offers similar advantages:
Equity: ownership of any property has the potential to build equity over time. Your return on investment will obviously be higher and faster if you pay cash up front; but you will still build equity throughout your ownership as you pay down the loan and your property appreciates in value.
Control: when you buy commercial real estate, you have more control over its use. This includes upgrades or additions that you would otherwise have to run past a landlord before completing (if you received permission at all).
Predictable payments: if you purchased your property with a loan, you will have the option of a fixed payment and interest rate over time. This is often preferable to a lease, whose monthly payment can be renegotiated to a higher amount every time you re-sign.
Tax breaks: commercial property owners can deduct a certain amount from their taxes, reducing their taxable income overall.
Potential for passive income: if you are not using the entirety of the property you have purchased, you have the potential to rent out this space to other businesses. This can help you pay down your loan faster and, eventually, act as an additional source of revenue for you.
Cons of Buying vs Leasing Commercial Real Estate
Of course, there are certain drawbacks to owning a commercial space. These include:
Higher up-front costs: if you decide to buy commercial real estate, you will likely need to secure a sizable down payment in order to qualify for a loan (up to 40% in some cases). You will also be responsible for closing costs and fees associated with the sale. This amount may be cost prohibitive for some.
Less flexibility: if you decide to leave the property, you will need to go through the lengthy process of selling it. In the event you are able to pay off the property, you could be hit with early-repayment fees, which can be quite high with commercial properties. Leasing gives you the flexibility to leave the property as soon as your term is up, or earlier if your landlord is willing to negotiate.
Less cash flow: more money spent up front means much of your capital is now tied up in the property itself. This can leave less liquid financing available for other necessities of the business.
Fair-rate financing: it can be more difficult to find a lender for commercial real estate. You will want to find one with a reasonable interest rate and an adequate repayment term. If the rates go too high, or you are expected to pay off the loan quickly, it may be better to lease until you qualify for a loan at a lower rate.
Full responsibility and liability: when you buy commercial real estate, you are responsible for all repairs and upgrades to the property. You will also be accountable if anyone is injured on your property, which entails monthly liability insurance payments. Business owners who are already stretched thin may find leasing is worth the time, energy, and cost that owning the building would require.
Loss of value: while it is not common, there is always the chance that your property will depreciate in value over time. If you decide to sell, you would suffer a loss of valuable capital that could have been re-invested in the business.
Loan Options for Buying Commercial Real Estate
There are many types of loans that can help business owners buy commercial real estate, each with its own eligibility requirements, repayment terms, interest rates, etc. It’s a good idea to speak with a financial expert prior to applying, as he or she can help you find the best loan options for your specific needs.
That being said, one of the best options for small business owners is the SBA 504 loan. With fixed payments, low interest rates, long-repayment terms (up to 25 years for real estate), and lower down payment requirements, this loan mitigates many of the concerns first time buyers have when it comes to financing a place of operation.
SBA 504 loans are specifically for fixed assets, and this includes real estate. Depending on your qualifications, you may be eligible for up to $5 million through an SBA 504 loan. This is often plenty to purchase both commercial real estate and other fixed assets you may need to conduct business (equipment, furniture, supplies, etc.)
You will be limited as to the use of the property, however, since SBA loans do not permit buying and holding real estate. In other words, you will not be able to rent out any unused part of your building under this type of loan’s terms.
If you meet the eligibility requirements for the SBA 504 loan, your next step should be to speak with a Certified Development Company (CDC). CDCs are non-profit organizations that help facilitate the application process for SBA loans, including the 504 and 7a.
If you are a small business looking to buy commercial real estate in the state of Colorado, contact the caring and qualified professionals at Cedco. We are an SBA-approved CDC that has helped hundreds of businesses achieve their dreams by securing the best SBA loans available to them. Whether you need help buying a new business space or you are looking to expand an existing one, we are here to help. Call or go online today to schedule a free consultation.