Two smart long-term real estate options
When the jury was still out on your business’ survival, you probably didn’t want to enter into a long-term location commitment. But if you think you’re going to make it, now might be a good time to take a serious look at where you want to establish your business.
Long-term business real estate planning means either direct ownership or a long-term lease. I’ve covered the direct ownership issues and advantages quite a bit recently, but let me remind you of a few key reasons I consider it to be the stealth benefit of business ownership.
- You own the property personally and your company pays you rent.
- You have control over your real estate future.
- Rental income increases over time.
- The rent is passive income, read: no payroll tax.
- Under a triple net lease to you, your company will pay all property expenses.
- You deduct depreciation and interest personally.
- The real estate appreciation accrues to you.
- When you sell the business, lease the property to the new owner as part of your retirement.
Now let’s focus on that second option.
A long-term lease is several years in length, such as five, ten, or more, and are necessarily more sophisticated. The first evidence of sophistication will be in who pays what expenses on the way to determining how much the base rent will be.
Unlike when you rent an apartment with an all-inclusive fixed monthly rent payment, in long-term commercial lease, typically some or all of the property’s operating expenses are allocated to the tenant. Called a “net lease,” here are the three classic variations.
1. A single-net lease includes the basic monthly lease payment, with possibly a very limited number of other obligations that will vary from property to property.
2. A double-net lease will have a smaller monthly lease payment, plus typically all property expenses (insurance, taxes, etc.) except exterior maintenance.
3. A triple-net lease has all the elements of a double net, plus the tenant typically pays all operating expenses, including maintenance. Because of the full expense commitment, this lease will have the lowest monthly commitment.
It’s very likely you’ll consider rental spaces that differ in price, terms, square footage, etc. In order to compare them accurately, you’ll want to convert all lease expenses into an annual square-foot rate. Here’s how you do the math, let’s say, for a five-year lease:
Add all the annual obligations, like lease payments, insurance, taxes, maintenance, etc., plus the amount of all of the scheduled increases over the full term, and divide that total by five. Then divide that aggregated annual number by the interior square footage of the space, which will produce the annual square-foot rent rate you’ll use to compare properties.
Unlike the basic monthly lease payment, additional obligations like insurance, taxes, and maintenance may hit you with one annual bill. And while taxes and insurance are mostly predictable, maintenance and repairs not so much. So establish a monthly reserve in order to have the cash when the annual expenses occur, and to cushion the blow when the roof leaks or the air conditioner goes out.
Finally, consult with your attorney and CPA before you sign.
Write this on a rock ... It’s smart business to make long-term real estate decisions, but you have to be smart about it. Surprises are for birthdays – this is business.
