LLOYDMINSTER, Saskatchewan — For the dry cleaning plant owner who operates from a leased premises and the lease is about to expire, the question arises as to whether it is better to own or lease your plant’s real estate. However, when investment capital is limited, continuing to rent is the only option. For the established operator who has the wherewithal, if the business has outgrown the plant’s size or the landlord demands are unreasonable, it becomes a matter of weighing the options of leasing, buying or building, and selecting which is best.
Most would say that owning is the only way to go. Yet, the big box stores and many industrial concerns lease. Maybe they are telling us something. As there are ups and downs to both options, it becomes one of determining whether the benefits of ownership outweigh the disadvantages.
Owning vs. leasing your plant’s real estate is not about occupancy. You can always buy, build or rent the plant space you need. It is all about the wisest employment of available capital. Money is not made by owning an asset, but by the use of it.
COST OF OWNING VS. LEASING
Let’s assume the optimum dry cleaning plant has 10,000 square feet of floor space. Allowing for some onsite parking, about 15,000 square feet of land is required. If buying or building an average-quality building, including limited modifications, special dry cleaning plant systems, and equipment installation, an investment in the $1.5 million range is suggested.
If mortgaging, say, 75% of that investment, or $1.125 million, at 5.0% for 20 years, the annual debt service would be approximately $89,000. Add to this a return on your equity investment of $375,000 that is comparable to other commercial real estate investments of, say, 9.0%, or $33,750 per annum, your property cost would be approximately $122,750 per year ($89,000 plus $33,750).
However, were you to borrow the $375,000 from Aunt Jane at, say, 6% interest with a 10-year amortization, the annual payments to her would be approximately $50,000 for a total of $139,000 per year ($89,000 plus $50,000).
If leasing at $12 per square foot per annum, it would be $120,000 per year for 10,000 square feet. Property taxes, insurance, utilities and maintenance are additional in both cases.
So, depending on your cost of financing, if buying or building, including the return on equity, it could be $122,750 or $139,000 annually. If leasing, it could be $120,000 per year. This suggests that for the shorter term, leasing is the better way to go. But it may not be.
If you have the equity parked in some bank at a negligible return, or discount any return on your equity, it is about a break-even proposition. With borrowing the equity, on a cash flow basis, for the early years, you are a loser. Still, with the buying, using the demonstrated interest percentages, you would retire the $375,000 loan in 10 years and the $1.125 million mortgage in 15, after which your debt service would be nil. If leasing at the same rate, you would still be forking out $120,000 per year. Over the longer haul, as you are money ahead, owning the real estate is the better way to go.
UNDERTAKE A COST COMPARISON
In following through the noted figures, be advised that they are for demonstration purposes only; do not accept them as gospel. You must work out your own cost of buying and financing or leasing.
I don’t have the slightest idea of what it would cost to buy or rent a 10,000-square-foot building in your community, so you might get a better deal on interest than what I’ve shown. (I do know that rates are at an all-time low.) It could be that the equity capital is not there, or Aunt Jane says “No.” And, you might not be able to buy or build what you want for $1.5 million, or rent a good-quality building in a good location for $12 per square foot.
It is important that you undertake a complete cost analysis comparison, which would include building adaptation for a dry cleaning plant; purchase and installation cost of the new equipment that you would require; removal and reinstallation costs of retained equipment; and returning your vacated premises into the same condition it was prior to your occupancy.
Check back tomorrow for the conclusion!
Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult an attorney or tax adviser for advice regarding your particular situation.
Have a question or comment? E-mail our editor Dave Davis at [email protected].