If your business requires commercial premises to operate, one of the key choices you will be faced with is whether to buy or rent. Deciding between the two often requires careful evaluation of various factors such as business needs, market conditions, financial stability and potential risks. In this article, our experienced commercial property solicitors explain the key considerations involved when deciding to buy or rent commercial property, including the advantages and disadvantages of both options. We also visit some of the key legal and financial elements of the transaction.
Specifically, we cover the following:
- How long do I plan to stay in the premises?
- Can I afford to buy the premises?
- What are my business needs?
- What is the commercial property market like in my area?
- Space requirements
- Property Location
- What are your long-term or short-term goals?
- Advantages of buying commercial property
- Disadvantages of buying commercial property
- Advantages of renting a commercial property
- Disadvantages of renting a commercial property
- Legal and financial considerations
- Summary
How long do I plan to stay in the premises?
It is important to analyse your business's long-term goals, financial capabilities, and businesses stability to determine your length of occupancy.
Renting commercial property offers flexibility, especially if your business is in its infancy with uncertain growth or if you anticipate relocating in the near future. Renting allows you to occupy the premises for a specified period, and it is possible to negotiate break clauses within the lease to terminate early. On the other hand, if your business has stable growth projections and long-term plans for operations that require a fixed location, purchasing commercial property may be better suited.
Can I afford to buy the premises?
Buying commercial property typically requires substantial upfront costs. Access to capital is essential, without straining your business’s’ finances. This includes funding an initial down payment / deposit as well as associated transaction costs (such as legal fees, property surveys and stamp duty land tax), all of which add up and can impact affordability.
Next, consider whether your business is generating sufficient income to cover mortgage payments while maintaining a healthy cash flow for other operational needs. You should also factor in the ongoing cost of owning commercial premises, such as funding its maintenance, insurance, potential renovations or repairs.
What are my business needs?
When contemplating whether to buy or rent commercial property, your unique business needs and operational requirements may be a key determining factor. Some businesses have specific needs that may make buying a better option, for example:
Custom-built facilities and specialised infrastructure
If your business requires a facility with specific infrastructure, advanced technology or specialised equipment, such as laboratory spaces, research facilities or manufacturing operations, it may be more suitable to buy a property that you can tailor to your unique requirements.
Commercial leases commonly restrict a tenant’s ability to make alterations to the property or require the landlord’s consent. As such, unless the property up for lease has already been built or designed to suit your needs, renting is unlikely to be commercially feasible for businesses who require custom-built facilities, specific layouts or infrastructure.
Location-specific needs
Some businesses need to be strategically positioned in a particular physical location for customer accessibility, business visibility, brand recognition or supplier proximity. The availability and suitability of rental properties in a desired location may be limited. Buying may therefore be a better option, particularly if you are planning to fix your business location for the long-term and build-up goodwill, which can be threatened by the termination or expiry of a lease.
What is the commercial property market like in my area?
Understanding local market conditions, trends and the overall economic outlook can help you assess whether it is a better time to buy or rent. The market impacts property availability, price, lease terms, rental yields and capital growth / investment potential. In particular, high demand and limited supply can result in higher property prices and competitive leasing terms. Conversely, an oversupply of properties may provide more negotiating power for tenants or buyers.
Seek advice from estate agents, property consultants, or market analysts who can provide you with valuable insights, market reports, and data specific to your locality. For example, there may be planned infrastructure developments that are likely to impact property values, or emerging sectors driving demand. Understanding these trends can help you anticipate future market conditions and make informed decisions.
Space requirements
The nature of your business, number of employees, required amenities, storage and inventory requirements can all feed into your business’ spatial requirements. Assessing how much space your business needs to operate both now and, in the future, can dictate whether you end up buying or renting. In particular:
- Larger premises: if your business requires larger premises to operate, buying may not be an option if you do not have the upfront capital to fund the purchase (larger premises generally attracting higher costs, which in turn attracts higher stamp duty land tax). Leases without a premium may therefore be a more suitable option, particularly if you want to secure property in a prime or desirable location.
- Business growth: consider your business's growth trajectory and evaluate whether you anticipate expansion or downsizing in the foreseeable future. If your business is in a growth phase and you expect to expand operations, buying a property that can accommodate future needs might be a wise investment. However, if your business is subject to fluctuations and its growth trajectory is uncertain, then flexibility to adapt is key. Renting may be easier to adjust space requirements, especially if you negotiate a break clause.
Property Location
Your target location in itself or combined with other factors can dictate your decision whether to rent or buy.
- Property prices: the cost of commercial properties can vary significantly depending on their location. In prime areas or city centres, property prices may be higher, making it more financially viable to rent rather than buy.
- Flexibility: if you are unsure about the long-term viability of a particular area, renting allows you to relocate more easily. Buying a property, on the other hand, ties you down to a specific location and makes it more difficult to move if needed.
- Stability: if stability is important to your business, for example building up goodwill or a solid customer base in a physical location, then the certainty that comes with buying may be more appropriate. Leases by their very nature are granted for limited periods of time, subject to rent reviews and ultimately at the discretion of the landlord.
What are your long-term or short-term goals?
Assessing long-term goals:
- Expansion and scalability: if expansion is foreseeable, consider a property that can accommodate your future growth. This may involve buying a property with potential to expand, or perhaps renting a larger premises that you can grow into if expansion is imminent.
- Stability: if stabilising in a particular area, building up goodwill and a steady customer base is your ultimate goal for your business, buying gives you a fixed location and more control over your property.
- Equity: if your business plan envisages building or releasing equity to fund other projects, property ownership may be more suitable to benefit from appreciation in value overtime.
Evaluating short-term goals:
- Flexibility and agility: if your business requires flexibility in terms of location or size for the time being, consider short-term lease options for testing new markets or business ventures.
- Financial considerations: evaluate the financial implications of buying versus renting in the short term. In particular, consider the impact of upfront costs associated with buying on your operations. This may set you back or strain your business’ finances.
- Market conditions and opportunities: the current state of the commercial property market in your area, or emerging market trends and investment opportunities may mean tapping into potential now that your business could benefit from later.
Advantages of buying commercial property
Investing in commercial property offers several advantages that can benefit your business, such as:
Stability and control: Buying provides stability and the assurance of having a permanent base for your business operations. Ownership also allows you to have full control over the property, including customisation, renovations, and branding.
Equity and asset appreciation: Buying can lead to built-up equity over time. As you make mortgage payments, you increase your ownership stake in the property (unless you purchase an interest only mortgage). Commercial properties also have the potential to appreciate in value over time, offering the opportunity for long-term capital gains.
Potential rental income: If you have excess space or are not fully utilising the entire property, you have the option to lease or rent out the extra space. Rental income can provide an additional revenue stream to apply to your current operations or save to fund future expansion.
Potential for expansion: Buying commercial property may provide flexibility for future expansion or adaptions depending on the potential and size of the property. As your business expands or evolves, you may have the option to utilise the property for additional operations, office space, or storage. If, on the other hand you find that you have more space than your business requires, you can lease out the surplus space to generate additional income.
Control over operational costs: Owning commercial property allows you to have more control over operational costs. You are not subject to rent increases or lease negotiations, providing stability in budgeting and financial planning. Over time, owning a property can be more cost-effective than renting, as mortgage payments may be relatively stable compared to increasing rental rates.
Branding and image: Owning a property allows you to establish and customise the space to reflect your brand identity, enhancing your business's image and reputation. With a permanent location, you can build a long-term market presence and brand recognition, providing stability and reliability to customers and clients.
Disadvantages of buying commercial property
While buying commercial property comes with several advantages, there are also certain disadvantages that businesses should consider before making a decision:
High initial costs: Purchasing commercial property typically requires a substantial upfront capital investment, including down payments, legal fees, property surveys, and other associated costs. Investing a large portion of your capital may impact, limit or delay your ability to invest in other business opportunities such as product or service expansion. In addition, securing financing for commercial property can also be quite challenging, with strict lending criteria.
Long-term commitment: Buying commercial property involves a long-term commitment and may limit your ability to adapt to changing business needs or market conditions. If your business needs to relocate or expand to a different area, selling or disposing of the property can be time-consuming and disruptive.
Responsibility for maintenance and repairs: As the owner, you are generally responsible for property maintenance, repairs, and upkeep, which can be costly and time-consuming. Unexpected repairs or maintenance issues can arise, leading to additional expenses.
Market volatility and risk: Commercial property values can be subject to market volatility, which may lead to potential fluctuations in the property's value. Economic downturns or changes in market conditions can impact the demand for commercial property and potentially affect rental income and property values.
Limited liquidity: Commercial property is considered a relatively illiquid asset, meaning it may take time to sell or convert the property into cash if the need arises.
Advantages of renting a commercial property
Renting commercial property can offer several advantages over buying, depending on the specific needs and circumstances of your business. Key advantages of renting commercial property include:
Flexibility: Renting is generally considered to provide more flexibility compared to buying. You can choose the location, size, and type of property that suits your needs without committing to a long-term investment. This means you can adapt and relocate your business more easily if your requirements change in the future.
Lower upfront costs: Renting typically requires less upfront capital compared to purchasing commercial property. In particular, buying a property usually involves a sizeable down payment, as well as other associated costs such as surveys. Renting in comparison tends to require less upfront expenses, although some leases do come at a premium.
Maintenance and repairs: The responsibility for property maintenance and repairs often falls on the landlord or property management company. Although costs of repairs are typically recouped by the landlord through various mechanisms in the lease (for eg service charge), the main benefit to you as the tenant is that it saves you time which you can use to focus on your business.
Access to prime locations: Renting often enables businesses to access prime locations that may be financially unfeasible or unavailable for purchase. High-demand areas with excellent foot traffic or specific commercial / retail parks may have limited ownership opportunities or come at a significantly higher cost. As such, renting enables you to establish a presence in sought-after areas, potentially increasing visibility and customer traffic.
Tax benefits: Rent payments are usually considered a business expense, which can be deducted from taxable income, lowering your overall tax liability. However, it's essential to consult with a tax professional to understand the specific tax implications for your business.
Disadvantages of renting a commercial property
Despite its advantages, it's important to note that renting does have its limitations, such as:
Lack of long-term investment: When renting, businesses do not build equity or ownership in the property. Unlike buying, where property value may appreciate over time, renting means that the money paid in rent does not contribute to long-term asset accumulation. If property values rise, the landlord reaps the benefits, while the tenant does not share in the potential financial gains.
Limited control: Lease agreements often come with restrictions on modifications, renovations, or customisation of the space. In many cases, you need to seek permission from the landlord for any desired changes, and this lack of control can restrict your ability to tailor the property to your specific operational needs.
Rising rental costs: Over time, rental costs can increase, especially in high-demand areas or when lease agreements expire. You may face rent hikes when your lease is due for a rent review or renewal.
Dependency on the landlord: Renting means relying on the landlord for various aspects of property management. If the landlord is unresponsive or uncooperative, it can create difficulties for your business. Issues such as delayed repairs or maintenance, disputes over lease terms, or changes in property ownership can be disruptive.
Uncertainty: When the lease term ends, there is no guarantee that the landlord will renew the lease or that the terms will remain favourable. This uncertainty can create instability and disrupt business plans. Even if your lease has security of tenure (a legal right to remain at the premises after expiry of the lease), there are still grounds, albeit limited, that the landlord can utilise to take back possession of the property lawfully.
Legal and financial considerations
Whether you decide to buy or rent commercial property, it is important to approach these transactions with careful consideration, including:
- Seek professional advice: appointing trusted advisors to guide you from the outset can ensure a smooth process and successful outcome. This includes hiring commercial estate agents to help you locate a suitable property, and the right legal team to structure the deal, navigate any complexities and protect your interests.
- Conducting due diligence: before making any commitments, it is essential to conduct thorough due diligence on the property you are interested in. This process involves investigating the property's legal, financial, and physical aspects. Your solicitor will conduct searches and investigate the title, while a surveyor can check the structure and environmental health of the property / land.
- Heads of Terms (HOTs) and agreements: Buying or rent commercial property is document heavy. Once you have identified a suitable property, negotiations will begin, and it is common to establish Heads of Terms (HOTs) as a preliminary agreement before drafting the formal contract. HOTs outline the key commercial terms and conditions, including rent, lease term, repairs, and any special provisions. It is crucial to review HOTs carefully and seek legal advice to ensure your interests are protected.
Once the HOTs are agreed upon, a formal lease or purchase agreement will be drafted. Your solicitor will review the document to ensure it reflects the agreed terms, protects your rights, and complies with the relevant laws and regulations. We also help negotiate any necessary amendments or additional clauses to protect your specific interests.
Understanding the financial aspects of buying or renting commercial property can help ensure you are financially prepared for the commitment, which include:
- Stamp Duty Land Tax (SDLT): SDLT is a tax paid when purchasing property in the UK (known as Land Transaction Tax in Wales). The rate of SDLT depends on the purchase price or lease premium of the property. Different SDLT rates apply to different portions of the property price. It's important to factor in SDLT costs when calculating the overall purchase or lease costs of the property.
- Creditworthiness: when renting or buying commercial property, landlords and lenders often assess the creditworthiness of the tenant or buyer. This involves evaluating financial stability and ability to meet rental or mortgage payments. Factors such as credit history, business financial statements, and references may be considered. Maintaining a good credit score and providing evidence of financial stability can increase your chances of securing a favourable lease or mortgage.
- Business plan and financial projections: for commercial properties, lenders or landlords may require a detailed business plan and financial projections to assess the viability of your business and its ability to generate revenue to cover the rent and or property-related expenses.
- Additional costs: apart from SDLT, there are other expenses to consider when buying or renting commercial property. These may include legal fees, survey costs, property valuation fees, insurance, property maintenance, utility bills, and business rates. These expenses can impact the overall financial commitment and should be factored into your budget.
Summary
Buying commercial property is a big step for your business and requires careful consideration. Whether you prioritise stability, equity, branding, flexibility, or financial security, a thorough evaluation of your specific needs is key to the decision-making process. In addition, weighing up the pros and cons of each option, relative to your business objectives, can help you make a more informed choice.
Here at Harper James, our friendly team of commercial property solicitors have decades of experience advising business owners in both property rentals and purchases. Get in touch with us today to discuss your property needs.
