Count small business owners among Floridians who may not be cheering Florida's red-hot real estate boom. Apart from salaries, rent or mortgage payments often represent a business's largest - and most intractable - fixed cost. "For every dollar of rent a business pays," says Jerry Osteryoung, executive director of the Jim Moran Institute for Global Entrepreneurship at Florida State University's College of Business, "that business typically will need to generate $7 in sales." Ouch.
As recently as a few years ago, the decision to buy rather than rent - assuming a business owner had the cash for a down payment - was something of a no-brainer. Interest rates were at historic lows, and in many Florida markets commercial property prices had not appreciated to a point that fully discounted that interest-rate bargain. As a result, the monthly cost of ownership (debt service plus maintenance, repair and property taxes) often came in well below the monthly cost of renting.
"In my eleven years of advising entrepreneurs, I have never encountered one who regretted buying the company building," Osteryoung says flatly. "But I've run into many who regretted not buying the company building."
Still, rising interest rates, soaring construction costs and higher vacancy rates in some markets have altered the cost-benefit equation for buying versus renting. Here are five tips from real estate experts and entrepreneurs
"For every dollar of rent a business pays, that business typically will need to generate $7 in sales."
- Jerry Osteryoung
1. Weigh All Your Options
Conventional wisdom says you should deploy your capital in your core business and leave property development to people with expertise in that area. In 2006, that is still a very compelling argument and is the model employed by many highly successful national companies, says Eric Rapkin, a Fort Lauderdale real estate attorney with Akerman Senterfitt.
"Ownership offers the advantages of reduced tax liability and equity buildup, no question," Rapkin says. "But leasing requires less upfront capital and allows more flexibility for rapidly growing businesses or those that plan to downsize in the near future."
As a practical matter, though, a small business typically isn't growing so rapidly that owning the building creates problems, Oster-young says.
Osteryoung offers one caveat: "If you have to choose between buying inventory and buying your building, you should of course buy inventory. But if you can do both, you should at least consider buying the building."
2. Do the Math
Darryl Robinson doesn't sugar-coat it. "The Miami market has been a little out of control," says Robinson, vice president in the Miami office of Transwestern Commercial Services, a national real estate firm. But business owners willing to do the math may find that buying right now can be a winning choice, despite the sky-high prices.
In Miami, for example, soaring construction costs may have a silver lining for today's buyers. "Horizontal development for years has been constrained by geography, and vertical development is now being constrained by price," Robinson says. "Dade County is largely built out from the Atlantic to the Everglades, and now labor shortages are driving construction costs to the point where it's hard to make the numbers work on new verticals. So anyone who buys now is not likely to see the value of their investment undermined by new supply."
Robinson advises making the rent-versus-buy decision by analyzing all of the costs and benefits of both options over the length of the lease. Put in the simplest terms: If after a 15% down payment, the total monthly cost of ownership is close to the total monthly cost of renting, potential appreciation and the tax benefits tip the scale toward buying.
3. Look at Intangibles
Karen and Burt Leibowitz learned about the vicissitudes of renting in dramatic fashion in 1989, five years after acquiring Dade Towel, a Miami-based distributor of hotel supplies throughout Florida and the Caribbean.
"Our landlord asked us, 'How soon can you get out?'" Karen Leibowitz says. "It was quite a shock. We decided after that we wanted to control our own destiny."
The Leibowitzes had the luxury of shopping in what was then a buyer's market. "There were lots of vacant buildings," Karen Liebowitz recalls. They settled on a 15,000-square-foot warehouse across the street from a residential area, put on a new roof, leased the space they couldn't use to tenants and raised the rent every two years. As their business grew and leases expired, the shoe was now on the other foot: They were the ones asking tenants to make other arrangements. Dade Towel now occupies the entire building, and the mortgage is paid off.
"The rents covered most of the mortgage payment, and we had such peace of mind," Karen Leibowitz says. "I think more business owners should consider this."
4. Consider Using a Commercial Broker
If the prospect of weighing a complex array of factors - market risk, operating expenses, appreciation potential, return on investment, cash flow and tax benefits - gives you heartburn, Akerman Senterfitt's Rapkin recommends engaging a commercial broker with expertise in the type of property you're considering to help with the rent-versus-buy decision. In Florida, the seller or landlord customarily pays the commission, so retaining a buyer's broker is an inexpensive conduit to valuable expertise. Most brokers will require clients to work with them exclusively and will expect to get paid a commission on any transaction that occurs, so if you want to exclude a property you are already considering, Rapkin advises putting the exception in writing in the engagement letter.
To find the right broker, Rapkin recommends getting referrals from other professionals you do business with. "Everyone in almost every profession is touched one way or another by real estate," Rapkin says. "If there is a good broker out there, chances are your attorney or your accountant is going to know who that person is."
In negotiating a lease or sale, don't be afraid to ask for more than you think you can get. In soft markets, savvy negotiators often can wring surprising concessions. When a 2004 merger created the need for a larger facility, Aegis Computer Services - the Next Generation set its sights on a 5,000-square-foot building on one of the busiest roads in Tallahassee, close enough to cultural icon Chez Pierre for a company sign to be seen from the restaurant's verandas. Even so, the former home to a travel agency had been vacant for three years. "We knew the owner was very motivated to have someone in the building," CEO Pamella Butler says.
So Aegis made an offer the owner could not refuse. Aegis would pay for all tenant improvements and pay top dollar in rent. In return, the lease gave Aegis a 24-month option to buy the building.
"Everything worked out beautifully," Butler says. "Last May we were able to purchase the building after just 13 months. The rent credit helped minimize our down payment. We structured the purchase as an LLC partnership, so the tax benefits flowing to me and my partners have been considerable."
Aegis, with a staff of 16, is actively seeking two to three employees and could grow to 25 employees within the next several years, at which point it will outgrow its current location. Butler isn't worried. "We'll rent or sell this and find another building."