Why Buying Beats Renting
If you have equity available in property, or cash in the bank and you aren’t thinking of buying your own commercial premises, you might want to reconsider.
Almost every business owner reviews their options regarding leasing a property versus buying their own about every three years. (ie. whenever their lease is coming up for expiry). For many, they have an inherent belief that buying has to be better than renting, but the true benefits over the long term are often not explained from a business perspective.
To begin with there are many non-financial reasons to buy your own premises:
- Stability – you own the place and so you are not at the whim of landlords that may want to have you moved on for their own personal gain – ie. They want to sell the property to a developer or change the property themselves
- Expansion – want to build a mezzanine floor, new kitchen or put in extra toilets etc? Why not add value to your own property rather than improving it for the landlord?
- Location – choose your own location and stay there so that suppliers and customers know exactly where to find you. Referral and repeat business is always easier to obtain if people know where you are.
Of course as a business owner, you know all of the above reasons already. What you may not have considered is the long term financial gain and return on equity that you can achieve by owning the building you are in.
Let’s consider the following scenario:
|Purchase Price||$800,000||Rental Cost if leased||$72,200|
|Purchase Cost||$32,000||Outgoings Cost if leased||$10,800|
|Available Depreciation||2.5% per annum||Bond – 3 Months Rent||$18,000|
To understand the true benefits of owning your own premises versus renting you need to calculate the financial reasons for doing so. As with any investment into an asset (and that is really what this is) you need to look at the return you are likely to achieve. This return is often known as Return on Equity (ROE) or Return on Capital Employed (ROCE).
If we assume that the minimum deposit needed to purchase the property is 25%, then the Capital Employed is the deposit used plus the purchase costs. If you are leasing the premises then you might use the Bond amount as the Capital Employed.
On balance, the deductions on each scenario are approx. the same. However, the ROCE calculation is where the differences really lie. To fully appreciate the value you really should forecast this over a period of time equal to that of the lease you might be considering. In the following calculation, only one year of returns has been calculated. The ROCE has been calculated on the capital growth return only.
12 Month Capital Growth
So, there it is. The Return on Capital Employed calculation based on different capital growth rates over one year.
Assuming your total Capital Employed is $232,000 then a Capital Growth of just 5% on the property provides you with a Return of 17%. IF you were fortunate enough to experience capital growth of 7% this return would increase to 24%.
This is the return you miss out on when you rent. In fact with interest rates at reasonable levels, you might find that you improve your cash-flow as well as gain on any growth obtained.