If you’re looking to acquire commercial real estate (CRE), buying and leasing are two options you can consider:
- Buying real estate typically requires more cash upfront but it allows you to build equity, has more flexibility in making modifications to the property, and has fewer long-term variable costs.
- Leasing real estate requires less upfront money, but you won’t get ownership interest to build equity and your lease payments could be increased over time.
When comparing buying vs leasing commercial real estate, there are also differences when it comes to other items, such as rates, terms, and qualification requirements. As a result, the best option will depend on your specific circumstances and goals.
If you’re looking to acquire CRE but are unsure where to start, Lendio is a company we recommend as it allows you to work with a dedicated funding specialist who will learn about your specific needs to get the best funding option available.
Summary of Buying vs Leasing Commercial Real Estate
How a CRE Lease Works
With a CRE lease, you’re given the ability to occupy a property temporarily. Lease terms are typically one to five years. Depending on the specific terms of the lease, you can renew upon expiration of the lease or vacate the property at the end of the lease if you decide to move elsewhere. Some leases may also give you the option to terminate the lease early if you agree to pay a penalty or satisfy other terms.
CRE leases can be complex. They must address various items, such as who is responsible for maintenance, repairs, and other property expenses.
Leases are usually structured in one of the following methods:
- Full-service lease: This is a fairly common type of lease for an office building and leaves the responsibility of virtually all maintenance-related items to the landlord. This can include things like utilities, repairs, property insurance, property taxes, and cleaning fees. While this can be convenient for tenants, these leases usually carry higher payments.
- Net lease: This is typically offered by landlords who do not want to carry the responsibility of paying for property taxes, insurance, or maintenance. Net leases can offer tenants lower monthly lease payments but, in exchange, they’ll be responsible for paying some of the expenses associated with buying real estate.
- Modified gross lease: This is similar to a net lease in the sense that the tenant would pay for property taxes, insurance, or maintenance. The big difference, however, is that a modified gross lease has a tenant pay a fixed dollar amount to cover those costs. As a result, changes in the property’s taxes, insurance, or maintenance fees would not affect the tenant’s lease payment.
Pros & Cons of Leasing Commercial Real Estate
| Pros | Cons |
|---|---|
| Requires less upfront money | Means no ownership interest |
| Makes it easier to switch properties if they no longer suit your needs | Means lease payments can increase upon renewal |
| May qualify you for tax benefits | Requires you to get landlord or owner permission to make improvements or changes to property |
- Less upfront money required: Leasing a property typically only requires a security deposit. This can be a fixed dollar amount of several months’ worth of lease payments. Meanwhile, buying would require a down payment of 10% to 20% of the purchase price of the property.
- Easier to switch properties: When a CRE property lease expires, you can choose not to renew it and simply vacate the property. This allows you to acquire another property that may be a better fit if your business needs have since changed. Meanwhile, purchasing real estate can be more time-consuming and costly because it requires you to find a willing and able buyer to sell the property to.
- Tax benefits: As a business owner, you can deduct certain costs associated with leasing commercial real estate. Due to the complexity of tax rules and regulations, we recommend working with a tax professional to ensure you maximize all deductions and tax breaks you’re entitled to take. You can also check out our list of common tax write-offs for self-employed individuals.
- No ownership interest: A CRE lease provides no ownership rights. As such, you cannot build equity in the property to take advantage of any increases in property values.
- Lease payments can increase: Although payments can be fixed for the duration of the lease, landlords have the right to increase the minimum required payment amount once the lease expires.
- Must get approval for property modifications: Since you won’t gain any ownership rights to the property, most leases prohibit any major changes from being made to the property without written approval from the owner.
How Buying Commercial Real Estate Works
When CRE is being purchased, both the buyer and seller must agree to the terms of the sale. This commonly includes things like the purchase price, deadlines, and each party’s rights and responsibilities. An escrow company is typically involved to facilitate the transfer of funds and to coordinate the scheduling of any documents that need to be signed.
Many buyers make use of a commercial mortgage loan to purchase CRE. Different types of these loans exist, which we detail in our article on types of CRE loans. To get financing, buyers must satisfy a lender’s requirements. If approved, proceeds from this loan are used to pay the seller.
Pros & Cons of Buying Commercial Real Estate
| Pros | Cons |
|---|---|
| Offers the ability to build equity | Requires a large down payment |
| Doesn’t need approval to conduct improvements or renovations to the property | May require a loan, and it may be difficult to qualify for one |
| Has fewer variable costs associated with commercial property payments | Makes it more challenging to move business location |
- Ability to build equity: As the property owner, you can build equity in two main ways. If you obtain a loan, you can build equity by paying down the loan with regular monthly payments. You can also build equity as the property value increases with changes in the real estate market or any improvements you complete.
- No approval is needed for improvements: As the full property owner, you can make any changes you want to the property without any separate approval from a landlord.
- Fewer variable costs: Regardless of whether you purchase the property with or without a commercial mortgage, buying commercial real estate eliminates the possibility of a landlord increasing a lease payment at renewal. Many commercial mortgages have a fixed payment for the life of the loan. Check out our guide on CRE rates to see how they’re determined and how you can improve your chances of getting the best-advertised rate.
- Large down payment required: Most commercial mortgage lenders require a down payment of 10% to 20% of the purchase price. Depending on the business, this can deplete a company’s financial reserves and its ability to handle emergencies.
- Qualifying for a loan can be difficult: To get a commercial mortgage loan, borrowers must meet a lender’s requirements. This often involves a review of a borrower’s credit, income, and assets and the condition and value of the property being purchased.
- Challenging to change business location: If the property no longer meets your needs, switching to a new location can be more difficult, as you’ll need to find a new buyer willing and able to purchase the existing property. Meanwhile, leases have more flexibility as you can simply choose not to renew the lease when its term ends.
Who Should Consider Leasing Commercial Real Estate
Consider leasing commercial real estate when you:
- Want to spend less money upfront: If you want to acquire real estate for as little money out of pocket as possible, a CRE lease can be a much better option. Leases may only require a small security deposit, whereas purchasing property would have a larger down payment requirement. Choosing a lease could also help your company retain financial reserves, which may help cover emergencies or be used to invest in other areas of your business.
- Can afford the higher monthly payments: Although leasing commercial real estate has lower upfront cash requirements, the monthly payments are generally higher than what you’d have if you bought it with a commercial mortgage loan. As a result, you’ll want to consider the impact this may have on your future cash flow.
- Don’t want a long-term financial commitment: While lease payments can be higher than that of a mortgage, the potential upside here is that leases require a much shorter commitment. If you are unsure about your long-term financial forecasts, are worried about what might happen if the payments end up straining your cash flow, or want the flexibility and peace of mind of not being stuck with a payment for too long, a lease could be the better fit.
- Don’t anticipate needing to make major changes to the property: Making permanent changes to CRE can be difficult if you’re leasing, as you won’t have any ownership rights. Many leases prohibit changes from being made without the approval of the landlord or owner. If you do need to make changes, it’s best to make sure they’ll be approved before signing the lease.
- Anticipate needing to move in the short term: If you think your business needs might change or otherwise force you to physically move to a different location, it’s easier to go with a lease. Once your current lease expires, you can choose not to renew it and find another property to acquire.
Who Should Consider Buying Commercial Real Estate
Buying commercial real estate may be the better option if you:
- Have funds available for a down payment: To buy commercial real estate, many borrowers use a commercial mortgage loan. Lenders issuing these loans often require a minimum down payment of 10% to 20%. If you can afford the amount of the down payment without concerns about how it may impact your financial reserves, you can take advantage of the lower payments you’ll likely have as opposed to a commercial lease.
- Have good credit and finances: Unless you have enough funds to buy commercial property free and clear, you’ll likely need to get a loan to finance the purchase. To do this, you’ll need to have credit and finances that can meet a lender’s minimum qualification requirements. Regardless of a lender’s requirements, you’ll also want to be sure you’re financially stable and can afford to commit to making payments on a long-term commercial mortgage loan.
- Need to make heavy modifications to the property: Conducting renovations, repairs, or other permanent improvements to CRE is easier when you’re the owner of the property. Since you won’t need to wait for a landlord’s permission to make changes, you can also complete improvements on a faster timeline.
- Want to retain the property long-term: Retaining ownership of a property long-term can allow you to take advantage of any increases in property value. You’ll also have more flexibility to do things like rent out the property for additional income or sell it to take advantage of equity gains. We recommend thinking about how likely it is you’ll outgrow the location, the chances you’ll need to relocate, and whether you would want to retain ownership in those circumstances.
Frequently Asked Questions (FAQs)
Leases are generally better if you can afford higher monthly payments but don’t want to spend as much money upfront to acquire property. Buying a property can be the better option if you want to build equity and have the freedom to make changes to the real estate.
Yes. You’ll typically need to have good credit and finances to qualify for a commercial mortgage loan. While some lenders can issue financing to businesses with bad credit, rates tend to be higher.
To get a lease, you’ll need to find a CRE broker who can help you identify a property and negotiate lease terms. To get a commercial mortgage loan, you’ll need to find a lender that issues this type of financing before applying and providing the required documents. You can learn more in our guide on how to lease commercial real estate or our guide on how to get a business loan.
Bottom Line
Leasing and buying are two ways to acquire real estate. Each has benefits and drawbacks, and the best one will depend on your circumstances, preferences, and goals. Before making any decisions on whether to lease vs buy commercial real estate, it’s important to consider your company’s short- and long-term goals and the strength and stability of your finances.
