If you are having trouble deciding whether to lease or buy commercial real estate for your business, then this article is for you. We cover the pros/cons of each option, and give you a step by step breakdown of how we calculate the cost of leasing vs. buying using a real-life commercial property as an example. After reading this article you’ll have all the information you need to decide whether leasing or buying your location is better for your business.

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**Leasing vs. Buying: The Bottom Line**

If you plan to stay in the same business location for 7 or more years, then buying is generally much less expensive than leasing. In the live example we analyzed, leasing cost **$322,616.40** **more than buying over a 15 year time period**. When the occupancy drops from 15 years to 7 years, however, the costs are about the same. When staying in the building for less than 7 years in our example, it would have been cheaper to lease than to buy.

However, when evaluating whether to lease or buy your business location, cost is not the only factor. Other important factors to consider, and which can make leasing more attractive, are:

- Buying is going to cost you a lot more upfront than leasing. Can you afford to tie up money in the down payment for a mortgage?
- Even if you can afford it, would that money be better spent if you invest it in growing your business?
- Will you outgrow your space and need to move in the next few years?
- Do you want to deal with the added hassle of maintaining the property?

**Buying vs. Leasing: Example Business Property**

To give you the best comparison, we took an actual commercial property in Aurora, IN and used it as a reference point. The building is a retail space of 3,228 sq. feet. It has a main sales floor/retail area (52×30), 3 office spaces, an unfinished basement, a good-size parking lot, and prime frontage on a busy road.

The commercial property is currently for sale for $256,980. Similar properties in the area currently lease for $8 a square foot, and the building is 3228 sq. feet. We use these numbers ($8 X 3228 sq. ft.) to calculate the 1st year lease payment amount of $25,824.

We assume a 15 yr. occupancy of the building and a triple net lease agreement. In a triple net lease, the lessee pays the maintenance, property taxes, and utilities as if they were an owner. (Learn more about the different types of leases)

We found that purchasing commercial real estate would save the business owner a total of **$322,616.40** **over 15 years **in this example. Please note, there are a number of assumptions which were made, and outlined in the details section below, that might be different for your particular situation. However, we can say with confidence that for a business which stays in one location for a long-time (over 10 years), there are major cost benefits to buying your location instead of leasing.

Below, we give a summary of our findings, followed by a detailed break down of the major factors and logic behind our calculations. This same logic can be followed to analyze and get a rough estimation of the buy vs. lease costs of any commercial property.

**Buying vs. Leasing: Out of Pocket Costs**

In this example, when comparing out of pocket costs only, leasing costs **$80,755.97 more than buying **over the 15 years. However, this does not take into account the value of the building (which is paid off and owned in full at the end of the 15 years), tax savings, or opportunity costs.

When the value of the building is taken into account, leasing costs **$426,617.42 more **over 15 years in this example than buying.

How We Made These Calculations

**Tax Savings**

When leasing commercial real estate, you can generally deduct all your costs. This is not true when buying a commercial commercial real estate, although you can deduct your mortgage interest expense, and recurring costs for things like maintenance, and the deprecation of your building. When you factor in these tax savings** leasing costs you $331,402.48** more over 15 years in this example than buying.

How We Made These Calculations

(Special thanks to Andrew Schwartz of SchwartzAccountants.com a CPA who specializes in advising healthcare practices on these types of issues and helped with this section)

**Opportunity Costs**

Buying costs much more upfront than leasing, because of the down payment required for a mortgage. Typically the down payment for a commercial mortgage ranges from 10 to 30%, in this example we use 20%. There is an opportunity cost to tieing up this money in the building instead of investing it in your business.

In this example, the lease payment was also higher than the mortgage payment so there is also an opportunity cost for leasing.

When we factored in opportunity costs, leasing cost **$347,887.72** more than buying.

How We Made These Calculations

**How The Time You Occupy The Building Affects The Numbers**

To see how the time you occupy the building affects the numbers, we re-ran all our calculations using a 7 year occupancy instead of 15 years.

When looking at out of pocket costs and the value of the building only, **leasing costs $179,417.40 more** over the 7 years than buying.

When factoring in tax savings** leasing costs $84,184.40 more** over the 7 years than buying.

When factoring in opportunity costs **leasing costs $5,082.75 more **over the 7 years than buying.

How We Made These Calculations

To calculate the out of pocket cost difference of leasing vs buying commercial real estate we tallied up the upfront and recurring costs for both leasing and buying. Then we simply subtracted the total costs for buying over the 15 years from the total costs of leasing over the 15 years. Here is the full explanation of each step:

**Explanation of Leasing Commercial Property Upfront Costs**

Landlords generally require a security deposit that is at least equivalent to one-month’s rent. In this area, commercial properties lease for around $8/sq.ft/ year. So, if you take the square footage of the building (3228) and multiply it by your cost per square ft ($8), you will get your yearly rental rate ($25,824). Divide that by 12 and you have your monthly rate as well as your security deposit, which is around $2,152 in this case.

If you have used a broker, there is also a broker fee that you must pay, generally around 10% of yearly lease total x number of lease years. In this case we assumed an initial lease of 3 years which would equate to a broker’s fee of around $7,700. Brokers are not paid again if the lease renews so this is a one time fee. Some brokers charge per sq. ft/year. Check with your local commercial real estate broker to see how they calculate their fees.

Also, from the various real-estate professionals I have talked to, it is advisable to get a pre-lease inspection, to determine possible costs/problems (mold, structural integrity, etc). Scott Pruitt, Vice-President of Operations at Commercial Building Consultants, quoted me a price of .5% of total property cost or less. For this building, around $1,285 or less.

There are also attorney fees for lease negotiations. Robert Pellegrini, Attorney and Real-Estate Law expert, explained that attorneys usually charge by time/material. With most negotiations taking 2-4 hours, expect to pay between $400 – $2,000 in fees, depending on location and total time. In this case, being a rural area and fairly uncomplicated lease, probably around $700. We therefore estimated the total due diligence fees for leasing of $1,985.00.

Altogether then, leasing this building would cost you around $11,837 in upfront costs.

**Explanation of Upfront Costs When Buying Commercial Property **

When buying commercial real estate, your initial costs will include due-diligence fees and closing costs.

Due-diligence fees are all of the fees related to the legal side of getting your new building up and running, including your property assessment, attorney fees, permit fees, inspection fees, etc. For this building, we estimated $10,000 in Due Diligence fees.

Closing costs include bank fees, processing fees, appraisal fees, etc. These costs vary widely depending on area, property value, bank, etc. In this case, from some general state-by-state research that I did, closing costs would be around $4000 for this building.

The purchase price of the building is $256,980 so assuming a 20% down payment on the mortgage, that would be an additional $51,396 in upfront costs.

Assuming due-diligence fees of $10,000, closing costs of $4,000, and a down payment of $51,396, you would be paying $65,396.00 or so in initial costs for this building.

**Explanation of Recurring Costs When Leasing Commercial Real Estate **

Leasing commercial real estate can be very confusing, especially considering all the different leasing arrangements. There are three main one’s which you should familiarize yourself with: percentage, gross, and net.

**Percentage**– Monthly rental rate + set percentage of your monthly sales.

**Gross**– Rent is all-inclusive. The landlord generally pays for property taxes, maintenance, etc. while the tenant is only required to pay their monthly rent.

**Net**– Rent + some or all of other building costs such as property taxes, maintenance, etc. There are varying levels of net leases.

Our leasing article has a more detailed explanation of each of the leasing types.

Triple net leases are considered the standard lease arrangement for retail spaces, which is why we assume a triple net lease in our example calculations. Recurring costs for triple net leasing include your lease payment, utilities, property tax, maintenance costs, and insurance.

Retail utilities average around $1.5/sq. ft/yr – $2.5/sq ft/year. Water bills add additional costs. A safe estimate for this building for electric, natural gas, and water would be around $8,500/yr.

Property Taxes are around $6,000/yr.

Retail insurance will cost around $1500

Factor in about $1.50/sq. ft/yr for maintenance/improvement costs, which gives you around $5,000 for yearly maintenance.

This puts the total recurring costs for leasing at around $46,824 for the first year.

To calculate recurring costs over the following years we assumed a 2% annual rate of inflation. (You can see our full inflation calculations in this spreadsheet). That gave us a total recurring cost for leasing over the 15 years of $813,578.01.

**Explanation of Buying Recurring Costs**

Recurring cost for commercial real-estate buyers includes mortgage payments, utilities, property taxes, insurance, and maintenance/improvements.

To calculate the mortgage we subtract out our 20% down payment ($51,396) on the $256,980 purchase price. That gives us a mortgage of $205,584. Assuming a 6% interest rate on the mortgage, we used this mortgage calculator to calculate our yearly mortgage payment of $20,817.96.

Retail utilities average around $1.5/sq. ft/yr – $2.5/sq ft/year. Water bills add additional costs. A safe estimate for this building for electric, natural gas, and water would be around $8,500/yr.

Property Taxes on this property are around $6,000/yr.

Retail insurance will cost around $1500

Factor in about $1.50/sq. ft/yr for maintenance/improvement costs, around $5,000.

That brings the total for the first year recurring costs for buying to $41,817.96.

To calculate recurring costs over the following years we assumed a 2% annual rate of inflation. (You can see our full inflation calculations in this spreadsheet). That gave us a total recurring cost for buying of $679,263.04.

**Buying Vs. Leasing: Out of Pocket Cost Difference**

If we consider only the out of pocket costs then we simply add the upfront and recurring costs for buying together and then subtract them from the upfront and recurring costs for leasing.

Upfront Cost For Buying: $65,396

Recurring Costs For Buying: $679,263.04

**Total Costs For Buying:** 744,659.04

Upfront Costs for Leasing: $11,837

Recurring Costs For Leasing: $813,578.01

**Total Costs For Leasing: **$825,415.01

Cost Difference: $80,755.97 more for leasing over 15 years.

**Profits From The Sale Of The Property**

The above numbers do not take into account the fact that at the end of 15 years our mortgage is paid off, meaning we now own the building outright. Assuming an appreciation rate of 2% per year, at the end of 15 years the building that we paid $256,980 for originally would be worth $345,861.45 (compound interest calculator).

When factoring in the value of the building, the total cost for buying drops over the 15 years from $744,659.04 to $398,797.59.

This substantially increases the cost advantage of buying over leasing. With the value of the building factored in, leasing costs $426,617.42 more over the 15 years than buying.

To help understand the tax consequences of buying vs. leasing commercial property we spoke with Andrew Schwartz of SchwartzAccountants.com a CPA who specializes in advising healthcare practices on these types of issues.

**Tax Consequences of Leasing Commercial Real Estate**

Calculating the tax savings involved with leasing is straightforward. You can generally deduct all costs associated with leasing. So we simply multiply the total amount paid over the 15 year lease ($825,415.01) by 35% which gives us $288,895.25 in tax savings.

**Tax Consequences of Buying Commercial Real Estate**

The tax consequences of buying are less straightforward.

Property is a capital asset, which means it is not deductible as a business expense. You can however depreciate the value of the building over a 39 year period, and deduct the amount the building depreciates by each year. Land does not depreciate, so you need to subtract out the value of the land from your calculation. The cost of a capital asset is recovered over the life of the asset, which for buildings is generally 39 years. As with the lease we assumed we pay 35% taxes on the profits of our business.

To calculate our annual depreciation we need to first subtract out the value of the land from our $256,980 purchase price. We estimate the value of the land to be $50,000, giving us 206,980 that we can depreciate over 39 years. That means we can deduct $5307.18 each year for 15 years, giving us a total deduction over that 15 years for depreciation of $79,607.69. Multiplying this number by 35% gives us our depreciation tax savings of $27,862.69.

We can also deduct all our interest expense. The same calculator we used to calculate our mortgage payment will give us the total interest paid over the life of the loan, which is $106,686.23. Multiplying this number fo 35% gives us our interest expense tax savings of $37,340.18.

We can also deduct all the non mortgage related recurring costs ($366,992.68 x .35) which gives us $128,447.44 in additional tax savings for buying.

Assuming we sell the building at the end of the 15 years, we will have to pay capital gains tax (15%) and depreciation recapture (25%). Using our compound interest calculator and compounding the initial $256,980 value of the building at 2.5% for 15 years, the value of the building at the end of 15 years would be 372,183.66. That is is an increase of $115,203.66.

$79,607.69 of that is going to be our depreciation recapture on which we pay 25% or $19,901.92 in taxes. The remaining amount ($35,595.97) is our capital gain, which we pay 15% or $5,1339.40. To finalize the tax savings calculation for buying, we need to subtract the total taxes we pay on the sale (25,241.32) from the tax savings ($193,650.31).

Leasing Tax Savings: $288,895.25

Buying Tax Savings: $168,408.99

When tax savings are included our total cost for leasing over the 15 years is $536,519.76.

Our total cost for buying is $230,388.60

When Factoring in Tax Savings leasing costs us $306,131.06 more over the 15 years than buying.

**Other Notes on Taxes**

Also if a large portion of the value of your building lies outside of the building’s envelope (ceiling, walls, and floor) then you may be able to deduct those items over 5 or 7 years instead of 39 years. This is called accelerated depreciation. Using accelerated depreciation generally only makes sense if your property is worth more than $500,000.

In my conversation with tax expert Andrew Schwartz, he mentioned that purchasing commercial real estate through a separate entity, gives you a tax advantage as well as 2 other primary advantages:

**Tax Advantages:**If you buy your property through a separate corporate entity, you can then rent the property to your main business. If you set the rent at your mortgage payment + depreciation, then you can create a tax deferred stream of income.**Liability:**It shields the property from liability associated with your primary business. If something happens and your main business is sued, then your property is protected because it is held in a separate corporate entity. The reverse is also true. If someone slips and falls on your property and sues, then your primary business is protected.**Flexibility:**If you ever decide to sell your business, then you can do so without losing your property, and continue earning rent on your property after you sell the business. Conversely if you ever need to raise money for your business, you can sell the property without selling the business.

**Opportunity Cost For Buying Commercial Real Estate**

If we buy the building, we have to lay out $53,559.00 more in upfront costs than when leasing. This is an opportunity cost, because by investing that money in the building it “costs” me the opportunity to invest that money in my business or elsewhere.

When calculating opportunity costs, the best I can do is an estimate. It is impossible to know what the return on that money would have been if I had invested it in my business. For this example I am going to estimate that if I invested the money in my business I would have earned a return of 10% per year over the 15 years.

As discussed above we anticipate that the property will appreciate by 2.5% a year, so we would not be earning no return on the money laid out upfront if buying. However, in this example, we are saying that we will earn 7.5% more if we invest the money in the business instead.

Using this compound interest calculator to compound the difference in upfront payment $53,559.00 by 7.5% over 15 years I get the opportunity cost for buying of $158,474.51.

**Opportunity Cost For Leasing Commercial Real Estate**

In this example I am paying more in yearly costs for leasing than buying, so there is also an opportunity cost associated with the additional money that I tie up each year when leasing. If I buy, my total annual costs are $41,817.96. If I lease, my total annual costs are $46,824.00. Leasing costs me $5006.04 more each year than buying.

Using this same calculator, I start with 0 as my current principal and an annual addition of $5006.04, compounded at 10% for 15 years, and I get my total leasing opportunity cost which is $174,959.75.

Total Opportunity Cost For Buying: $158,474.51

Total Opportunity Cost For Leasing: $174,959.75

My opportunity cost when leasing is $16,485.24 more over the 15 years than when buying.

When factoring in opportunity costs leasing costs me $322,616.40 more over the 15 years than buying.

*A note on inflation: In order to keep the calculations from getting out of hand, I did not include inflation in the opportunity cost calculations. As much of the recurring costs for both leasing and buying increase at the same rate of inflation, this should not drastically affect the numbers.

To see how length of stay affects the numbers we recalculated everything based on occupying the location for 7 years instead of 15. Here’s what we found:

**Out of Pocket Costs**

To calculate the out of pocket costs for 7 years for buying, we took the upfront costs and added them to the mortgage payments over the 7 years (mortgage payment calculated using this calculator). Then we took the other recurring costs over the 7 years factoring in 2% inflation (inflation calculations in this spreadsheet). Then we did the same for leasing.

These calculations resulted in the following: Leasing will cost you approximately $360,618.77 over 7 years. Buying will cost you approximately 367,919.83 over 7 years. So, in terms of out of pocket costs only, buying costs $7301.06 more than leasing. This does not factor in the value of the building, tax savings, or opportunity costs.

**The Value Of The Property**

At this point you will still have 8 years left to go on your mortgage. We can see using the same mortgage calculator we have been using in the rest of this document that we still owe approximately $118,750 on the building.

Assuming the building has appreciated at 2.5% per year, you should be able to sell it for $305,468.46. After you have paid off your mortgage ($118,750) this will leave you with $186,718.46. After subtracting out this gain from your total costs, you are left with a total cost of $181,201.37 for owning over a 7 year period.

When factoring in the value of the building, leasing costs you $179,417.40 more over the 7 years than buying.

**Tax Savings**

Assuming the same 35% tax rate, we can deduct all of our leasing costs over the 7 years ($360,618.77 x .35) gives us $126,216.57 in additional tax savings when leasing.

With buying you can deduct the interest portion of your mortgage ($72,155.00 calculated using the same mortgage calculator we have been using all along). This gives you an additional gives you an additional $25,254.25 ($72,155.00 x .35) in tax savings.

As discussed in the section above we can also deduct the $5307.18 each year for 7 years ($37,150.26) in depreciation. $37,150.26 x .35 = $13,002.59 in additional tax savings.

Assuming we sell the building at the end of the 7 years we will have to pay capital gains tax (15%) and depreciation recapture (25%). Using our compound interest calculator and compounding the initial $256,980 value of the building at 2.5%, the value of the building over 7 years would be 305,468.46. That is an increase in the value of the building of $48,488.46.

$37,150.26 of that is depreciation recapture, which we have to pay 25% or $9287.57. The rest ($11,338.20) is our capital gain which we pay 15% or $1700.73.

To calculate the tax savings for buying we add our interest deduction ($25,254.25) and our depreciation deduction ($13,002.59) and then subtract our capital gains and depreciation recapture taxes ($10,988.30). That gives us a tax savings for buying over the 7 years of $27,268.54.

Tax Savings For Leasing: $126,216.57

Tax Savings For Buying: $27,268.54

In this example we save $98,948.03 more in taxes when leasing than with buying.

When factoring in tax savings leasing still costs you $80,469.37 more over the 7 years than buying.

**Opportunity Costs**

To calculate the opportunity costs we used the same numbers as in the 15 year example, but simply compounded over 7 years instead of 15. This gives us the total opportunity costs over the 7 years:

Opportunity Cost For Buying: $88,857.01

Opportunity Cost For Leasing: $9,755.36

In this example my opportunity cost for buying is $79,101.65 more than leasing. When factoring in opportunity costs leasing still costs $1367.72 more over the 7 years than buying.

If you are going to be staying in your building for more than 7 years, then you are generally going to be better off buying than leasing (from a pure monetary standpoint). The longer you stay in the building the more the cost advantage for buying increases.

However, monetary cost is not the only consideration. If the extra upfront cash you invest in buying hurts your ability to grow your business, then leasing is going to be the better option. Similarly, many people may prefer to invest the extra time it takes to manage the building in running their business instead.

Ready to get free quotes on commercial real estate? Click here to get multiple quotes on office space for rent in your area.

Liz

This is a great article,

We are looking to purchase a building in our downtown. Great open storefront downstairs with an upstairs that could have 1 or multiple units for rent. We are looking to purchase it for our office, but want to understand if the company should buy it and rent out the space above or if we should start an llc that owns it and leases out the space to us and rents out the space above. I’m not sure if it works out the same either way or it provides some tax advantages one way or the other. There is also the protection of our business if it is a separate llc as well I am guessing.

Thanks,

Ian Atkins

Hi Liz,

You’re right, there are tax and liability advantages to having a separate LLC own the real estate and lease it to your business and others. The only other thing to consider is whether or not you’ll need financing for the purchase. If you need a commercial real estate loan, the lender may place restrictions what company is financing and owning the real estate.

Hope that helps.

Best,

Ian

chandrashekar

Good explanation about buying and leasing it very useful.

Joe Hislope

Great article, very helpful. I’m looking at leasing a property for a second location. Everything it right with this property (size, price, location, parking, etc) except the building needs renovating on the inside due to the nature of the business of the last tenant versus the nature of our business (they were a bank, we are a violin shop). Is such renovation cost typically the sole responsibility of the lesser? What if said renovation increases the buildings value?

Thank you, and best regards,

Joe

Jason Rueger

Joe,

It really depends on the contract. Sometimes, the owner will help out financially or at least waive rent until the build-out (renovations) is done. I would honestly advise getting a good commercial real estate lawyer to help you with the process. It may cost a little upfront, but will save you lots of headaches in the long run.

Jason