Real Estate for Business Owners: Lease or Buy?

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Speaker 2
00:28
Welcome everyone to Finlip by uwa. Today I’m joined by Jameson Smith and we’re going to talk about does it make sense to purchase real estate as a business owner or are you better off leasing? So obviously there’s many factors here. There’s, you know, tax benefits deferred to both sides and there’s also time considerations and then also control considerations, among others. So Jameson, give us some initial thoughts to kick it off.
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Speaker 3
00:55
Yeah, let’s just first set the stage with renting. If you rent your office, you know, you’re generally locked into a lease, could be five, 10 years, you don’t have control over it. You know, somebody else owns a building, you can probably do whatever, you can make some changes, but within limits. But at the same time it could be a lot less hassle. You know, something happens to the ceiling, you call the property manager, they come fix it. Very simple, very easy owning. You’re in charge of all that stuff yourself. So you know, you have to maintain the building. Could be cheaper, could be more expensive. Depends. There could be some tax benefits. I would say the biggest thing would be probably more control though. So what’s. I know you’ve analyzed this for UWA would have been your general thoughts looking at each one.
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Speaker 2
01:45
Yeah, it’s a very confusing, there’s many pros and cons. So I think the first thing is you have to realize I’ve talked to, obviously I work with a lot of business owners and you know, recently I was golfing with a business owner and unfortunately they were an industry where their business was worth almost nothing. But the real estate they had purchased in different areas around the country basically saved them and still being able to retire. So the, and the business that they were in would utilize the real estate. So everything was structured so it was a purchase of the business plus the real estate, but like 90% of the value they had derived and you know, saving the retirement was from the real estate. So there’s that side of it where it’s like diversification. You know what happens if something happens.
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Speaker 2
02:31
In my industry, at least we own a physical asset. The other side of it though is, you know, right now we Rent. And we rent because we’re a fast paced, young growing firm. And the last thing, I don’t think it’s worth any of our time to have to go fix a plumbing issue or, you know, figure that. And obviously you can hire property management, stuff like that as well. So just purely from a business perspective, I think you have to first look at what’s the longevity of your business. So the reason we’re considering purchase, we expect, you know, we’re going to be doing this, you know, for the rest of our lives, essentially. I don’t ever see myself retired, but my 30s, so 30, 40 a year. I’m just speaking for myself specifically.
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Speaker 2
03:14
So at that point, you know, purchasing a property, okay, it’s checkmark. If you think you’re trying to sell it, grow this and sell it in five years, you probably shouldn’t be purchasing a building because a lot of stuff could happen in the real estate market over that shorter period of time that could be a giant distraction to actually building your business up. So purely from like a cash flow perspective, are you purchasing a building and are you playing landlord to, you know, five or six other tenants? That could be a giant distraction. Again, you can hire a property manager that will cut into the returns to do that, but then you may control the space.
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Speaker 2
03:55
What I found in researching this is that what’s currently happening and just to address the current environment is there’s a lot of good deals out there. However, a lot of the loans that happened on these commercial spaces prior to Covid were what were referred to as non recourse loans. So let’s just say hypothetically, someone bought a building for 5 million bucks, and now the building’s worth 2 million because half of it’s vacant. The, you know, maybe the square footage, it was $20 a square foot, maybe that’s 10. Now, no one wants to be in these, you know, let’s say downtown Pittsburgh, for example. And so let’s just say hypothetically that there’s $3 million left on that note.
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Speaker 2
04:39
Well, the seller of that building, if they get a, if they accept it, a $2 million purchase price, right, they paid 5, they’re going to accept a $3 million loss. Now because that’s non recourse. If they go to the bank and say, hey, that’s a non recourse loan, the best offer we have is 2 million. We’re not. And they just kind of let the building deteriorate. It’s the bank’s problem now. The bank takes it over. The bank has the note of three. Now if you’re that person, they’re taking less of a loss. If the bank is now, you know, selling it because again, it’s non recourse loan.
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Speaker 2
05:19
The reason I bring this up is you kind of see these situations where there’s a little bit of a push and pull of like some of these owners are like purposely letting their buildings go south. And so right now it’s an attractive time to look at getting a deal. It’s also a really scary time because as a new purchaser, guess what? Banks philosophy, they’re not handing out non recourse loans. These are going to be, you know, backed up by personal assets. And so I just want to say that because if you’re currently considering this, it’s a different playing field. If you’re getting advice from someone that did 10 years ago, they may not realize the current playing field and what’s all at play. So with that being said, let’s just talk about tax benefits. If you’re renting a building, it’s really simple.
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Speaker 2
06:02
If you’re using the building that you’re renting for the purpose of business, it’s a tax deductible expense out of your business. Pretty simple. You’re paying 100 grand a month or 100 grand a year in rent, 100 grand a tax write off. If you purchase a building, there’s a lot of stuff you can do. You can depreciate the thing over 39 years. You can, you can accelerate, you can do a cost segregation study, H vac, landscaping, sidewalks, parking lots. You can do it, you get 30, 40% of it. You can do a 34% accelerated appreciation with huge benefit upfront to save taxes, maybe saving so much in taxes, like the down payment is basically a wash of the tax savings and then ongoing all of your interest on the mortgage, the maintenance on the building, the appreciation, all this is a tax write off.
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Speaker 2
06:55
So if I buy a building and then I make, you know, let’s just say hypothetically ewa a client of the building, well that’s a way I can get money out of the company instead of going to my tax break and go to that llc and then out of that llc, it’s now passive income. So I can arbitrage that passive income by negating the depreciation, the repairs and expenses. And so maybe that rent payment I’m paying to myself, it’s just a way for me to get money tax free essentially out of my business. Because of all the deductions now that comes with a lot of strings attached. Maybe I’m managing other tenants, I’m dealing with all these other distractions. Right.
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Speaker 2
07:32
But from a tax perspective, owning a building, although more complicated, it could come with a lot more benefits, especially if you take an active role in that or if I’m 750 hours per year or more, then not only, you know, that stuff could also then just come off of actual like earned income. If someone’s in the top tax bracket, that could be saving you 37% federal and coming down from there. So lots of considerations. Obviously, if you’re running a successful business, it’d be hard for you to take an active status on the real estate side. But maybe you have a spouse. If you’re married, filing jointly, it doesn’t work. Suddenly they’re the active. Well, it all flows onto one tax return. So that person, you know, basically has a couple hundred thousand negative income. That positively affects your family situation as well.
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Speaker 2
08:20
So we see that, we’ve actually advised that to several clients that have purchased real estate. Hey, let your spouse manage the thing. If they’re interested and they want, let them run the books, let them run the coordination of the repairs and let them put 750 hours a year or more into it and document it because it’s going to save you arm and leg in taxes.
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Speaker 3
08:36
Yeah, well, just talk through if you are going to go through that logistically. So obviously you’d want the building owned in a separate LLC to properly structure this correctly. And there’s going to be some asset protection benefits if you merge it with your existing business and you have other tenants and they sue you. You know, if it’s all under one roof, there could be problems.
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Speaker 2
08:56
But yeah, although unlikely. And you’re subjecting your business to unnecessary liability or you’re subject to the real estate. Done. That’s if you’re in a high pro, you know, high profile business.
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Speaker 3
09:04
Yeah. So having a separate LLC and then you basically would have a lease agreement between the business and the other business to lease it to them. And then like you said, the, let’s say business one, you get the tax deduction from paying the rent and then business two, where you flow, the rent payment flows into, if you use that depreciation, it could offset all that rent and then some of the rent and then essentially you’re pulling it out tax free because the depreciation is going to wash off the taxes. So could be a huge tax benefit. And Then the other thing is some people like that it’s just another income stream.
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Speaker 3
09:41
So I’m thinking one business owner that we work with, you know, owns a building, has tenants, has a business there, and it’s kicking off like 200 grand a year of just after expense, cash flow to the owner that he. Yeah, sounds great. Yeah. He has to deal with a couple tenants. But it’s, you know, pretty. Yeah, you know, pretty. It’s not that intense.
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Speaker 2
10:02
Lucrative.
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Speaker 3
10:02
Yeah. So it could be. Could work out really well. There’s a lot of variables, but yeah, that’s one thing is a lot of business owners like, well, I could have this other income stream that gives me some. Some safety. And like you said, there’s assets outside of the business that hold their value, no question.
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Speaker 2
10:17
Yeah. So there’s lots of tax considerations. I think more important than the tax consideration. Don’t let the tax tail wag the dog. Is what are the needs of the business? If you’re in a business that. That’s rapidly expanding and like the current space you’re in, you have to keep negotiating rents. And maybe it’s like you’re on floor two and floor four suddenly because nothing’s available. Well, if you’re that rapidly, maybe owning your destiny a little bit more and owning the building and being able to. But one thing to be careful about though, is that if you buy a building that’s been in existence, they have all these old leases. You have to check what you’re capable of. You may not. You may be stuck with a tenant paying you $10 a square foot for the next 10 years.
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Speaker 2
10:56
Well, you’re trying to get the cost up to 25 a square foot, kind of pre Covid level. You may have a difficulty doing that and you may not even have the power to boot. Even after the lease is up, that tenant may have the first right of refusal to stay in the building. So you may be. You may be inheriting some really bad business deals that you don’t know about that you think, oh, yeah, it’s my building, I can. Well, commercial real estate works a little bit different. Yeah. Then like a one year, you know, family deal that you’re renting your house.
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Speaker 3
11:25
Yeah. And a lot of these leases are 10, you know, five to 10 years. So yeah, a lot of times they’re locked in. Well, what would you say if you wanted to put in a golf simulator to your business? Is it better to rent or the building?
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Speaker 2
11:38
I think either or. You just need to have good negotiation skills. If you’re renting to talk to the building.
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Speaker 3
11:42
What’s been your experience?
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Speaker 2
11:44
What do you mean, what’s been my experience?
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Speaker 3
11:45
Thinking about putting a golf simulator.
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Speaker 2
11:48
Well, we’re right in the middle of it. This was hopefully going to be. Now that’s out in the open. Not a surprise anymore. We’re thinking, you know, a lot of our clients like the golf, and they’re looking at places that, you know, unfortunately, we’ve chosen our destiny here to be in Pittsburgh, where there’s five months a year, basically, you can’t golf. So I think also after Covid, a lot of people kind of settled in these zoom calls. I think better relationships can be developed face to face. So to do that, to convince people to come in, I think you need to have a.
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Speaker 3
12:18
An attractive offering.
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Speaker 2
12:19
Yeah, attractive offering. So maybe, you know, we review your financials, and then we play nine and 30 minutes on the golf spirit. So that’s. That’s on a strong consideration right now that basically, you know, we don’t own this place. And we’re looking at. The ceiling’s not high enough, so we may or may not have started popping out. And we found that we could actually.
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Speaker 3
12:35
Yeah, you can get rid of the drop ceiling, and there’s another five feet that.
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Speaker 2
12:38
Yeah. So luckily, we work with a very good, you know, good relationship with our building owner, manager, etc, so they’re gonna let us do it if we decide to do it. So you don’t need to own a building to do really cool stuff, apparently. Yeah. But, yeah, just from a business perspective, I think that’s gonna pay itself because.
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Speaker 3
12:57
Get people in the office.
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Speaker 2
12:58
Get people in the office. Yeah. Bring their friends and. Yeah.
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Speaker 3
13:02
What about. I think it’s good to know if you do office renovations when you rent.
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Speaker 2
13:08
What.
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Speaker 3
13:09
What are the taxes?
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Speaker 2
13:09
Like, just all deductible? Yeah, they’re all deductible. Any furniture you purchase, all deductible.
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Speaker 3
13:15
Yeah. So you don’t need to own the building to get, you know, all the tax benefits.
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Speaker 2
13:18
Yeah, yeah. No, no question. No question. And the, you know, just looking in the. Because I was considering purchasing a building downtown, and they were asking basically what they were asking versus what I thought it was worth. It was. It was half. Half price. And I took it to the commercial. He’s like, actually, you were absolutely right. I had it valued. And he’s like, it’s actually worth a little bit less because of these factors. So I think, personally, if I were to predict. No one has a magic forecast, but I think things will get a little bit worse in some of these downtown areas. It’s pretty scary out there, but nobody.
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Speaker 3
14:02
Wants to drive into downtown to go to work when they just work from their house and do the same thing.
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Speaker 2
14:06
Yeah, My prediction is I think in 10 years we’ll shift back to. More people will be in. We basically never left. We’ve always been here. We’re deemed an essential business. And I think that’s. That was an important part of our camaraderie culture. Growth of the business from day one is being in person. Well, social distancing and phone, all protocols obviously. But yeah, I think it’s. Personally, I think there’s opportunities out there, but I think that if you jump in too quickly, you could, it could still be a little bit of a bloodbath.
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Speaker 3
14:38
What about without giving too many details, what are your big. Would have been a regret, but not buying the building, what, probably five or seven years ago that you used to be in.
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Speaker 2
14:50
Oh, yeah. No, I think you’re always considering this and it’s always like pressure. Oh, no, no. But yeah, there was an opportunity where I was. Could have bought a building at a prior firm. And so that would have been quite disastrous because I left that prior firm and if I owned the building, that would have made things a lot more difficult and a lot more negotiations and legal aspects probably. And I’ve heard that building has lots of maintenance issues and that was kind of my gut. So I’d be looking for something that’s very streamlined, very well maintained, as, you know, something we could hire, outsource. I wouldn’t want any of what we do if our clients are. Or current business EWA to be disrupted in any way.
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Speaker 2
15:26
It basically be a way to protect EWA if we think we need the extra space or if we didn’t have a good relationship with the current, you know, building manager and felt like they could accommodate our growing needs. And that would be a strong consideration.
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Speaker 3
15:39
Yeah, and I would say that’s. If you’re growing, I mean, one of the downsides would be you’re kind of locked into a space. So if you buy a space and you outgrow it really quickly, kind of like where you were before, like you could be in some serious trouble if you want to move, if you want to, you know, sell business, etc.
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Speaker 2
15:56
I think if I put a golf simulator here too, and I buy a building, then I will be the only person in the new building and you guys will all be here. I won’t Be able to get anyone done. Whether we even are tenant here. I think you guys will just show up and we just take the domain.
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Speaker 3
16:10
What?
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Speaker 2
16:10
Eminent domain. Once you’ve been into places or a certain level, they can’t kick you out.
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Speaker 3
16:14
Oh, yeah. I don’t know anything about that.
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Speaker 2
16:16
Okay. I don’t think we’re dragging anyone out if we put the simulator in here.
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Speaker 3
16:19
Well, you could just take the simulator and we put it in the new building.
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Speaker 2
16:21
True, true. Yeah, that would be the plan.
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Speaker 3
16:24
Yeah.
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Speaker 2
16:25
So, all right, so bottom line, whether you rent or buy, definitely get a golf simulator. Both with. Regardless of what choice. We don’t know whether you should rent or buy. We know whether you’re renting or buying, you should definitely have a golf. So that’s today’s takeaway. Yeah, I think it’s a good takeaway.
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Speaker 3
16:39
Yeah.
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Speaker 2
16:40
No, but in all seriousness, case by case analysis, we’re happy to help. We’ve. I said the majority of our clients that have considered purchasing a building have purchased a building. Usually they’re renting at first, but we’re doing this deep analysis, understanding it’s not as good. Neither is, you know, basically, our takeaways. Our advice is buying is not nearly as good as it sounds and renting is not nearly as bad as it sounds.
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Speaker 3
17:04
Yeah.
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Speaker 2
17:05
But here’s the needs of your business, here’s your goals, and I’d say probably two thirds of our clients down this path end up purchasing a building. A lot of them, we don’t have any that purchase downtown. Just full disclosure. These have been more around like established, like suburbia areas around Pittsburgh or in other areas around the country.
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Speaker 3
17:23
Yeah.
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Speaker 2
17:23
But yeah, usually if you’re going down this path, I would say more often than not, you will end up buying a building. But just having a clear understanding of it’s not as good as. Or bad as it sounds on both sides. Understand the pros and cons, but making sure that your peace of mind, time returns, business needs, client needs. Client needs should be first.
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Speaker 3
17:41
Yeah.
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Speaker 2
17:42
All of those things have to be balanced out. Just not just. You saw a TikTok video about how to save taxes.
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Speaker 3
17:46
Yeah. I’ll give one more example too, that I think is applicable. So clients I work with, two physician, husband, wife, each own a private practice and both paying a lot. Two separate buildings, both paying a lot in rent. And one of the practices is surgery, is they’re surgeons and they don’t do their surgeries in the office. They go to a surgery center or hospital.
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Speaker 2
18:09
The money.
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Speaker 3
18:10
And so the hospital just Came back within the last couple weeks and basically changed the terms of how much money they owe back to the hospital if they do the surgery there. So one suggestion that or discussion we had was what if you bought a building, you moved both practices into this building, you’re gonna, it’s gonna be less than both of your rent payments. Plus you now could build this operating suite in the building, save money from what the hospital is charging, you do the procedures in house and have all these tax benefits that we talked about.
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Speaker 2
18:38
Surgeons, you get two codes, you know, typically from insurance, Medicare. If you do the procedures there, you get the op, you get both, you.
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Speaker 3
18:45
Double debt, not double debt, you get more revenue.
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Speaker 2
18:48
Two sources of revenue versus one source.
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Speaker 3
18:50
And they could also have other surgeons in the area come operate in that suite and collect revenue off of. Yeah, so it’s super nuanced, specific to the business. But that’s just one recent use case that, you know, this is a heavy discussion and something we’re really thinking about.
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Speaker 2
19:04
Yeah, I would say, you know, go down the path of education empowerment, realize neither is as good or bad as it sounds. But then usually it’s a pretty obvious answer. But usually when it’s like I want to purchase a building because I think it’s a good investment, you’re running a full time business that’s usually just keep renting. But if you’re like my business needs like I’m worried about running out of space, that’s usually the path. Or I can, it’s just more lucrative then that’s usually the path where it’s like, okay, this is glaringly a no brainer to purchase a building. Like if you’re a surgeon or whatnot or if you have high inventory, you know, stuff like that, you need to have the flexibility and a services business like ours.
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Speaker 2
19:42
I’m thinking about a friend who actually negotiated three years all at once negotiate a really low rent and he’s glad he did that. Flexibility, service based business, you just need to be really flexible and that space and everything, that’s not, it’s not the same considerations in certain industries. I think it’s very industry specific as well.
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Speaker 3
20:03
Yeah, for sure.
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Speaker 2
20:04
So but. All right, well thanks for joining us everybody. Look forward to catching you next week.
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Speaker 1
20:08
Thanks for tuning in to our podcast. Hopefully you found this helpful. Really hope this is as beneficial and impactful to as many people across the nation as possible. So hit the follow button, make sure to rate the podcast and please share with any friends or family members that.
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Speaker 2
20:24
Would also find this beneficial. Thank you. Very much.
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