Are you looking for the right space for your business? Whether you’re opening your doors for the very first time or seeking a location to accommodate your projected business growth, it’s essential to find the right commercial real estate for your needs.
At Select Funding, it’s our mission to provide businesses with the working capital they need to pursue their most important business objectives. We’ve created this guide to commercial real estate 101 to help you understand the basics and find the best possible location for your business.
What is Commercial Real Estate?
Commercial real estate is any real estate, whether it’s a building, a retail space, or an office suite, that is rented for commercial purposes. Examples may include a suite in an office park, a single office in a building, a small retail store, a restaurant space, or a warehouse. The occupants of commercial real estate use the space for income-generating activities.
The primary distinction of commercial real estate is that it is not used for personal purposes. Residential real estate is used as living space for individuals or families and not for income-generating activities. In most cases, commercial real estate is located in areas that have been zoned for commercial and business use.
Should You Rent or Buy Business Space?
Deciding whether to rent or buy requires consideration of many factors. There are pros and cons to each option.
Pros and Cons of Buying Commercial Real Estate
Here are some pros and cons of buying commercial real estate for your business, starting with the pros:
- You’ll gain equity in your property over time.
- Selling your property may allow you to earn a profit.
- You may be eligible for tax breaks for interest, depreciation, and certain non-mortgage expenses.
- You may have the option to earn income by renting your property (or part of it) to other businesses.
- You can control the property and remodel it in any way you choose.
Here are some of the potential downsides of buying commercial real estate:
- You’ll need enough liquidity to make a substantial down payment on the property you buy.
- It can be difficult to qualify for financing for a commercial real estate mortgage.
- There may be prepayment penalties for commercial loans.
- You won’t have the same liquidity that you would if you rented an office space.
- It’s not a guarantee that commercial property will appreciate and there’s a possibility you could have to sell at a loss.
Many of the benefits of buying commercial real estate are the same as those for buying residential real estate.
Pros and Cons of Renting Commercial Real Estate
Now, here are some pros and cons of renting commercial real estate for your business, starting with the pros:
- You won’t need to compromise your liquidity with a large down payment.
- You’ll pay a fixed monthly cost as rent.
- You may not be responsible for routine maintenance as you would if you bought a property.
- There are tax advantages to renting, including the possibility to deduct your lease payments, insurance payments, and property tax payments.
- It may be easier (and more affordable) to rent in a desirable area than it would be to buy.
- Commercial leases are sometimes easier to qualify for than commercial mortgages.
Here are some potential cons of renting to consider:
- You won’t be accruing equity on the rental property.
- If you get a triple-net lease agreement (more on that later), you will be responsible for rent, insurance, property taxes, and maintenance.
- In some cases, your monthly rent may be higher than a mortgage.
- You won’t have the option to rent out some of your space to earn passive income the way you would if you owned a space.
- You may have limited control over what you can do with your rental property and may not be able to modify it to meet your specific needs.
Either option may be the right choice for you, but you should consider the pros and cons of each before you make a decision.
What to Know Before You Rent Business Space
Renting is often the best choice for businesses that are just getting started or established businesses that don’t have enough working capital to finance a large down payment.
Types of Commercial Leases
There are several types of commercial leases that you should know about before you rent business space:
- Fully Serviced Lease. The tenant pays only their rent and the property owner is responsible for everything else.
- Single Net Lease. The tenant pays rent and property taxes.
- Double Net Lease. The tenant pays rent, property taxes, and insurance.
- Triple Net Lease. The tenant pays rent, property taxes, insurance, and maintenance expenses for the property being rented.
- Ground Lease. A ground lease is typically a triple net lease that gives the tenant flexibility in how a rental space is built and designed. It offers companies the flexibility to build a space out to their requirements. The downside for tenants is that the building owner is entitled to any improvements made to the property if you leave.
- Percentage Lease. A percentage lease may be a good option for new companies because they pay a low base rent plus a percentage of their business revenue. It can keep overhead costs down initially but may result in high rent when a business is successful.
Rental Agreements
There are some clauses that can impact your decision to rent business space for your company. Here are a few to consider.
Length of Lease
It’s common for commercial leases to be longer than residential leases, which usually last for 12 months before they must be renewed. The average commercial lease lasts between three and five years. It may be extremely difficult to break a commercial lease, with a hefty fee if you need to move out before the lease expires.
Annual Increases
Most commercial leases have annual rent increases built in. You may be able to negotiate the increases but once you sign the lease, you’re locked in.
Exclusivity Clause
Depending on what type of business you have, you may be able to negotiate an exclusivity clause in your lease. An exclusivity clause prevents businesses that provide the same services as you from renting space owned by the property manager and may be particularly useful for medical practices and service providers.
Legal Advice
Whatever type of lease you’re offered, we strongly recommend having a commercial real estate lawyer review your contract to make sure that you understand what you’re agreeing to and what your responsibilities are.
What to Know Before You Buy Business Space
Buying commercial real estate requires a large up-front investment and an understanding of the legal responsibilities that come with owning your business space.
Key Considerations for Buying Business Space
There are five main considerations that you’ll need to keep in mind before you buy commercial real estate.
Price
For most business owners, price is the most important thing to consider when buying property. Prices for commercial properties may range from $500,000 to millions of dollars depending on the type of property you’re buying, its square footage, and its location and function.
Location
Location should always be part of the calculation when purchasing commercial property. Businesses that rely on foot traffic must compete for desirable spaces. It’s common for investors to buy properties with an eye toward renting them, so finding a space that’s for sale may be a challenge. You’ll need to view the property’s location with your vendors, business partners, and clients in mind.
Zoning
Most commercial properties are in locations that are zoned for commercial use, but you should check the local zoning and permitting regulations to make sure that you can use the space for your business.
Functionality
When you buy a commercial property, you can redesign it as you like. Since buying commercial property is expensive, it makes sense to look at the property’s existing design and layout and if you can, find a property that will require as little redesign as possible to be functional for your business.
Resale
Resale is an important factor to consider when looking for commercial properties because there is always the possibility that you will outgrow the space or choose to relocate to a space that’s suited to your changing needs. Any commercial property you buy should have good resale potential.
Steps to Buy Commercial Real Estate
Here are the steps required to purchase commercial real estate:
- Get your finances in order. Lenders will want to see that your business is financially sound before they loan you money. You should have at least two years of personal and business tax returns, a current financial statement, a current profit and loss statement, and the most recent three months of business bank statements. Individual lenders may require additional information.
- Research lenders. Not every lender offers commercial mortgages, so you’ll need to narrow your choices and research each one.
- Get pre-approved for a mortgage. Having a pre-approval letter shows sellers that you’re serious and that you have the financial means to buy property.
- View properties. Identify properties that are within your budget and meet your needs and tour them to see if they are suitable for your business.
- Make an offer. Once you find a property you like, you’ll make an offer through your real estate agent. The agent can help you with negotiations and draw up a purchase agreement.
- Complete your mortgage application. After you have a purchase agreement, you’ll go back to your lender and complete your mortgage application. Make sure to be responsive to any requests for additional information to streamline the underwriting process.
- Close on your loan. The final step is to schedule your closing and close on your loan. At the closing, you’ll pay all closing costs and money will change hands.
As we noted above, we strongly suggest working with an experienced commercial real estate attorney to make sure you understand your contracts.
Get Working Capital to Buy or Rent Business Space
Buying or renting business space can help you achieve your most important growth goals, but it also represents a significant financial responsibility. The information we’ve included here will help you decide whether to buy or rent space and help you get through the process.
Do you need working capital to buy or rent commercial space for your business? Select Funding can help! Learn more about our business financing and start the application process today.
