As part of a job application process, I, a young twentysomething, was tasked to tackle the complicated world of the real estate market. Below is the writing sample that got me that job.
This is a question every potential occupant is asking themselves. According to ERATE, interest rates for mortgages are at 3.88 percent — the lowest they have been in decades. Before any major decisions, it is wise to weigh the pros and cons of renting or buying commercial real estate. Which decision is best for the business objective? Which decision is best based on market trends? The following will help brokers, renters, owners, and potential clients to make an informed decision.
Renting Over Buying
According to the National Association of Realtors’ (NAR) latest Commercial Real Estate Outlook, office vacancies are projected to decline to 12.5 percent by the fourth quarter of 2016 and decline to 11.7 percent in 2017. If a renter or buyer wants to act, they have to act soon.
- The initial investment to rent a property tends to be lower than owning. For some small business owners or start-ups, making a large real estate purchase can be out of the question. Renting space allows an investor to make small payments over a period of time instead of a down payment. Overall, this will result in less debt. Instead of taking out a large loan to pay the mortgage, paying monthly rent is more manageable in comparison.
- Renting offers relocation opportunities. The retail sector is changing—and fast. What used to be big box stores are now off-price retail and e-commerce fulfillment centers to keep up with consumer trends (Building and Design Construction). Additionally, renting space provides an opportunity to relocate the business if consumer needs or demographics change. By 2020, 29.5 percent of the United States population will be 56 and older. With this demographic, spending on services will grow at the expense of spending on goods (CRMTrends).
- No long-term equity. A renter will not have an opportunity to build long-term equity on the property. Once the term ends, the property reverts to the owner.
- Yearly rental rate increases. The NAR Commercial Real Estate Outlook states that rents for office properties rose 3.2 percent during the first quarter of 2016. These price escalations can add up. For example, current Philadelphia market trends indicate a rental rate increase of 3.1 percent for retail properties compared to last year’s prices (LoopNet).
Buying Over Renting
The Federal Reserve has been keeping rates low because of the economy. According to The New York Times, they might be sticking around. A buyer may want to take advantage of the “buy low, sell high” strategy.
- No exposure to rental rate increases. One of the cons of renting is dealing with rate increases every year. Not only do retail sector rental rates increase, but office sector rental rates have increased as well. According to LoopNet, rental rates for the office sector increased at 0.9 percent over the past year.
- Owning real estate can help create net worth. An individual seeking to become a landlord may purchase property, then rent the property for profit. The NAR estimates investors accounted for 27 percent of home sales in 2011, up from 17 percent in 2010 (Forbes).
- Purchasing real estate can be risky. The market is cyclical and the economy is still in recovery from the Great Recession. Buying business real estate can be a risk. Participants in The Real Estate Roundtable’s quarterly “Sentiment Survey” remain uneasy about overseas threats, oil prices, and cyclical issues. The survey’s “Future Conditions Index,” measured on a scale of 0-100, has fallen 13 points from this time last year (from 62 in Q2-2015to 49 in Q2-2016).
- The property is a non-liquid asset. In case of an emergency, the property cannot be easily sold and quickly turned into cash. If a company wants to sell the property quickly, the value of the property can result in a loss (Investopia).
Overall, brokers, renters, owners, and potential clients need to make an informed decision based on the business objective, market trends and what is financially better for their goals and objectives.
The NAR Commercial Real Estate Outlook states that although the first quarter of 2016 was weak, the demand for commercial leases continued to rise with the increased employment and confidence. This shows that it is a great time for businesses to be purchasing commercial real estate regardless of the sector they are involved in. Although there are risks involved, the interest rates have reached such a historic low that investors should jump at the chance before the Federal Reserve raises interest rates.