As a real estate professional I am always asked: "How much does it cost to buy a building?" My answer is: "That depends on the size of the building, where it is located, what the zoning is and what you plan on doing with it?" The questions people should be asking me is: "Should I buy a building?" and "Does it make sense for me to buy a building?" Now those are real estate questions!
While there are many different reasons to buy a building, the reasons should depend upon the nature of the purchase and the costs associated with buying. It is not enought to simply say: "Lets stop paying the greedy landlord and pay ourselves and own our real estate."
In this artilcle I will attempt to discuss three relevant questions people should be asking before buying and a discussion related to each of the questions.
Question 1. "Should I buy a building?" My standard answer is: "Maybe." I will start with the premises that it's logical for a business to purchase a property for the business to occupy when the annual cost of ownership is equal to or less than the anual cost the business would expend in rent, assuming a modest (less than 20%) down payment. The annual cost of ownership analysis must include all relevant ownership costs which include (but may not be limited to) property taxes, property insurance and property maintenance (the so called triple net or "NNN" fees in a single tenant lease). The buyers goal should be to acquire "fee simple ownership" (ie. no association membership). However, that dream can be relatively expensive when compared to leasing the same building.
Let's see why:
a) A tenant can lease property and have the landlord pay a portion (or all) of the NNN fees;
b) A tenant is only obligated to occupy a property for the durration of the Lease;
c) A tenant can transfer or assign a lease to someone else [landlord permission required] with relative ease.
Whereas a building owner pays all NNN fees, plus the unknown (ie fire, flood, earthquake, vandalism). Tenants are quick to vacate whenever there is an expensive problem to be solved. And, it is no secret that an owner pays all costs up and until the property is sold to someone else.
Question 2. "Does it make sense to purchase a building?" Maybe. Lets get a calculator and start making assumptions. First, assume it is summer of 2009, you want to move your printing business, the building you are renting is 10,000 square feet, the rent is $6,500 per month, NNN fees are $825 per month ($125 for landscape maintenance, $450 for property taxes and $250 for property insurance) and the landlord (who bought the building brand new in 1979 for $400,000) wants a five year lease. Second, assume a similar building in the area can be purchased for $1,500,000. Third, the property tax rate in area is 1.25% . Third, assume a lender is willing to loan 85% of the purchase price for 25 years at 6.5% interest fixed for five years and charge 2 percent (2 points) for making the loan. Fourth, assume all escrow related fees (appraisal, environmental, title, insurance, recording, etc.) will cost $6,000. Fifth, assume no prorated property taxes or insurance has to be reimbursed to the seller in escrow. Sixth, assume the cost to relocate the business is $100,000. Now we're talking real estate!
The annual rent is $78,000 and annual NNN fees are another $9,900 [Wow. $87,900 sounds like a lot of rent money!] But, remember, in California, the NNN fees are subsidized with below market property taxes thanks to Proposition 13.
Now the cost to purchase will be $225,000 down payment, $6,000 in escrow fees and $100,000 relocation expenses total $331,000. (3.77 years of rent and NNN fees.) The $1,275,00 mortgage at 6.5% interest for 25 years will equal $8,608.89 per month. [According to my handy dandy HP12C calculator.] The new property tax rate (which increased based upon the fair market value of the property at time of sale) is $15,937.50 or $1,328.13 per month. The monthly landscape and and insurance stay the same. Therefore, the monthly cost to own the building is $10,312.02, or $123,744.24. [Hey wait a minute, that's $35,844.24 more than rent each year! That equals $179,221.20 over five years! Ouch!]
The opportunity cost of purchasing must include the down payment, escrow fees, moving costs and additional monies paid over the base expenses of rent for five years. As shown above the opportunity costs total $510,221.20 or 5.8 years of rent and expenses. A renter saved $70,721.20 ($510,221.20 - $439,500) by not purchasing the building. [Wow, how can it be that expensive?]
Question 3. "What would the purchase price have to be to justify buying the building as an investment?" In real estate finance the math is simple: Take the annual income, less vacancy and reserve expenses and divide it by a capitalization rate (in this case the cost of to borrow or 6.5%). Therefore, the $78,000 annual rent less five percent for vacancy and reserve expenses equals $74,100. Now divide net annual income of $74,100 by the cap rate of 6.5% and the building value to an investor equals: $1,140,000. [Wow, that is $360,000 less than the market value of the building!]
The moral to this analysis is do your homework before buying. While rent may seem expensive, it may be...and it may not be.