Buying Your Building, You Might Want to Rethink That
A very wise professor told me many times, “If you want to be successful in business, you need to invest in what makes you money.” Its only as you start to work with businesses either struggling to find the money to finance the growth of their business or struggling to find the money to keep their businesses alive that the truth of this maxim starts to have real meaning. So, what are these things we should be investing in? The answer to this question depends upon the nature of your business. If you are a retail or wholesale business, it means investing in the inventory that you sell; if you are a manufacturing business, it means investing in efficiencies in the manufacturing processes; and in a service business, it means investing in people. The key is in determining what it is you sell or do that drives your income. This seems to be one of those statements that is so patently obvious that it is stating the obvious. However, if this is obvious, why do so many small and medium businesses rush out and buy items such as cars, boats, and even aircraft through their businesses. All of these items or ‘toys’, as they are sometimes known, just tie up cash that could be generating money. But the item that can tie up the most money, is the purchase of a building.
It is natural for any Small or Medium Sized Business to compare the amount they pay for rent to the monthly amount they would pay on a mortgage and to think to themselves “Why wouldn’t I build equity for myself rather for my landlord.” Rather than thinking this you should be asking yourself “What business am I in?” If you are honest, in most cases the answer is something other than real estate. It is easy to forget that if you buy the property you are now responsible for all repairs and maintenance required by the property, whereas if you rent these costs are the responsibility of the landlord. These costs when they occur draw cash flow away from the business.
But there is an even better reason to hesitate before you decide that buying the building is a good option for you to follow. What was forgotten when you compare the monthly cost of leasing versus buying is the fact that when buying a property, a down payment is required. This down payment can range from 25% to 35% of the building value. Let’s say the property cost $500,000 that means we are tying up between $125,000 and $175,000 of money that could be used to make money. This amount of cash invested in what makes you money could make a significant impact on your business. If you have a retail business with a gross profit margin of 40% this would give you an extra $50,000 (Assuming a down payment of $125,000) to apply towards expenses or potentially straight to your bottom line (profitability). This gets even better if your inventory turns 4 times per year as now you have an extra $200,000 to use in your business. If you are a manufacturing business, you can use the money you would have invested in the building to improve the efficiency of your manufacturing process. If you are a service business, you can invest in personnel. Whatever your business there is something you can invest in that will improve the profitability of your business.
This same principal can be applied to the lease or buy discussion when considering the acquisition of equipment. I prefer to look at this decision in terms of cashflow as well. You could pay cash for the equipment, but this would be foolish, as per our previous discussion, this money could be used to make money. Whether you borrow money or whether you lease the equipment you still have to provide a down payment. In this case, the down payment is usually significantly larger when you are borrowing from a bank than when you are leasing the equipment. The lower down payment when leasing leaves you with more money to invest in the day to day needs of your business. You can get benefits from leasing the equipment in other ways as well. Leases are usually structured so that the monthly payments are reasonable but there will be a significant balance remaining to pay at the end of the lease term. The key here is that this process enables you to afford more expensive equipment due to the payments being lower than the equivalent loan payments
So why do I care about using the money to grow my business? Surely if I invest in the property, my property will appreciate and I will increase the value of my business that way. That’s true but most small and medium sized businesses make most of their money when they sell their businesses and if the business is successful this figure usually far exceeds any increase in the value of the commercial property. The sale price of your business is frequently a multiple of your sales figure so it is in your interests to grow this sales figure as large as you can.
Is it ever a good idea to buy the property? The answer to this is yes, if the circumstances are right. Those circumstances are when the business has large amounts of equity not working and/or large amounts of cash sitting around doing nothing. In these instances, buying the property may be the best use of your money.