May 21, 2020

Should I Buy or Rent My Location?

9 minutes

Buying your business's real estate is not a black and white decision. It will depend on what your long term goals are.

McDonalds always owns their real estate, but Walgreens never owns their own real estate. How can both be right?

We advocate for real estate ownership as an investment and diversification tool. However, we rarely advocate owning the real estate if your business is the primary tenant because the value of the asset is tied the success of the business. If the business has to shut down, the value of the real estate will take a huge hit.

Buying the real estate for your business doesn't have to be a long term strategy. One strategy is purchasing or developing the real estate on behalf of your business and immediately selling it for upfront capital. For example, a doctor could purchase the real estate for his practice and sign a 10 year lease to himself. Since the lease is the primary value driver of the building, the doctor can sell the real estate for a profit as soon as the lease is signed.

Let's say an empty 3500 sf building is be worth $1 million. If the doctor buys it and signs a 10 year lease at $36 per square foot, the total income would be $126,000. If there is $20,000 in annual maintenance and taxes, the net operating income, NOI, would $106,000. The real estate for healthcare practices often trades at a capitalization rate of 8.5%. In order to calculate the value of a building, take the NOI and divide it by the cap rate.

$106,000/8.5% = $1,247,000.

The doctor has increased the value of the building by $247k by signing the lease. The quickest value jump happens the moment the lease is signed. At this stage, he will have to evaluate whether he will get a better ROI by holding his real estate or selling it to an investor and reinvesting the money in other real estate or his own business.

Many healthcare operators we work with have a plan to scale to multiple locations. Typically, the operators get a 30% to 50% return on their money when they invest it into growing their core business. Over time, investing in the real estate of their practice locations yields somewhere between 9% and 11% ROI.

This is why so many well known, successful businesses rent their locations. The ROI is simply much stronger by investing in the growth of their business than the real estate the business sits on.

Likewise, some business with deep pockets. develop the real estate for their new locations so that they can flip them for upfront capital. Generally, it's not worth holding the real estate after the value creation since they can get a better return by replicating this process or investing in the business.

In this episode we break down the pros and cons of both options so you can get a clear picture of what to look out for when answering this question.

If you need help finding the perfect location for your practice or you're ready to invest in commercial real estate, email us at [email protected].

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