Businesses face space quandary: Lease, buy or build new facility?

A few years ago, Dave Nielsen was at a crossroads.

His business, Dave Nielsen Ltd., was quickly outgrowing its 3,000 square feet of leased warehouse and office space at a Boulder industrial park. When the landlord of the facility raised the rent, Nielsen faced a tough decision: Should he continue to lease space for his small business, perhaps moving into a larger facility? Or was it time to own a building? And if so, should he buy or build?

It is a quandary that many growing small businesses face, and experts agree business owners should carefully weigh several factors before making a decision.

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Nielsen, whose firm sells fabric and other raw materials to local apparel and luggage companies, shopped around for lower rental rates, but discovered that most leases in the area were similar to rates at the industrial park.

He also looked at purchasing an existing building, but the market was devoid of office/warehouse combinations in the size he needed. Purchasing a newly constructed building was not a viable option either: Most contractors, Nielsen says, manufacture speculative buildings that are too large for a small business, because the bigger the building, the lower the cost per square foot — and the more bang for the buck.

Ultimately, Nielsen decided to build his own facility. In 1995, he purchased a one-acre lot at the Colorado Tech Center in Louisville, and, a year later, a general contractor began construction of Nielsen’s new 5,200-square-foot warehouse and office.

“I think owning your own building is a great way to go,” Nielsen says. “The problem with it is coming up with the 30 percent down.”

The initial down payment to purchase or build an office is commonly the major obstacle for a small business. Nielsen feels fortunate that he had enough capital to cover the initial cost, because his monthly payments are lower than they used to be.

“It’s costing me less, per square foot, to own my own building than it was to lease,” he says. “But you’ve got a big chunk of money that was there and is now gone.”

One advantage of building, Nielsen says, is the ability to customize the facility. He designed his offices and created a high loading dock for his warehouse, enabling trucks to unload materials directly from the truck bed without using a ramp. The business owner’s future plans represent another benefit of owning: Nielsen hopes to expand some day and lease space to other businesses.

But the building process was not easy, he says, calling it “a very stressful nine months.” In one way, Nielsen laments not finding a suitable existing building to buy, because it would have eliminated a lot of the headaches and delays involved in building from scratch.

For the most part, leasing is usually preferable to buying for most start-up companies and fast-growing companies, because such companies need lots of working capital and cannot afford to tie up money in real estate, says Michael Guidarelli, sales/marketing manager for the Boulder-based firm O’Connor Development LLC. O’Connor served as the general contractor for the construction of Nielsen’s new office and warehouse.

In addition, if a company is expanding, it will likely outgrow its office space periodically, and leasing provides more flexibility — especially if the landlord owns an array of properties to meet the business owner’s quickly changing needs.

“Companies that are in fast-growth mode,” Guidarelli says, “in many cases, are better off leasing than owning.”

But he is quick to point out that each company’s situation is different. For some firms, owning a building may be the way to go. A machine shop that needs special power outlets and equipment, for instance, may be better off building or purchasing a suitable facility because any alterations or improvements made to leased space are left behind if the company is forced to move.

“When you grow more and more,” Guidarelli says, “you’ve got to start all over again. You can’t take that with you.”

On the other hand, he says, firms in volatile markets, such as the aerospace and defense industries, may want the flexibility of a leased space to help weather the peaks and valleys of contract-driven income.

For a family-owned business, owning a building is an investment for the future — especially if the value of the property is appreciating with each passing year. Another attractive aspect of owning, Guidarelli says, is simply the freedom from landlord hassles; being “in control of your own destiny.”

The decision all depends on a company’s needs. “It’s a cost-benefits analysis,” Guidarelli says. “What might be best for the company today may not be the best for the company in two years.”

Sam Nein, a commercial broker for Coldwell Banker Van Schaack in Boulder, says leasing is usually the most popular option for small businesses for several reasons.

Unlike residential renting, a commercial lease is tax-deductible. In addition, Nein says, most small businesses need a building between 5,000 and 10,000 square feet — a size that can be almost “cost-prohibitive” to build because the price per square foot of a small facility is significantly higher than that of a large building. Even buying an existing building can put a huge dent in a pocketbook, due to the deferred maintenance that an older structure inevitably needs.

“And remodeling can cost more than new construction,” Nein says.

In some cases, however, a small business may want to snatch up a building of its own if the property is in a good location and the company’s field depends on high visibility, such as the retail market.

If a small business owner does decide to start down the long and winding road toward building an office or store, Nein recommends putting together a team of experts to help accomplish the daunting task of running a business and a construction project at the same time.

Instead of trying to “surf” the learning curve of financing, design and construction processes, Nein advises first-time builders to meet regularly with their “board of directors” — a panel of professionals who have gone through the procedure many times before: the architect, banker, general contractor, accountant, attorney, Realtor, even the building’s future janitor.

If they meet as a group, Nein says, it is easier to balance each person’s priorities, keeping everyone on the same page and ensuring that all of the project’s needs and goals are met. “It’s much like putting an orchestra together,” he says.

One of the members of that orchestra is often someone like Roberta Wolff, a vice president in Vectra Bank’s Small Business Administration department. An SBA loan frequently is a crucial ingredient in a small business’s ability to own property. Wolff, who regularly helps companies obtain SBA loans for the construction or purchase of a building, says owning has several advantages over leasing.

First, she says, ownership brings control. There is no haggling with a landlord over leases, fees, maintenance or contractual changes.

In addition, owning a building has tax advantages. Patrick O’Kelly, a certified public accountant at the Boulder firm Johnson, Cahill & O’Kelly, says business properties typically are owned by individuals, not companies. It is preferable for a business owner to list the building in his name and lease space back to the company, O’Kelly says, because rental income is not subject to Social Security (FICA) taxes.

The third advantage of owning a building, Wolff says, is that as long-term investment, it can benefit a business owner well into retirement. For example, if an individual decides to retire and sells the business, he or she can keep the building and continue collecting rent from the new owner.

Wolff says “98 percent” of all businesses in Colorado qualify for SBA loans, which can reduce down payments from 25 or 30 percent to 10 percent. Especially with the help of an SBA loan, she says, owning property is often more desirable than leasing.

“For an existing small business,” she says, “there are more benefits than drawbacks to owning your own building.”