Article

Landlord or tenant - property ownership or lease?

More and more organizations are giving up ownership in favor of leasing. And here a key question arises - which option is more profitable for a company?

May 20, 2020

A company's headquarters is its flagship business card. However, whether an organization leases or owns its space, it often stems from a company’s structure, business profile, or simply from its history. Along with the spread of the asset-light business model (with low value of capital assets in relation to the value of operations), more and more organizations are giving up ownership in favor of leasing. And here a key question arises - which option is more profitable for a company?

Ownership can mean more independence…

There are a number of advantages to owning premises. By owning the building can add brand recognition and prestige to a company’s reputation. Total control over a property allows for modifications, without the need to consult with outside parties, such as property managers or other tenants. Owning a property is also often associated with the greater availability of parking spaces for employees and visitors. This can be especially important for companies with large vehicle fleets.

... but not without limitations

However, ownership also means a number of restrictions. First of all, it relates to freezing a substantial amount of capital that could otherwise be put to work and generate income for the entire company. Ownership also means limited flexibility, in terms of expansion or reduction of occupied space, depending on the current needs of the organization. Moreover, as property management is not the core business of most companies, owning a building is associated with the need to allocate additional human and capital resources, often much higher than if such activities were outsourced to specialists.

Lease - flexibility and economy of scale

The main benefit of leasing space is flexibility. An organization can almost solely determine and select both the location and space of its headquarters according to its specific needs. Often, within an office complex, one can find "flex" offices, which offer flexible office space for short-term rent. This option allows for a company to rapidly ramp up or ramp down the amount of office space it needs. Because lease costs are directly related to the size of occupied space, offices are usually more effectively planned and managed.

Another aspect of the benefits of the lease model is the optimization of expenses as an organization bears only part and not all of the costs connected to maintaining the property. The range of management activities is also much narrower, as it is limited to the leased area and not the entire building and its surroundings.

Operating within a larger building or business district usually involves taking advantage of the economy of scale generated by the presence of more companies in a given location. It also means a wider range of amenities within an office complex and greater recognition of the location itself. Modern office complexes consist not only of buildings, but increasingly often attractive public spaces between them. And as research from many HR companies shows, the location of an office in an attractive part of the city, which is usually well-served by public transport, is an increasingly important factor for attracting talents, especially from the generation entering the labor market. Finally, the presence of other companies in the building or office complex also creates more opportunities for cooperation and networking.

However, there are some limitations to the leasing option as well. Any major change must be agreed with the property owner, which may be a barrier to development. In addition, one should also remember to plan to extend a lease well in advance of its expiration.

A company profile is key in making a decision

Both models - property ownership and lease - have their advantages and disadvantages. Therefore, when building a company's real estate strategy, the aforementioned factors and, above all, the specifics of an organization, should be taken into account. However, from a purely financial perspective, which model is more beneficial?

The answer to this question is not a straightforward one and requires a very detailed financial analysis in many areas. If you are considering selling your building to enter into a lease agreement, it will be crucial to determine the price you will be able to get for it. This will depend on the potential of the property, i.e. its location, technical condition, and its potential for future development.

Another important factor will be the cost of capital which varies for each company, and the resulting minimum necessary rate of return on investment. Whether it is more profitable to operate in one’s own building or lease space also depends on what time limits we set for the analysis. Although real estate markets feature a relatively high level of security, they can also experience cyclical market changes. Selecting the right moment to start a lease should, therefore, be preceded by detailed market analysis, taking into account the demand and supply forecasts and anticipated rental dynamics. 

What options do we have in the case of ownership?

It is also worth remembering that for companies seeking liquidation of assets, the sale does not necessarily involve moving away from their existing premises. An interesting solution is sale & leaseback, which means selling the building and remaining in it as a tenant. So a company can stay in its current location without the need to move and manage the process of change. Such a solution, apart from an immediate cash injection, eliminates the need to allocate resources to administer the property.

On the other hand, selling and moving to a commercial building means that a new office can be arranged to answer the current needs and trends of the workplace, without disrupting operations.

So making the right decision on whether to own or lease means looking at a wide range of factors related to company strategy through a meticulous and wide-ranging analysis. Its outcome will depend on a number of factors including financial, market, and property based aspects.

At a time when organizations are increasingly looking for opportunities to optimize costs, it is worth looking at previous real estate strategies and thoroughly analyzing different business models in order to optimize both costs and the way an organization operates.

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Jan Jakub Zombirt
Director, Strategic Consulting