In today’s world, Which is More Profitable: Buying a Property or Renting It?
For years, the key strategy to amass wealth has been pretty straightforward: buy real estate and keep it. Property ownership has long been regarded as the clear winner when it comes to financial success and stability.
Unfortunately, the contemporary economic scenario, characterized by fluctuating interest rates, evolving working patterns, and higher costs of maintenance, has made this calculation rather difficult. The choice between buying and leasing is not an easy task now for any individual investor in real estate and any entrepreneur searching for business premises.
In order to figure out which alternative results in better earnings in today’s economic climate, we need to get rid of any outdated assumptions and look into some actual figures and risks.
Why Buy? The Power of Multiplier
There are few ways that can ensure safety of one’s investments better than real estate investment, and this is mainly because of the presence of several streams of profit that a person can gain by becoming an owner of the property.
1. Profit from Equity Increase and Capital Appreciation
By purchasing property using mortgage, every payment becomes the form of savings system, because part of the loan payments goes to pay down the loan, which means transforming somebody else’s money into your own. On average, within 5 to 10 years of ownership, the growth of real estate prices in high-growing regions surpasses the inflation rates. And when it grows up to 4 to 6 percent, then multiplier is used on the entire value of the asset.
2. Inflation Hedge and Fixed Costs
The fixed rate of the mortgage will protect you against one of the silent killers of your business – increasing rents. While the rental rate is increased based on the cost of living, the fixed rate of the mortgage will remain constant. With the guaranteed payment plan, cash flow and margins will be assured for at least 10 to 15 years.
3. Special Tax Benefits
Depreciation is one of the tax savings accounting deductions without any out-of-pocket expenses. Your mortgage interest, real estate tax, and capital expenditure are all tax deductible.
Ownership Issues of Today
Nevertheless, despite the mentioned above advantages, there are also some issues related to the purchase of assets in today’s environment which may seriously influence profitability margins:
- High Capital Investment: The down payment will involve at least 20%, perhaps even 30% capital investment as well as closing and legal costs. The money invested in such a non-liquid asset is an opportunity cost since it can’t be used for expansion of the company, hiring employees and investing in a liquid market.
- High Interest Rates: The existing mortgage rate means that a bigger share of each monthly payment will cover interest payments, not the accumulation of equity.
- Maintenance Cost Uncertainty: All maintenance of the property, increasing costs of insurance of the property, taxes and, potentially, some unexpected costs in order to repair the property are all on the owner’s head.
Leasing – Benefits from Flexibility, Liquidity, and Capital Efficiency
Back in olden days, leasing was viewed as “throwing money out of the window.” However, modern businesspersons and investors understand the power and benefits of leasing as a method of smart leveraging of their funds and investments.
1. High Level of Liquidity and ROI
The major advantage of leasing is its high capital efficiency associated with the business process. Instead of putting $150,000 into real estate investment as the down payment, one might invest less money in a form of a security deposit and leasehold improvements. All the rest will be used for core business activities, such as marketing, inventory, technology and finance investments, which bring about 15-25% ROI.
2. Flexibility and Quick Response
The requirements of the market and of its customer base can evolve very quickly. What is working well now might become less effective five years later. In leasing, you have an opportunity to increase in size, to downsize during economic downturns, and to relocate to another geographical location at the end of the term of your lease without the hassle and costs associated with the purchase of property.
3. Predictable Expense Profile
In the majority of commercial leases, the issues of major repairs, insurance and roof maintenance are still the landlord’s responsibility. It makes possible for you to more accurately predict your expenses and secure your cash flow from any unforeseen, potentially lethal, costs.
Key trade-off issues in face to face comparison
- Upfront costs: If you choose to purchase then you have to pay upfront costs like 20% to 30% down payment and huge closing costs, but if you go for lease then you will have only advance payment and fit-up costs.
- Periodic outflows: You will have periodic outflow in terms of servicing your debt, on the other hand, you will be facing with uncertain cost of repairs/ maintenance whereas in case of lease you will have rent escalation but no cost of uncertain repairs.
- Equity building: Monthly payments made in purchasing generates equity whereas in case of lease no equity will be generated. It simply means that your financial performance will entirely depend upon how effectively you will reinvest your money back in the business.
- Flexibility: Sale of real estate is a difficult proposition whereas lease option provides time when your lease period ends, which allows you to move due to market dynamics.
- Taxes: Being the owner of real estate property you get deduction in form of depreciation, interest cost and capital gain, but being lessee you will be able to deduct only lease payment.
Buying will become more profitable in the following circumstances
1. A Long-Term Plan of Ownership
The real estate property will be owned or used by you for a long term which is at least 7-10 years or more. In this span of time, the real estate property will be capable of incurring the cost of closing and dealing with market cycles.
2. There is Some Structural Constraint in the Location of Supply Side Nature
If there is some structural constraint in the location, the ownership becomes safe and provides security in the long run along with appreciation.
3. The Business Provides Moderate Profits
In these kinds of situations, the additional money provides low return through conservative investments.
The scenario under which leasing becomes more profitable includes
1. Highly Profitable Main Business
Where everything that you put in your main business is very profitable, then tying it up in real estate will definitely lower your net worth at some point in time.
2. When Flexibility is Needed
Startups, growing firms, or those wanting to test their mettle in the market require flexibility and do not need the balance sheet burden of ownership.
3. Interest Rate Higher Than That of Rental Returns
Where interest rate becomes higher than the cap rates in the local commercial real estate, interest payment will be more expensive than rental payment.
Conclusion
There can never be an all-in-one strategy when trying to identify which one of the two is more profitable.
If you are trying to increase your wealth and build up some equity and get a tax write-off benefit, then owning would serve the purpose well. But, if you are an operator who wants some flexibility in his business and uses liquidity for growth, then renting out the equipment would be preferable.
An intelligent investor is not just concerned about the investment, but takes other factors such as cost of capital, etc., into consideration as well.
