Over the long term, purchasing your own commercial property is almost always a better choice than leasing. However, there are lots of factors to consider and certain assumptions to be made that will affect whether buying commercial real estate is in your best interest. The biggest assumption supporting the purchase is that commercial property values will continue to appreciate over the long term. Historically, this has been true in most urban markets, but not all. Fortunately, in the Culver City and West Los Angeles market there has been impressive long term appreciation for all property types during several real estate cycles.
Advantages of Purchasing a Commercial Property:
- No exposure to rent increases
- Long term appreciation with favorable capital gain tax advantages
- Potential rent income
- Potential for favorable refinancing and taking cash out
- Tax deductions for depreciation
- Control of your own property
- Ability to adjust space requirements to your needs
- Impressive image and pride of ownership
- Makes potential sale of business more attractive if real estate is included
Buying your own building is not for everyone, though. For many companies, it’s just a matter of finances. An owner-user may apply for a SBA-backed commercial real estate loan which requires 10% downpayment and an investor using conventional commercial financing will need to pay a 25% or more downpayment. Even though interest rates are also at historic lows right now, some businesses can’t take advantage of it. Many small business‘ and business owners (as investors) simply don’t have the capital to devote to a commercial real estate investment, despite the potential long term benefits. Even if an owner-user does have the downpayment money, they might feel that the timing is not right because of the real estate market cycle or other factors that affect their financial investments. A smart business person will weigh both the advantages of buying versus leasing before making a major decision to proceed either way.
Advantages of Leasing a Commercial Space:
- More financial flexibility and no major downpayment
- Tax deductions for lease payments
- Mobility and the ability to expand and contract easily
- No risks of ownership such as potential capital loss or property being outdated
- No property management issues and focus on primary business objectives
There are many reality available financial spreadsheets that calculate the potential return on investment (ROI) for a purchase vs. a lease based on various market cycle conditions, but there are some basic rules to follow that don’t require crunching lots of numbers and making hypothetical assumptions. As stated earlier, the Culver City and West Los Angeles commercial real estate market over just about any 10 year period has risen significantly which would favor a purchase over a lease. Let’s take a closer look at the numbers and the basic rules to see if and when purchasing retail, industrial, or office properties in Culver City makes sense. A study by the CCIM (Certified Commercial Investment Member) Institute looked at real estate market cycle considerations and determined the following:
- 1% appreciation rate indicates a long term contraction and recession cycle. Leasing is the better option.
- 3% appreciation rate closes the gap between leasing vs. buying. Leasing is slightly better in the short run, but buying may be better in the long run depending on other considerations.
- 5% appreciation rate makes leasing and buying equal from a purely financial point, but given the other advantages to buying, this growth rate would favor a purchase.
Now that the basic investment rules have been established, let’s examine the historical sales and recent asking prices in the Culver City Metro Market Area.
The average asking rental rate per sq ft/year for Office properties in Culver City, CA as of Dec 14 was $31.27. This represents an increase of 0.9% compared to the prior 3 months, with an increase of +5.3% year-over-year. County-wide, average rental rates in Culver City are -0.4% lower at $24.35 per sq ft/year for Office properties currently for lease.
Loopnet provides data for the metro, county, and state on most property types, but only provides city data on a limited basis so several assumptions will need to be made to accurately look at the Culver City market. In 2009 during the recession, the office rents in Culver City were very similar to the LA County and Los Angeles Metro market rates. However, the recovering economy has boosted Culver City office rents much higher than other metro and country areas. As Culver City has continued to grow as a creative hub, the expansion of nearby Silcone Beach, companies looking for less expensive alternatives to Santa Monica on the Westside, the impressive growth of Downtown Culver City, and various other factors have pushed rents approximately 30% higher than the Metro and County averages.
Sales prices for commercial real estate estate are generally determined by the income that property generates or potentially will generate. If a 30% premium is added to the asking sales rate chart above, then currently Office Buildings in Culver City are selling for $350 to $400 per square foot which is fairly accurate depending on Class, Location, etc. From 2009 to 2011, the average Culver City office building was selling for less than $300 per square foot. It’s fairly obvious that purchasing an office building during this time was a wise investment compared to leasing a space, especially on a short term lease. Culver City Office rents have shot up during the past 4 years and if your company wasn’t locked into a long term lease with options to extend, you have been feeling the sting of market rent adjustments.
The example above assumes that you guessed the market bottom totally correct and reaped the maximum benefit, but what if you purchased a property at the peak in 2007 or 2008. The property is probably fairly close to breakeven right now, but you may have a slight gain with the property continuing to appreciate to the foreseeable future. While nobody wants to hold on to a property for 7 or 8 years and not make any substantial appreciation, it is important to note the other advantages to ownership listed above including the paying down of the mortgage which builds equity over time which paying rent does not. Also, if you assume that purchasing an office building for your business is a long term investment, then over a 10 year holding period the property seems poised to make a healthy return even after suffering though an historically long and deep recession recently after acquisition.
A quick review of the Retail Property Asking Sales Prices in the Culver City Metro Area versus the Retail Asking Rents in the Culver/LA Metro shows similar trend lines to the office market. Unfortunately, this data does not include the specific City of Culver City Retail Prices which are higher than the metro averages, particularly for food use in the Downtown Culver City area and general retail along the major boulevards. Generally, the analysis of the retail commercial real estate market in Culver City is similar to the office market analysis above. The decision to purchase a retail property in Culver City is very often determined by availability on the market rather than precise financial comparison of multiple properties. There is a scarcity of quality retail properties for sale in Culver City. If you can buy an existing property or even develop a new one, the long term advantages are numerous.
If you plan on leasing a retail space, then secure a long term lease with reasonable fixed rate increases to insure against large market rate fluctuations. Restaurant space for lease in Downtown Culver City has doubled and tripled in some cases in the last decade. Other retail space rent has increased at a healthy rate, as well.
Again, the basic analysis of lease vs. buy is the same for Culver City Industrial Properties. The trend lines are similar to retail and office properties, but the highs and lows are much more pronounced with industrial space. Just like retail space, there is a scarcity of industrial commercial real estate in Culver City for sale and the data above is for Los Angeles metro and county not specifically Culver City. The average prices in Culver City are going to be considerably higher than the LA metro area. The Hayden Tract, in particular, has very high priced industrial property that has really transition to an area creative office and special purpose properties for the entertainment industry and other creative/artistic industries. Double digit growth rates over the past few years in the Hayden Tract are not uncommon.
Due to scarcity and other factors, rents have also been increasing steadily for industrial spaces for lease in Culver City, particularly amongst smaller units. Lots of start-up businesses and creative types near the Culver City Arts District have been looking for live-work spaces that further push up the rental rates. Again, the same rule as office and retail properties applies. Secure a long term lease with fixed rates or risk eye-popping rent increases.
Under current market conditions in Culver City and adjacent areas, purchasing a commercial property will be advantages in the long run. It’s just a matter of having enough capital to get started. Most commercial loans don’t require a personal guarantee and are based on the income that the property generates. If you have a stable business that’s paying rent and you have enough savings to put a downpayment on an office, retail, or industrial property, then now is a good time to purchase a building of your own.