Shop Space: Buy, Lease or Renew?

This article originally appeared in the September 2024 issue of THE SHOP magazine.

By Mark E. Battersby

Whether for the property housing a specialty automotive aftermarket operation or other business assets, lease and rental payments are one of a business’s largest recurring expenses. Which leads to the question of whether it is better to buy or lease your shop space. Or, in the case of an existing lease, whether to renegotiate.

One of the most important factors in determining whether to purchase or lease commercial space is the amount of time the performance, restyling or customization operation expects to spend in that location. After all, when space is leased, the operation typically pays a higher cost in order to be able to walk away at the end of the lease term.

Meanwhile, if the plan is to stay in the same spot for at least seven years or more, research shows it makes more financial sense to buy your property.

TO BUY OR NOT TO BUY?

While purchasing a building will require more money up front, including the cost of everything from a mortgage down payment to real estate attorney fees, weighing the investment potential of the building is essential.

Is it more prudent to put the operation’s funds into purchasing the building or invest that money into the shop?

Until recently, all commercial real estate usually maintained its value over time if it was maintained properly. However, should the location not pan out, moving is an option with a lease. With a purchase, however, selling the property at a favorable price may be difficult.

Still, typically—even in today’s economy—it makes more sense to buy, especially for a long-term business with sufficient funds for a down payment and six months of mortgage payments. Buying might also be an attractive option for an automotive aftermarket business that:

• Plans to rent out part of the space to generate a secondary income stream
• Plans to build equity in the property
• Plans to reorganize the space as needed

Unfortunately, many shop owners aren’t ready to become property owners. Purchasing commercial property is a big investment requiring significant capital, and some organizations may have difficulty finding or qualifying for financing.

In these and other cases, leasing might be a better option.

LEASING

Leasing doesn’t require a sizeable down payment or a search for financing. Of course, as with buying, location is important.

Equally important is the lease itself, or more correctly, the options offered with a lease, such as:

• Renewal options that spell out whether the tenant has the option to renew a lease when it expires and usually spells out the amount to be paid. The renewal option gives the shop protection from unreasonable rent increases when the lease ends.
• Purchase options that spell out any right or obligation to purchase the leased facility at the end of the lease term, along with a fixed price or range and other terms.
• Destruction or condemnation provisions that specify whether the landlord is required to rebuild if the property is destroyed, whether rent will be abated and whether the lease can be terminated if the facility is totally or partially destroyed. This option also spells out the rights of both the landlord and tenant in the event the facility is taken by eminent domain.

PRIOR TO RENEWAL NEGOTIATIONS

Both sellers and landlords are aware that a reliable buyer or a tenant who consistently makes payments on time is desirable—and in the best position to negotiate or, in the case of an existing lease, renegotiate.

Obviously, no seller or landlord will agree to reducing a financially strong buyer or tenant’s purchase price or rental payments—unless, of course, the restructured agreement will create an economic advantage for the seller or landlord.

For shop owners, rental properties located in areas with high vacancy rates offer excellent opportunities to renegotiate and reduce payments. When it comes to renegotiating an existing lease, there are three situations where it might make sense to approach your landlord and/or lessor:

• The specialty automotive aftermarket operation is struggling
• The local economy is suffering from a downturn
• The operation’s lease is expiring within a year or two

Since every landlord and lessor is fully aware that it takes time for any business to shift to a new space, lining up a replacement should be the first move in any renegotiation plan. Taking the time to research before approaching the landlord or lessor can save money in the long term.

Among the factors to consider before negotiating:

• Are there any lease options? If yes, what is the length of the option lease or rental agreement, and does it meet your requirements? Lease options are usually for the benefit of the tenant or lessee, so exercising an option instead of renegotiating a new lease or rental agreement could be more beneficial.
• Is the current rent or lease amount fair? Researching payments for similar properties or equipment along with noting incentives offered to others should be routinely undertaken. Competitive rates, terms and incentives offered as alternatives play a crucial role in any renegotiation.
• Are the current needs of the shop or business the same as when the lease or rental agreement was entered into? Relocating to a smaller space or more convenient location, or upgrading essential equipment are all options to consider.

Renewal negotiations should begin as early as possible, with consideration given to what will happen should those negotiations fail.

Is there a backup plan if things don’t work out? Prolonged renegotiations and possible expiration of existing leases or rental agreements make it essential to begin renegotiations early.

RENEGOTIATING TACTICS

Research and multiple alternatives obviously play an important role in both negotiation and the renegotiation process. So, too, do tactics such as the following:

• Creating competition. Even if an automotive aftermarket business owner or manager doesn’t want to relocate or switch leased equipment, it pays to shop around and collect legitimate competitive offers that can be used as leverage in the renegotiation process.
• Have the lessor or landlord give the first offer. Whether a first lease or a renewal, always resist making the first offer.
• Always ask for more than needed. Whether negotiating or renegotiating free rent, tenant allowances or other terms, always ask for more than is actually needed. If three months of free rent are needed, ask for five. If two fixtures are required, ask for four. By asking for more than the operation expects to receive, it has positioned itself to strategically give and take depending on the importance of certain provisions to the business.
• Don’t forget to negotiate non-rent or non-lease issues. For tenants these include parking, signage, carpet, paint and deposit or personal guarantees that may have previously been agreed to. For equipment rentals, are on-site repairs or maintenance required? Are repairs or replacements included? As a current tenant or lessor, many of these issues will cost a landlord/lessor less to provide than finding a new tenant or lessee.

EXTENSIONS = SMALLER PAYMENTS

In today’s economy, no landlord or lessor will readily agree to reducing a financially strong specialty automotive aftermarket business’s lease payments unless, of course, the restructured agreement provides the other party an economic advantage as well.

Fortunately, there are situations when such economic benefits are possible, which can turn into a win-win for all parties concerned.

If a shop is financially sound, it would be unrealistic for any landlord/lessor to reduce contract terms simply because market conditions have deteriorated. There is, however, the so-called “trading dollar exception” where the landlord—with the permission of its lenders—agrees to a payment reduction.

This allows a creditworthy tenant savings on its payment obligation for the duration of the current lease term by reducing the amount of space leased or simply reducing the payment amount.

These agreements usually require a tenant/lessor to agree to extending the lease for a five- to 10-year period at a rate equal to a projected market rate. Obviously, this practice will only result in short-term savings while requiring larger expenditures in the long run.

BUYING OR LEASING

Market conditions can change rapidly, and a well-informed shop owner or manager should continually strive to ensure they’re getting the best deal possible. That means weighing the various options available such as:

• Does the operation have the funds—or access to the financing—that would be needed to purchase?
• Does leasing make sense—or leasing with an option to purchase that would postpone the available funding question?
• If already leasing property that meets the needs of the business, would renegotiating the existing lease ease the financial burden or provide additional benefits?

Also, keep in mind that new accounting rules require all leases to be included on a shop’s financial statements as a liability that impacts the operation’s credit picture.

If stuck or overwhelmed, a real estate broker can help search for an affordable property that meets the needs of the business, while a commercial lease consultant can ensure the landlord is aware of all the options available to the specialty automotive aftermarket business.

Mark E. Battersby writes on financial and tax-related topics. Learn more at thetaxscribe.com.