To Own or To Lease? That is the Question.
Ahhhh, one of the most confusing topics among educational business owners: Should I lease or own the facility from which I operate my childcare business? This question and strategy typically evolves as the company grows, builds capital and the owner begins making moves to preserve that capital. And while you may hope this blog will answer this age-old question for you… there is no singular correct answer. Each individual must consider his or her own capital needs and business strategy—and these could very well change as your school develops and grows.
So, let’s analyze the pros and cons of each, shall we?
For new childcare business owners, leasing permits you to open your business without a large amount of capital. It’s much easier to qualify for a lease than to seek financing for a mortgage, amiright? Also, the lower cost of entry allows you to invest in your business rather than the brick and mortar of your facility. It also gives you the flexibility to move when the lease is up and as your company grows and needs more space.
For school owners who intend to grow, leasing allows you to use the cash that would otherwise be invested as a down payment for business development—purchasing additional equipment and materials, or even another school. And if you want to test new markets, leasing lets you mitigate your risk by giving you the flexibility of exiting if the market does not perform well.
For owners planning for their succession, selling as a “business only” opportunity is a great strategy. It will be important that lease terms are favourable to get the maximum value for your business, so be mindful that there is a limit on how much rent you can pay while remaining financially healthy. A good rule of thumb is to project what gross revenue your business can produce when it is 70% occupied and plan to pay around 14% of that in rent. This amount might be slightly higher if the building is new and maintenance is limited. It might also be as low as 10-12% if the building is older and requires more upkeep.
Unfortunately, landlords hold most of the power when it comes to determining the length and terms of a lease. Rent expenses often go up annually—and if the location becomes desirable this expense can become unsustainable for some schools as rent is due and payable regardless of the performance of a center. In a typical absolute net lease format, the tenant is responsible for all costs relating to the building including real estate taxes, property insurance, and repairs and maintenance—this is referred to as a triple net lease.
Real estate ownership can be very profitable over time. However, it takes a significant amount of capital to invest in real estate, leaving less to invest in your business which has a greater potential for return. And, as we all know, real estate markets can be unpredictable. But despite its challenges, there are a number of advantages to real estate ownership.
Owning your childcare business and the real estate it occupies gives you the flexibility to make changes to your building without having to obtain consent from a landlord. As the owner, you are the decision maker! In addition, you often build value by making mortgage payments instead of paying rent.
If you don’t intend to expand or develop additional sites, real estate can be a great investment for any excess cash. By purchasing real estate, you secure a long-term asset that is most likely to appreciate over time. And, when it comes time to sell, you can enjoy a future revenue stream by leasing the facility to your business’s new owners.
For owners who have operated their schools in growing markets, a real estate analysis may indicate that your facility could be of greater value if sold for another use. Working with a real estate broker familiar with the education industry can help determine this and if it’s worth selling your real estate and moving your business to a nearby facility to preserve enrollment.
Owning your real estate can be a great asset… but it can also be a great burden. As the owner you are responsible for EVERYTHING—payments, maintenance, repairs and renovations. And if you don’t keep up with the upkeep, you have the potential of getting stuck with an old, obsolete building that won’t be easy to sell.
The Bottom Line
It all boils down to resources and long-term plans. Choosing to own or lease your real estate is as much a personal choice as it is a financial one. So, as you consider your options, remember these key questions: Are your capital investments capable of producing higher rates of return when placed in your core business cycle or when they are placed in real estate investment? Are you comfortable leasing your real estate from a third party and managing that relationship in a way that is healthy for your company? And finally, are you open to the idea of retaining ownership of your real estate when you exit your business in the future?
Whatever your current cash and tax situations are, and whatever your future plans involve, taking the time to explore all aspects of real estate leasing or owning leads to great potential rewards in the future.
For more on how HINGE can support your real estate needs, contact our National Director of Real Estate, Mike Pepper, at firstname.lastname@example.org.