With the continuing expansion and creation of free zones and special economic zones, there are more and more opportunities for businesses to own their own premises rather than remain tenants. One of the most widely discussed challenges in the market is the increasing rental rates that are having to be paid, especially in some sub-markets, such as the Dubai International Financial Centre, where the availability of office space is limited.
With rentals continuing to increase, we have seen an increase in requests from clients to undertake scenario analysis as to whether to continue as a tenant or to buy the space. There are a number of key factors to consider that are specific to the commercial sector when deciding whether to rent or buy.
While the location of the property is obvious, one has to consider how the market is evolving, where will your clients be in the next 10 years and what is happening in the market that may affect where your business or your clients’ business will move. Importantly, there has to be some availability of suitable properties in the freehold market in the desired location.
As businesses grow, space requirements also expand or evolve. When leasing accommodation, the lease often specifies what works can and can’t be undertaken to modify the space and, more importantly, the condition upon which it must be returned at the end of the lease. While the lease maybe 10 years or so and such an obligation maybe disregarded as being distant, we are seeing a number of instances where large corporates took offices in shell-and-core condition 10 years ago and are now consolidating their businesses into new premises. In addition to the significant fit-out costs in their new offices, they have an obligation to reinstate the current property to it’s “as leased” condition, which requires additional budget — although this is not applicable if the space is owner occupied.
Meanwhile, expanding your own property is going to be limited also, and the while relocation is costly, there is limited residual burden if a rental tenant relocates. If the company owns the property, then it can be leased to a third party. However, in industrial markets, an asset may have depreciated in value and disposing it in the future may be a challenge.
The international accounting standards are changing and as such the way that occupational leases are recorded will soon be impacting companies’ profit and loss statements. This is an area of much ongoing discussion globally. Historically many companies preferred to rent as they didn’t want real estate assets shown on their accounts. Leases previously were also not shown, but will now be reflected, especially long-term leases. In some instances, this is making it financially more advantageous to own the asset rather than be a tenant, from an accounting standpoint.
Initial fit-out and relocation costs can be significant and usually depreciated over a number of years to minimise the financial effect on the balance sheet. The lease obviously needs to be of a length, or have security of renewal, to permit a period of depreciation.
There is obviously a different entry price between an acquisition and rental. It is important to look at the correlation between the costs of each — in essence to work out how many years of rent (assuming market conditions remained static) would you be paying to reach the same price at purchase and then determine in line with a business plan which is more advantageous.
Commercial mortgages exist, and while they are not as commonplace as in the residential sector, it is possible for companies to fund part of an acquisition through a mortgage.
Despite the risk of depreciation, disposing of an owned and operational asset by way of a sale and leaseback can be a very beneficial way of getting capital inflow. The majority of business continue to rent, preferring the flexibility of being able to upscale, downsize or relocate as and when required, but with the changes to the accounting standards and the increasing rental rates, maybe the mood is shifting and there will be more consideration towards acquiring assets in the future.