Reconsidering Real Estate: Why More Manufacturers Should Buy Their Buildings
Manufacturing business owners often contemplate purchasing their buildings. Some are influenced by the success stories of their peers, while others simply desire to invest in real estate. Though most will ultimately choose leasing, there are compelling reasons why more should consider ownership—reasons that might not be immediately obvious.
Consider this post your chance to more fully explore the lease vs. ownership debate, and determine what’s truly best for your manufacturing business.
Why Is Leasing So Popular Among Manufacturers?
From a practical standpoint, leasing is a popular choice among manufacturers for three main reasons:
Flexibility: Being able to walk away from a property if it’s not the right fit can feel like a safer bet. In a perfect (tenant-friendly) leasing environment, you can lease your facility for short-term or long-term at reasonable rates with favorable options. You can flex up and down or relocate as business needs dictate and at a reasonable cost.
Pain of Moving: For businesses that are already tied to a leased location, the cost to switch may simply make relocating unpalatable.
Capital Allocation: Oftentimes, there are other ways to spend money that provide more immediate financial benefits. Say you have a million dollars to invest. If you use that money for something like adding a business line, it could significantly increase your revenue or EBITDA. For example, if that $1 million increases EBITDA by $1 million annually and you operate in an industry where businesses sell at a 5x multiple, you’ve created $5 million in additional value from that investment.
At face value, these reasons can seem overwhelmingly compelling. But let’s break them down, one by one, to explore why these benefits might not actually be as good as they seem.
1. Why Leasing Isn’t Actually More Flexible
Contrary to popular belief (and my first point above), leasing doesn't always offer the flexibility manufacturers need.
Signing a 10-year lease might seem flexible at first, but what happens if your business outgrows the space or your facility requirements change? Options like subleasing can be difficult and often aren't viable due to the specialized nature of manufacturing facilities or lack of demand for that specific size/type of space. Landlords may even challenge your plan to sublease entirely.
Owning a building, on the other hand, leaves all of your options open at any time. You can sell, lease, or remodel whenever the space no longer meets your needs. No need to secure the approval and cooperation of a landlord. You are free to simply move ahead and do what’s best for your business, whatever and whenever that may be.
2. Landlords Can Use Your Hesitancy to Move Against You
Moving on to point #2 above, the fact is that manufacturers often face significant pressure from landlords who view them as captive tenants due to significant infrastructure in place and high relocation costs. The pain and cost of moving, and the hesitancy it creates, is noted and can be used against you for things like:
Increasing Lease Rates: Landlords are increasingly savvy about the high costs associated with relocating manufacturing operations. As a result, they may set lease rates just below the cost of relocation (move costs + improvements needed + lease rates elsewhere), effectively trapping manufacturers in higher-cost leases*. This is a trend we've seen firsthand at Modern CRE over the past few years, as the industrial market has become more institutionalized.
Terms & Length of Lease: Your institutional Landlord has their own goals & timeline. Say you’re approaching your lease expiration and you determine you’d like a 3-year extension(for strategic reasons, sale, acquisition, etc.). Because the Landlord has a different plan, based on their investment goals for the property, and because they know the cost and hassle for you to move is high, they may decide they will only accept a 7-year minimum extension, no matter your goals or needs.
*For instance, a landlord might increase the lease rate by 20%, knowing the manufacturer faces a 25% cost increase to relocate. This creates a scenario where the manufacturer feels compelled to accept the higher lease rate, even though it strains their budget.
3. Investing in Ownership Supports Growth Long-Term
Finally, let's look at the capital allocation argument. While money spent in the acquisition of a building may not at first appear to help the bottom line and certainly not as much as re-investment in the business, that doesn’t mean buying a building is the inferior path. In fact, building ownership, over the long term, provides critical flexibility to support sustainable business growth.
First off, ownership enables manufacturers more flexibility in accommodating new business. Adjustments that a lease would not easily allow, like bringing additional power to the building, adding a paint booth, make-up air, and roof penetrations, are no problem when the building is owned outright. Additionally, those improvements stay with the building that you own rather than remain for the benefit of your Landlord
Second, ownership grants far greater control over how you alter your space over time. Owning the core manufacturing facility provides the control needed for significant business changes and additional facilities (especially for warehousing) can be leased to create a more dynamic overall facility strategy. Your use within the facility can shift and change over time seamlessly to meet changing needs.
Finally, with ownership, manufacturers aren’t stuck with inflexible lease agreements. If you’re locked into a lease but need a new facility to accommodate your growing business, then you may be out of luck unless you want to lease another facility at terms you can’t control. If you own, all your expansion options, from selling and buying larger, to leasing ancillary, to expanding on-site, to building ground up at another location(and more) are available to you.
Ownership Protects Against Volatility
The recent volatility in lease rates has proven to be another major drawback for tenants. Managing and forecasting real estate leasing costs has become markedly more challenging due to inflation and high demand for industrial space.
Historically, annual base rent increases were around 2%. Now, they run as high as 5-5.5% annually. Over a five, seven, or ten-year lease, these increases can significantly impact your bottom line. However, when you own, you’re insulated from this type of volatility by regular, predictable mortgage payments.
Ownership Can Help Keep Maintenance Costs Low
If you don't control your building, you may be subject to fluctuating maintenance costs unless it's a full service gross lease (very uncommon). A landlord usually does not have the same incentives as you to be cost efficient for tasks like managing snow removal, landscaping, or maintenance. This dynamic can lead to higher expenses and higher admin costs.
On the flipside, ownership gives you total control over operational decisions. If you already have employees capable of handling snow removal, basic landscaping, or minor repairs, you can incorporate those tasks into their duties and avoid paying for outside contractors entirely.
Even when something does require an outside contractor, such as replacing the roof or re-doing the parking lot, ownership means the cost and timing of the work sit squarely within your control. While the problem you’re fixing may have come as a surprise, nothing about the way it’s handled will be a shock when you’re in control.
The Long-term Benefits of Ownership
In my experience, clients who decide to purchase their buildings rarely regret it after 10-15 years. They tend to discover that the long-term benefits are substantial, including:
Building Equity: Over 10-15 years of operations, significant equity will likely be built through owning a building. This becomes a crucial asset that helps with planning for the future, such as business succession or retirement.
Options Upon Sale of Business: When a business is sold, the new owner doesn’t always want to stay in the same facility you were operating in. With a leased property, the landlord’s interest may end up interfering with the sale in these situations. On the other hand, outright ownership allows you to hold all the cards and not have a business sale held up because of your Landlord. You can also continue to make an income after selling your business if the new owner chooses to lease the building from you.
That option, to lease the building to the new business owner, can be a particularly beneficial scenario in the long term. The lease provides an additional revenue stream and can be a flexible arrangement, depending on the buyer's needs. I’ve seen many owners use this or leasing the building to another unrelated business as a retirement stream of income.
Consider How Ownership Could Work For You
Through years of helping clients, I've seen exactly how long-term ownership provides control over assets. This dynamic has become even more pronounced in the past few years, which is part of what’s inspired me to write down my thoughts here.
While leasing is still the right decision for many manufacturers, more businesses should be challenging themselves to consider ownership. It offers control, flexibility, and long-term financial benefits that leasing cannot match. What’s more, ownership can help keep equity in the market, benefiting business owners, employees, and the community.
If you’re a manufacturer reconsidering the advantages of ownership, we’re here to help you navigate the complexities of that real estate decision. We’ll help you make choices that align with your long-term goals and business strategies. Whether it's through building equity, managing costs more effectively, or having the flexibility to grow and adapt, we want to help you access the long-term benefits that owning your building can provide. Contact Modern CRE today to learn more.