A business decision: buy, build or lease: what works for one company may not work for another. Weigh all options carefully.

Change is inevitable. Most businesses at one point or another need a new facility, usually because of a shift in the company's focus or market adjustments to accommodate growth or downsizing. Selecting a new facility is a big decision.

"Facility expenses is the second or third highest expense in about any company outside of payroll," said Bob Doughty, owner of CFO Growth in Anchorage.

Owners looking for new facilities have three basic options: buy, build or lease. No one option provides the best solution for all businesses because of the variables in each. What works for one company may be the worst choice for another.

"There is no right answer here," said Mike Hanrahan, principal at Mikunda, Cottrell & Co. in Anchorage.

By looking at the pros and cons of each option, and comparing them with the company's needs and future plans, owners can make the best decision possible.

"Some people want to buy real estate because they feel they've arrived, regardless of the needs of the business," Hanrahan said.

Ownership may have another psychological impact: giving clients, vendors and customers the impression of stability, deep roots and security when dealing with the company. With some industries, such as financial and high end sales, image could be an important factor.

THE BENEFITS OF BUILDING

Financially, ownership offers "perceived control," said Dennis McMillian, president of Anchorage based Foraker Group, a nonprofit capacity-building organization. "They are in control of prices and whether their expenses go up or not."

Company owners who build a facility also gain more control over expenses, as well as the added security of investing.

"If you build something, the residual belongs to the entity," said Suresh Srivastava, Ph.D., finance professor at the University of Alaska Anchorage College of Business and Public Policy.

If the company experiences a downturn, "the entity would still have the building," Srivastava added.

Owning the facility can benefit the company as an investment in its own right, "if you have a long-term investment horizon," CFO Growth's Doughty said.

AN EXACT FIT

Although buying is less expensive than building, building provides a few advantages o fits own that deserve consideration (renovating an existing structure costs 20 percent to 30 percent less than building, according to McMillian).

Building offers the option of creating a custom work environment, the cost of which may be offset by greater productivity.

"You get an exact fit," said Doug Taylor, a certified commercial investment member with the National Association of Realtors in Anchorage. "The primary thing is when people ac quire new property, they need to fit their needs as closely as possible.

"Using a building that fits allows your business to operate more efficiently."

Early this year, First National Bank Alaska opened its Dimond Center Branch in Anchorage, a facility" the bank built. The bank had "outgrown its (previous) leased facility," said Sue Foley, senior vice president.

Having 2,550 extra square feet of operating space wasn't the only benefit. Although the bank moved only a city block from its previous location, "it's a more convenient facility now," Foley said. "Access was extremely limited. Now there are more choices about how to access the building. It's a convenient location."

Building may be the only option for some companies because of a lack of inventory in the real estate marketplace, according to Bill Inscho, senior vice president and commercial loan officer for First National Bank Alaska. "A person would then have to build."

ON THE MOVE

Leasing also offers pluses and perks that can't be had by those who buy.

"You're more mobile," Mikunda, Cottrell & Co.'s Hanrahan said. "You can acquire bigger and bigger facilities to accommodate your growth. If you own, you may not be able to do that."

In addition to flexibility, leasing offers its own financial advantages.

"When someone leases something, the lease is tax-deductible," UAA's Srivastava said. "If you are leasing, you don't have as many up-front costs. The maintenance is the (lessor's) responsibility, usually."

Leasing also keeps more capital free to invest in equipment or inventory to expedite growth.

A compromise between buying and leasing is the buy-in clause.

"The expense for the first few years is less," explained Srivastava, "but it's larger later. Maybe the business would generate enough profit to buy the property. But if you would raise the money outright, it would be better than leasing for a few years and then buying it."

Raising funds through loans and grants would help the business even out payments for the property.

BUYER'S REMORSE 

All three options-buy, build or lease--carry with them their own drawbacks.

"You always have 'buyer's remorse,' whether it's ownership or lease," Foraker's McMillian said. "You'll have remorse no matter what you do."

Buying or building puts down roots, which can be good, but they can also entangle a company with real estate that cannot be easily resold. Ownership also ties up equity.

FNBA's Inscho said that typically a business must have a down payment of 25 percent of the total cost to obtain a loan to build or buy a facility. And, of course, there's the balance and interest to pay off for the term of the loan.

Building a structure that is too small may require subsequent construction plans and building one that is too large can tie up large amounts of capital for a long time until the company is able to recoup the cost of the structure (if ever).

Building also may be more expensive than the first estimates indicate.

"There's always something that's forgotten or overlooked," Inscho said. "You have to have contingency money."

Don't expect immediate results, especially considering Alaska's short building season.

"It's a long process," Inscho said. "You have to have architects, engineers ... the list goes on and on."

Owning real estate has everything to do with timing, both in the company and in the marketplace.

"You would probably want to build if yon have a long-term, stable business that will not outgrow its quarters. If you are going to build, the time to do it is before costs start appreciating rapidly," Mikunda, Cottrell & Co.'s Hanrahan said.

"If you are looking for a temporary investment because of an economic opportunity, and you want to exploit that opportunity while it's profitable, you probably don't want to be buying real estate, especially with business funds."

A CHANGING MARKET

Fluctuations in the real estate market can make property investments flush or flat. In the crash of 1986, many Alaska owners found themselves in the latter category with properties worth only one-third or less of what they had been. Despite a decrease in value, the property owners were bound to keep making loan payments, as the property would sell for far less than what it was worth.

Leasing out empty space to other companies is not always the best answer.

"In times of excess space in the market, you may have an empty building or tenants hammering you to lower the rent," Hanrahan said.

Being a landlord comes with a lot of responsibilities, such as building maintenance and improvements and managing tenants' accounts.

Hanrahan recalled that as a commercial landlord, he was "spending 30 percent of my time dealing with the building and not my business. I had to scramble to find tenants, deal with the building inspectors and municipal bureaucracy. You have to ask yourself, what business are you in ?"

He later sold his share of the building and bought a Porsche.

Expense stability--the very reason many business owners want to have their own facilities--can fluctuate a lot, especially if part of the facility is leased to other companies and the landlord must maintain the building.

"When you own the building, you own the headaches," Foraker's McMillian said. "On the best case scenario, you will contain costs when you build or own, but if something big happens, you don't have a lot of cash resources."

Hiring a property management firm may alleviate many landlord woes, but it also will shave about 10 percent off the rental income and the owner must still foot the bill for most maintenance and repairs.

A TAX ADVANTAGE

Company owners can possibly benefit by selecting an ideal tenant--their own company. If they own the property as individuals and not as a corporate entity, they may lease it to their company and retain more after tax dollars than through some other ownership structure.

A few of Hanrahan's clients at Mikunda, Cottrell & Co. have taken this route; however, property owners must not offer "substantial other services because it could be construed to be a separate business and therefore subject to self-employment taxes," he said.

For example, if an owner leases part of his building and provides office and secretarial services, that could be construed to be an executive suite--another business. Leasing only the structure and maintaining the structure and grounds, however, qualifies as rental real estate.

Leasing facilities is not the perfect choice for every business, either.

"If you are a renter, all you have after 20 years is a handful of rent receipts," FNBA's Foley said.

Lessees are also at the mercy of the landlord regarding their rent.

"When rent escalates, you could move," CFO Growth's Doughty said, "but it would cost $50,000 for moving me."

Doughty's corporate strategy business currently occupies 1,500 square feet.

With each of the three options bearing a variety of pros and cons, choosing to buy, build or lease can seem to be an overwhelming decision. But by taking some preventative measures, business owners can make the best decision for their situation. Picking any one option over another "depends on what you're trying to accomplish," Mikunda, Cottrell & Co.'s Hanrahan said. "Weigh the costs, benefits and alternatives of each. Some benefits can be psychological.

"Consider your long range plans and how well owning real estate fits into your business growth prospects. You need to consider the need for business expansion, the cost of borrowing, and the alternative ways to get the best returns on your invested capital."

CHOOSING CAREFULLY

Doughty also encourages his clients to take a long-term look at their companies.

"You have to look at your exit strategy," he said. "How long will you be in the facility and when do you think you're going to exit. A lot of deals get made on the basis of price and cash flow, but they don't consider market risk based on market strategy."

He summed up his strategy by adding, "you have to compare the price of renting versus the price of ownership. If you know you're going to be in business 15 years and you look at rent payments for 15 years versus never having to move and (deal with) escalating rent prices for 15 years, you'd be an idiot not to buy."

Taylor, with the National Association of Realtors, looks at what will fatten the bottom line the most.

"Do those dollars make more money invested in the company as operating capital, or does it make more sense to be invested in real estate?" he queried.

FNBA's Inscho believes in obtaining advice from a multitude of counselors.

"Get as much advice as you can from accountants, bankers and peers in your industry," he said. "The more people you talk to, the better. Use the networking process. It's a lot of digging; don't be in a rush."