Buy or Lease Your Building?

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What would make a remodeler buy a building instead of leasing?

January 01, 2009
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This month featuring:

 

Tom Swartz

Contributing Editor

Read the full discussion below or click here to listen to the conversation.



Choosing whether to lease or buy your business space isn't an easy decision. Every business is different. Our Remodelers' Exchange participants offer advice on how to make the call.



Tom: Ken tell us about your company, location, number of employees, how long you've been in business.

Ken Spears: Our company is Ken Spears Construction and we're located straight west of Chicago in the northern part of the state. We're a full-line design/remodel firm and we've been in business 33 years. We have 15 employees, five in the office and 10 in the field. We're on track to do about $2.5 million this year. 



Tom: Dave, let's hear about your company.

Dave Hollars: Kitchen Mart, has like Ken's business, we're celebrating our 33rd year this year. We're hovering between 65 and 70 employees based on the work load. We're in the greater Sacramento area servicing a about 50 mile area so we're kind of lucky to stay busy in a smaller radius. I don't want to have to drive to San Francisco to do work. We're a turn-key kitchen/bath/remodeling company. We do some small room additions if it's a bathroom, laundry room or a kitchen. This year we'll just miss our target of about $10 million.

Tom: Dave, did you start Kitchen Mart?

Dave: No, I did not.

Tom: And in 33 years of being in business it's grown to $10 million. Dave, vehicle-wise, what do you do as far as trucks for the guys?

Dave: We have Chevy ½ ton and ¾ ton vans. We have 37 vans right now, 3 of them are big box vans for cabinet delivery. We've got a fleet of 40; I have 5 sales vehicles as well. I bought 5 Hyundai Elantras this year for gas reasons.

Tom: Ken, what do you do for vehicles for the field?

Ken: We furnish our vehicles and all the tools that go in them. We have 8 Chevy vans, a trailer and a couple of trucks that we use for disposal, and we put all of them inside each night, as we have for 20+ years.

Tom: Dave, when we talk about a remodeling business, you've both have been in business for 33 years with $2.5 million for you, Ken and upwards of close to $10 million for Dave. We have the decision of what to do with our office and things of that nature. Dave, tell us whether or not you own your buildings. I'm looking for 3 types of buildings; the office itself, showroom if you have one, and the receiving building for the trucks, inventory and materials. Owning or leasing: how do you do it?

 

Dave Hollars, Owner

Kitchen Mart


Photo by Gary Laufman/Getty Images

Dave: We own two 10,000 sq. ft. buildings off of Highway 50. They are centrally located, so that we can jump on any freeway and any road. We call one of those buildings “Corporate.” It has the office, about 3,000 square feet of office space and 2,000 square feet of showroom space and the remaining part of that building is a cabinet shop. It's a 5,000 square foot cabinet shop. Adjacent to us, about 50 feet away, is another 10,000-square-foot building we own. That is project management, shipping, receiving and warehousing, and a 4,000-square-foot countertop shop carved out in one of the corners.

Tom: You own both buildings?

Dave: We own both of these buildings, and we lease the showroom space that we have up in Rocklin.

Tom: You also lease how many square feet for the showroom?

Dave: In Rocklin, which is about 27 miles from here right on Highway 80, we have signage on the freeway. We have a 2,000-square-foot retail showroom space there.

Tom: Just to be clear, you have two showrooms, one that you own and one that you lease?

Dave: Yes.

Tom: Ken, tell us about your operation, as far as owning versus leasing and what you've done, and how you're set up.

 

Ken Spears, President

Ken Spears Construction


Photo by Peter Wynn Thompson/

Getty Images

Ken: In our first 11 years, we worked out of our home. I had my shop in the basement, and we rented three rental spaces as we grew. We've decided we were spending a lot of time running back and forth between these places. We built our own 5,000-square-foot building, in a really small town of 900 people! We worked there, business grew. The market area expanded a little bit. After 20 years of being in one space and one area, we decided to start leasing a smaller building for our trucks at remote sites, called our “satellite” division. Last year, we decided to switch our worldwide headquarters from our town of 900 and moved to a town of 25,000 people. We leased a 7,200-square-foot building. It's actually in 3 sections. That's our worldwide headquarters now, and our old site is our satellite division. Our trucks come and go from the worldwide headquarters every day. We use the other site for storage and our woodshop is there now.

Tom: The 5,000-square-feet that you built is currently your satellite site, and that's where your shop is?

Ken: Yes. We own that personally.

Tom: In other words, you, Ken Spears, own that building?

Ken: Correct.

Tom: You then moved to DeKalb, is that correct?

Ken: Yes.

Tom: That's the corn capital of the world!

Ken: Absolutely! That's the heartland of America.

Tom: In DeKalb you lease a 7,200-square-foot building. What does that building house?

Ken: That houses our office. We do not have a showroom. We're in a small area. We use our suppliers for our showrooms. That's how it works here for us. Our office is here, our production team has it's own little section. We have a conference room and a selection room.

Tom: That's where you keep your fleet of vans and trucks?

Ken: Yes.

Tom: Dave, let's talk about ownership. Ken said he personally owns the building. How do you have ownership of your 10,000 square foot warehouses?

Dave: My predecessor, Jim Bartol, who started Kitchen Mart in 1976, is my “operating landlord” so to speak. He owns the two buildings. He and I have a buy/sell agreement in place on the business end and on the buildings that we're working out of. It's a sweetheart deal for myself, and a good deal for him as well.

Tom: You currently have a buy/sell agreement with the previous owner that you're working out. Tell me why you did that.

Dave: It was the easiest way for him to retire and for me to acquire the business and keep it running. I wasn't in a position to come in with a couple million dollars and offer a very nice gentleman a couple million dollars for his business that he worked so hard for. He wasn't willing to sell the business, but he knew he wanted to retire. In 2001, we entered into a buy/sell agreement. I've worked here for almost 15 years now.

Tom: This is great. Dave, if I could, and I'm not asking you do disclose what you don't want to disclose, but how did you come up with a figure of how much you're going to pay for those buildings? Are you not buying the buildings?

Dave: I'm not buying the buildings. I'm buying the business. When the buy/sell agreement for the business is done, I have first right of refusal on the buildings. He's not going to sell the buildings to anyone but me. We're going to take one thing at a time.

Tom: How did you determine the amount of money you were going to pay the previous owner for those two 10,000 square foot buildings?

Dave: In rent payment?

Tom: Yes.

Dave: Going rate; whatever the local market will bear. I get a little bit of a sweetheart deal.

Tom: Can you give a range of about how much that is?

Dave: $1.00 to $1.80 per square foot.

Tom: For all square feet? In other words, you don't differentiate whether or not you have showroom, office, etc.? $1.80 per square foot, for both buildings?

Dave: That is correct.

Tom: Ken, you personally own your 5,000-square-foot shop. How does that work?

Ken: It worked out really well for the first 20 years. It's three blocks from my home so I have no commuting. The income is nice; it comes through the business back to us in the form of income. It lets the community feel — you're here, we know you're going to be here. We get premium rents from that. You can adjust it that way, it works really well.

Tom: Give an approximate amount on 5,000 square feet. Can you tell me what rent might be in approximate terms?

Ken: About $5.00 per square foot. In our little town, that's more than anything else in town, in what you can get for rent. It's premium. It's about what we'd pay for where we're at now for a leased building.

Tom: Ken, what are the financial benefits to owning vs. renting?

Ken: Owning, you still get that income, rather than renting it. The commitment, again is a tax angle.

Tom: You have both. You have worldwide headquarters of 7,200 square feet that you pay about how much for?

Ken: About $4.00 per square foot.

Tom: What's the advantage of leasing that space? Why didn't you just build one down there?

Ken: It's not our market area, we have less money tied up by building. We were going to build our own building. We had the site, we were all ready to go. But, we determined our property taxes for that new building were going to be nearly as much as our lease payments. It frees up our capital to do other investing. We have less debt servicing to do. We're committed for three years, to be where we're at.

Tom: A three-year lease is what you signed?

Ken: Yes. We didn't design the building and that would be a disadvantage. But, we have what we want and it's pretty close to what we we're going to build. We're more flexible. We'll be somewhat in transition, we're looking to purchase the business in about seven years.

Tom: Dave, the financial benefits of owning vs. renting. You're in a very unique situation. You are an owner; looks like you're going to be an owner, you're acting like an owner; yet you're set up to pay the rent. Do you have a formal lease, or is it just an understanding for rent, or how did you do that?

Dave: We have a formal agreement. It's part of the buy/sell. It looks as if it's any other lease.

Tom: What would you say would be the financial benefits of the way you're doing it? The main thing is, you didn't have the capital to come up with buying the whole thing and still maintaining the 20,000 square foot of office.

Dave: The major benefit here, to Mr. Bartol, who has many years as the founder of the business, I should have invited him to be part of our conversation. The benefits to him for owning the business and the buildings are quite obvious. He owns the buildings outright, so it's a nice form of income for him. I look forward to someday to benefit from the same thing.

Tom: Because that's a rental income, which is taxed at a different rate sometimes.

Dave: I'm not really sure how to answer the question. For me, as the business owner, I have premium square footage in a great location, beautiful buildings, they're only 15 years old, and I'm not going anywhere. I don't have to worry about it, I've got a flexible owner. Times are a little tough, we can talk things through. It's real nice knowing that I don't have to be looking for something else.

Tom: This may be rhetorical, but Dave, to you need more capital to buy versus lease, and if you were to buy, where do you get that money?

Dave: The way our buy/sell agreement is, it's not an option for me to walk up to him right now with two million dollars and just buy the buildings. I would not want to do that; I'd want it to happen more naturally. When the time comes, I'm going to get a loan to buy these two buildings. It will be based on all the P&L statements of the business. It should be a pretty smooth transition.

Tom: It sounds like you've got it worked out good. Ken, when you made your decision to lease, what were three reasons that caused you to make the choice to lease your 7,200-square-foot building rather than build or buy a building?

Ken: The major one would be lower capital investment. It freed up the capital to invest in other things. There's no maintenance; I don't have to worry about plowing snow, taking care of the lawn, building maintenance, property taxes. Those would be the really big reasons. If we're still flexible after the end of three years, if this doesn't work, if we don't like it here we can go somewhere else. Or extend it, renegotiate our lease and continue on.

Tom: That was the next question. Is it flexible to own part of the building and lease out for other parts. In that case, you lease the whole 7,200 square feet.

Ken: Yes.

Dave: And, are you using the whole 7,200 square feet?

Ken: When it started out, we have basically about 5,000 square feet and the tenant moved out. We asked for an option to be the first one to get an opportunity on that, and we took it. It came up a year sooner than we thought. So, yes, we're using it.

Tom: In that you say you have all of your vans put inside every night. Is that right?

Ken: Yes.

Tom: Dave, what do you do with your vehicles?

Dave: The big box vans, the delivery vans, come back to the shop. The two dump trucks come back to the shop. We have two dump trucks specifically for the demolition crews. Virtually everything else goes home every night. Because I can send them from home to the job site every morning. I put GPS units on each vehicle. We use GPS for numerous reasons. We use it for payroll reasons, we can see where and when the vehicles start up and what job sites they're at. It helps me police that system and feel comfortable about them sending them home. Like Ken, we provide all the tools and everything in those vans.

Tom: What about gas?

Dave: We buy the gas. That is a piece of equipment owned wholeheartedly by Kitchen Mart. It's a nice benefit for the employees. Putting signage on all the vehicles is another reason why I don't mind them being in the neighborhoods where the guys live. It's rolling advertisements. I hear more than anything, “I see your vans everywhere, Dave!” We take pride in keeping our trucks very clean; no chips, scratches or flat tires.

Tom: Ken, with yours, do you supply the gas as well?

Ken: Yes, we do. We take care of all the maintenance. It's just about the same as Dave, except we don't commute as far as he does. Our longest commute would be maybe 30 minutes. We're in a small rural area. We're concerned where those vehicles might end up when they're off duty. They go back in the shop, and you drive your vehicle home.

Tom: So that's the big difference. They drive their vehicle in. So, they don't see your vehicle down at Al's Tavern at 5:30 or 6:00.

Dave: That is a big no-no. Some of the apprentices that drive trucks do bring their trucks back. It's virtually every one of our journeymen who have been here for years they get to take their vehicle home.

Tom: We're starting that; we're up to five now. But it's really been a very hard thing for me to do. Getting back to owning versus leasing. Ken, I didn't check on your market but, one would say if they read any newspaper in the world, that the economy is suspect right now. Even the people in the remodeling business that I'm chatting with are suggesting that they are being affected by it now whereas they probably weren't in the past. In other words, it took them a while to do it. Do you see any advantage or disadvantage of leasing during a down market or a potentially down market?

Ken: Yes. We were very apprehensive on making an investment. It's going to be about $750,000 to build the structure that we were looking for. We think our clients would've said, “Whoa, where'd you get the money to build that now?” So we think it was a really good decision for us to lease. Our work is in our area so we don't go very far away. Our clients are educated, we still have backlog, we're still going along, we're happy with what's happening, although our job size has gone down a little bit.

Tom: Yeah, they have. Dave, has there been a point where you look and you say your business is down about 20 percent, do you see advantages or disadvantages as far as leasing or owning?

Dave: Leasing the showroom up in Rocklin, which is just a showroom with two designers in it; that to me was a no-brainer. I guess if I really felt good about the economy over the last few years I might have looked for some space to buy. There's a lot of retail space in the greater Sacramento area that's for sale right now. But as things are pretty shaky, I was comfortable getting into a three-year lease up there. If things didn't work out, I would just close the doors, take the displays out and leave. From a commitment level, I felt very comfortable with that. It's not a giant commitment and it won't hurt us.

Tom: But that's a decision you made because you take a look and say “Wait a minute. If it's a market that could turn and continue to turn,” it depends on how much you read and how much you want to…

Dave: The potential for the market turning weighed heavily on my mind. But also watching what property values did here for five years in a row going up almost 100 percent, I wasn't willing to buy at the peak. I thought, this is just crazy, I'm not going to spend $1.4 million on a building. That is not a 1.4 million dollar building. And, it's been two years now and those buildings are half. Some of them are being fire-sold right now.

Tom: Yeah, and you would never have thought at the time. We've seen that a lot too, mostly here in Florida. The rates, they went up three and four times what I thought they were worth on the commercial buildings and they were still selling. It was almost like a frenzy. Now today, you can buy them for 50 percent although I'm not sure anybody would want to.

Dave: I know. Personally my wife and I have been looking at buying some property of our own and expanding Kitche Mart into those avenues a couple of years from now. I'm not buying anything now.

Tom: Ken, have you ever thought of leasing out any of your 5,000-square-foot shop or is that even a feasible idea?

Ken: Yes, we have considered that and we just have to see — again, it's a small town and there are some rental spaces. That would be a possibility some day. Maybe we wouldn't get the premium rent but we could either transition into that or just sell the property.

Tom: If you had to do that now, what would determine the rate that you would charge? Again, would that be going rate? It seems to me that one of the advantages you might have now, especially in a down market — I'm not going to spend a lot of time on the down market — but, the reality exists that I'm not sure we're completely out of it. Given that parameter, that's why I'm curious about whether we want to own or lease the space. Dave, is it feasible that you would lease some of the building you're in now?

Dave: No, we're using every square inch of it.

Tom: 20,000 square feet is a lot of square feet!

Dave: Between the cabinet shop, the spray booth, and the countertop shop, and the office space that's in both buildings. We're using every inch of it right now. It would be feasible if we cut our business in half. We're in a prime location and I could easily sublease out some of it. But, I don't see that, we won't need to do that.

Tom: But, because of the nature of the ownership of what it is, you have that flexibility to do that.

Dave: Sure.

Tom: If you were going to start out or grow a business. I don't think anyone is saying “I'm going to grow my business 20 percent this year” because of the economy. But let's say we have a person who is working out of the house, Ken, much like you and I'll address the question to you. They're working out of their house now and want to get out and do it. What advice would you give them to start looking, and where do they go first, as far as determining whether or not to own or to lease a building.

Ken: I would think right now would be a great time. You could scout around. If you have money to invest, you could probably get a really nice parcel in the area you wanted. If you're uncertain where your business is going or what it was doing, I'd say check into leasing. You're so much more flexible to lease for a short period of time, like three years — get a three year lease. If it didn't work out, as Dave was saying, you could just close the doors, pull out your stuff and start somewhere else. You've got to pay attention to what the market is doing, where the growth patterns are. We're not growing as fast as California.

Dave: I'm not so sure I'd disagree with that right now. We're jobbin' like a rock. Things are coming back to reality.

Tom: In Illinois, actually we've had one of the biggest years we've ever had. But, we also do restoration. Insurance restoration. That became part of it. We looked at commercial. We did some commercial building, but that's kind of dropped off now. That is critical. 

Now, for some last minute advice. Ken, what advice would you give to a remodeling contractor out there who is reading or listening to this and saying, “Ok, here's pros and cons and here's my advice to you whether to own it or lease the property?”

Ken: I would definitely consult with my accountant, CPA or whoever is your financial advisor. I would run different business models to see what you can support, and see what works, whether you're a small company, growing, holding your own or downsizing. You need to know what you need to do to make it work. Whether you're purchasing or leasing. Be positive with the different models. It will give you the confidence to move forward and make an intelligent decision.

Tom: Dave, what advice would you have?

Dave: I think it comes down to personal goals. Personal goals and then business goals. Prioritizing them and putting them on two different pieces of paper. You asked earlier if someone was thinking about starting their own remodeling company right now, I would think by all means — lease! Don't get married to a million dollar building. Build your business, build the lease payments into your business. Save a lot of money, put it aside. Ken has done the same thing for years. Jim Bartol did the same thing for many years. He started his business right out of his garage. He slowly built it up. He paid some rent someplace, I don't know where it was. He paid rent for about 10 years. He knew what he needed to do was to buy a building. And that was for personal reasons, a personal asset. When you're the owner, and you own the building as well, your business is on solid ground. You're not subject to all the changes out there, and is doesn't become such a burden. I think it would be: what are your personal goals and what are your business goals? If I was starting out today and had to start from scratch, I'd find a nice clean newer building, a three or five year lease, and make it happen. After five years, I'd re-evaluate things. If it was working for me, on the personal side, maybe renew. But, I'd want a building.

Tom: Eventually, you'd want your own building.

Dave: That's a nice chunk of change to go into retirement with.

Tom: That's the goal you would have. I have to tell both you gentlemen that you've given sound advice. And, very specific advice! You weren't beating around the bush too much. Your whole point Dave, and Ken would probably agree, that if you're going to start out and don't have a lot of capital, leasing is a great option. The goal is to own your own building because, in the long run, that's where you can have the asset that might take you into retirement or wherever you wish to go.

Dave: Absolutely. Like playing Monopoly.

Tom: I like that!

 

This month featuring:

Ken Spears, President

Ken Spears Construction, DeKalb, Ill.

Located just west of Chicago, the design/remodel firm has been in business for 33 years. The company has 15 employees: five in the office and 10 in the field. They're on track to finish the year at $2.5 million.


Dave Hollars, Owner

Kitchen Mart, Sacramento, Calif.

Kitchen Mart is also celebrating 33 years in business as a turn-key kitchen/bath/remodeling company. With 65 to 70 employees based on work load, the firm expects to just miss its target of $10 million this year.

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