Investment Blues: The Pros and Cons of Leasing vs. Buying An Office Space in 2022

Renting an office space is one of the biggest expenses of any company. So, business owners who have the means to purchase property often face a big decision: leasing vs. buying an office space. 

Buying a commercial space is often the most lucrative choice. However, it also involves risks in terms of liquidity of assets and property management concerns. Whereas leasing puts more money on expenses and limits the control of the tenant over the property.   

Investment has always been tricky, especially with properties. Land properties are assets that are considered illiquid and can only become one when it sells fast (which rarely happens). 

On the other hand, having an office space under a lease gives you a temporary place of operations that involves extensive expenses instead of earnings through equity. Both options are risky and costly but the best decision between the two boils down to your business needs and risk appetite. 

In this post, we aim to help investors and tenants see the big picture when choosing between leasing or purchasing an office space. As an RICS chartered surveyor, Phoenix & Partners will showcase the pros and cons of both commercial property investment and office space leasing to help you achieve an informed decision. 

What does leasing an office space mean?

A leasing or leasehold agreement on office spaces is a fixed and long-term agreement between a landlord and a tenant to occupy a property for business purposes. Both parties sign a lease contract that gives the tenant the right to assume possession of the property during the lease term. 

The lease contract becomes a legally binding document as soon as it is registered in the Land Registry. Any breach of contract or dispute over the stipulations in the lease can make the landlord or the tenant legally liable.

Leasing an office involves a long legal process that may take several months. At some point, tenants hire a surveyor or solicitor to draft and review a Heads of Terms Agreement (HoT) to ensure that the costs, liabilities, and rights over the property are settled properly between the two parties.  

As tenants assume possession of the property in a leasehold agreement, they are responsible for a lot of property concerns, such as:

• Tax and business rates.
• Dilapidations claims.
• Deposits.
• Property repair and maintenance.
• Building insurance.

Check out our separate post that discusses the things you should know about leasing a commercial space here.

The difference between leasing and renting (letting) an office space

Leasing and renting (letting) are often interchangeably used but they are technically different from each other. Here are the key differences between the two:

• Length of tenancy: One of the main differences between letting and leasing a commercial property is the length of the tenancy. Leasing contracts last for 5 to 99 years while rental contracts last for months or a year. 
• Exclusive rights and control over the property: Leasehold agreements give more rights to the tenant in modifying the property and handling other property management tasks. They allow the tenants to assume possession of the property during the lease terms. Consequently, the tenants are also responsible for the upkeep of the property, both in legal and structural terms.
• Agreement and notice duration: In a letting agreement, business owners can move in and move out of a property within a short notice. Whereas, leasing an office space requires a series of notices before the landlord and tenant agree to end the lease. The notices include Section 40 Notice and Section 25, which are sent 6 to 12 months before a landlord or tenant wants to vacate the property. 
• Costs and charges: Letting an office space becomes more attractive when it comes to expenses because you are only liable for the rent. Leasing involves all the costs in maintaining the property, taxes, business charges, and service charges. 

Pros and Cons of leasing an office space 

A leasehold is often an ideal option for enterprises with an established name. It provides the security and the control they can use to build the foundations of their operations in a certain location. However, it also comes with several disadvantages.

Pros:

• Flexibility to move locations: Businesses that lease office spaces often have the freedom to move to another location. They are not tied to the property and can navigate into new locations either to downgrade to a smaller office space or move to a more strategic location. 
• No upfront costs: The most attractive feature of a leasehold is it allows the tenants to use their capital for business opportunities. They have more balanced cash flows to use for the improvement of business processes or invest in another product line. 
• Fewer property management commitments: Landlords are often responsible for the structural renovations and repair of commercial properties.
• Take advantage of building services offered by landlords: A building with multiple tenants is responsible for the cleaning personnel and maintenance of shared spaces. It is an attractive feature for companies that don’t have the budget to hire maintenance staff.
• Exclusive rights over the property: Leasehold agreements grant tenants the exclusive rights to assume possession of the property. They can decide who can enter the premises and even the landlord should ask for permission to visit the property. 

Cons:

• Less control on property modifications: Though tenants have exclusive rights over the property, some structural modifications are still for approval of the landowner. 
• Rent expenses over equity: Leasing an office space leads to a potential loss in rental expenses instead of earning equity. Purchasing an office space gives your money the chance to grow through the property’s value increase over time.
• Risks with deprivation of assets: When a landowner gets into a financial hurdle or plans to convert the property into a residential property, the tenants will be forced to move to another location. 
• Increase in rental costs: Rental costs consistently increase every year. It is affected by several factors like inflation rates and rent reviews. Tenants may have the freedom to move to other office spaces, but moving expenses are another challenge to consider, not to mention the cost of the disruption of operations while moving to a new location. In the 2022 report of Oktra, the rental rates in the London for 2022 are as follows:

Questions to ask when leasing an office space

While deciding to lease an office space, here are some questions that can help you weigh its risks and opportunities for your business. A lease contract is legally binding. So, you have to ensure that you’re asking yourself the right questions, because signing to one makes it a done deal:

• Do you have plans for expansion in the next 5 to 10 years?
• Is the office space equipped with the necessary utilities to handle your tools and equipment?
• What facilities are included in the lease (parking, park, patio, etc.)?
• How often and how much is the rent increase?
• What kind of taxes do you agree to pay for leasing an office space?
• Can you sell your business and transfer the lease to a third-party?
• Can you sub-let?
• Can you add an out clause in the lease contract?
• Did you agree with the landlord in terms of the dilapidations claims?
• Are there any hidden costs or restrictions in the lease?
• Do the services included in the service charges clause affect your leased property or you are paying for a service that has nothing to do with building maintenance?

Crucial technical considerations when leasing an office space

Office spaces on lease are the business of landlords. So, it is safe to say that they will try to make more income out of it other than the rent. Most of the time, ambiguous clauses in the lease are used by some landlords to bring in more profit at the expense of the tenant.

When negotiating a lease with a landlord, here are some of the technical considerations that you should discuss to prevent them from outsmarting you with the costs:

• Rentable space and its cost: In the UK, rental costs are based on the price per square foot. To ensure that you are getting the space that you pay for, inspect the rentable space and look for areas considered rentable but can’t be used. Possible examples of these areas are sharp-angled corners, excessive columns, and other obstacles included in the rentable space.
• Capital improvements: Usually, structural installations and modifications are the responsibility of the landlord while tenants pay for the repair. Beware of landlords who charge you for replacing old HVAC systems or plumbing because replacement is out of the bounds of repair
• Exclusions from service charges: Service charges are the amount billed to a tenant for the maintenance of shared premises in the building. However, service charges alone can be vague. Ask your landlord or include a clause in the lease stating that the inclusions in service charges should be listed and sent to the tenant for auditing. Once the landlord complies, check for the charges that should be excluded from the list such as:

• • Property executive salaries.
  • Consultation fees & advertising costs.
  • Property market study fees.
  • Commissions.
  • Initial landscaping costs.
  • Structural replacements.
  • Tax penalties incurred due to the landlord’s failure to pay on time.
  • Increased interest charges due to the landlord’s refinancing woes.
  • Legal fees in dispute resolution involving the landlord.
  • Excessive fees the landlord pays to a contractor due to a special relationship.
    

• Dilapidations claim: Dilapidations are probably one of the most costly impacts of leasing an office space. They are parts of the premise that was altered by the tenant outside the covenants of the lease during the lease term. It is often issued at the end of the lease term. Before signing a lease, ensure that the inclusions in the dilapidations clause do not require you to do extensive restoration or repair of the property.
• Double charges: Double charges are a common issue in mixed-use commercial buildings wherein a facility is rented to the tenants and also charged to them under service charges under the maintenance category. The best example of these facilities is parking spaces. 
• Rent reviews: Rent reviews are often conducted by landlords to check the current market and decide if they will increase the rental rate. It’s worth asking your landlord about their plans for rent reviews and the things that you can agree upon regarding the rent increase.
• Casualties costs: Earthquakes and natural calamities can wreak havoc on properties. The lease should indicate that the tenant will not be liable to pay the rent of the property that is unusable due to the damage caused by casualties. This clause will protect a tenant from landlords who demand payment even if the office space is no longer usable.

Moving on to the investing side, let us help you see what it takes to buy an office space and how it can make or break your finances in the long run. 

Inside the world of commercial property investment: Buying an office space in the UK

Investing in properties is a gamble that investors take in exchange for better business opportunities. Ownership of a property allows them to modify the structure, plan future expansions, and earn from it through subletting and parking rentals. However, behind the dreamy property investment success comes the costs and responsibilities of maintaining a commercial property.

Average cost of buying an office space in the UK

During the peak of the pandemic in 2020, the commercial market is warned about the phenomenon called Death of the Office. However, research and surveys prove that it is not the case as new types of commercial spaces and changes within the use class order document have opened doors for new opportunities.

In Savills 2022 report about the country’s commercial property market trend, the yields of the office space market look more positive than expected. It remains unchanged in its 5-year-long position despite the commentary in 2020 and provides a bright opportunity for investors in 2022. However, there’s a specific twist in the preferences of investors. 

According to Financial Times, investors are willing to pour in £45 billion for serviced office spaces that support the flexible working pattern. More green-approved offices are also the focal point of the investment trend over the traditional office spaces. 

Traditional office owners, on the other hand, are now thinking of ways to convert their properties for other purposes. Thanks to the new amendment on the use class order, mainly Class E, that gives them the freedom to change the use of the building to a broader selection of property types. 

London and the East of England have received the most venture capital in 2021, garnering around £17,930,000 for London offices and £2,814,000 for offices in East England. 

The cost of buying an office space depends on the location. Based on the graph from Savills above, the venture capital for each location has increased for the past 11 years. The average venture capital throughout the whole country is £2,120,000. 

Income potential of an office space

As 2022 looks promising for investors, it also breeds new income strategies to adapt to the changing working patterns. A commercial property increases in value through different income streams, such as:

• Subletting
• Office space leasing
• Co-working spaces
• Flex-use buildings
• Parking space rental

One particular trend in the commercial property scene is the rise of warehouse and industrial space rentals. Class E of the use class order now allows the conversion of light industrial spaces to places for commercial, leisure, and entertainment space and vice versa. So, some investors opt for the cheaper option by purchasing a light industrial unit and renovating it into a mixed-use building where shops and offices are placed next to each other.

Pros and cons of buying an office space

The initial amount that you have to invest to purchase a commercial property is what scares most investors. However, the potential yield also makes the endeavour worth the jump. To help you see the whole investment process in a different light, here are the pros and cons of buying an office space:

Pros:

• Capital growth: The increasing value of a property is probably the most attractive aspect of investing in one. While you earn from rentals, the value of the property also increases as the local market changes – a total win-win situation. However, some factors might affect a successful commercial property investment, such as occupancy rate, tax amendments, market trends, and crises like the COVID-19 pandemic and war. Investors are using some metrics to forecast the potential income of a property using the cash on cash return formula. 

Cash on cash return = Annual pre-tax cash flow / Total cash invested x 100% 

• Security over the assets: Though tenants are protected by the law against short notice evictions, a landlord can still repossess the property for renovation or when he faces financial constraints. Having your own office space gives your business the security that no one will send an eviction notice or be bound by restrictions over the property assets.
• Full control over the property: As the owner of the office space, you can modify the structure and interior of the property without any restrictions. You may also opt for a conversion, sub-let, or lease more spaces in the building.
• Multiple income streams: Commercial properties provide a steady income for landlords through rentals, parking spaces, and service charges. An owner can also decide how many tenants a building can have and the services that he provides to them for extra income.
  
  The rise of co-working and hybrid working patterns caused many companies to look for small but serviced commercial units. These units allow them to focus on meeting business goals rather than worrying about hiring cleaning staff and maintenance teams. Long vacancies are the unpredictable part of leasing a commercial property. Sometimes, it takes months before a property will be rented by a new tenant which causes a lack of income for the landlord. Establishing a co-working hub can solve this problem.

   

  Companies that virtually exist need a place to collaborate and meet members for a project or any business endeavour. A co-working space gives them the space and the facilities that they need for a short time without committing to a lease agreement.

• Investment vehicle when inflation strikes: When the business fails to stay afloat during uncertain times like global and political crises, landlords can sell their commercial property as a cushion or a  last resort.
• Variety of potential tenants: Due to the use class order amendment in 2020, office spaces can now have several types of tenants. These include light industrial companies and businesses from different sectors.
• Tax benefits: The UK government provides several reliefs and allowances to property owners in hopes to bring in more investors and rebuild cities. These include:
  • Capital Allowance 
  • Business Premises Renovation Allowance (BPRA) 
  • Land Remediation Relief
• Leverage for other types of investments: Adding your commercial property to your statement of assets encourages other business opportunities in your path. It allows other investors and businessmen to see your investment capacity and how you can contribute to other future projects. 

Cons: 

• Property management woes: As the saying goes, the house that you live in is the house that you repair. All good things that we have are also the things that we maintain and fix. With a commercial property on the lease, you must ensure that the building is safe for use, the shared facilities are functional and clean, and the permits and taxes are updated.
• Tax Obligations: As a landlord, you are initially the one responsible for paying the property tax. However, you can negotiate it with your tenants if you want to give them the authority to pay for the property tax on your behalf. In case of late payments for taxes, you will be charged with penalties, even if the responsibility of paying them is on your tenants.
• Tenant issues and long vacancies: Lease agreements and charges disputes between tenants and landlords are the stressful part of leasing a property. Any installation or repair in the structure that is not clearly stated in the lease can breed disagreements that can lead to court and cost expensive legal fees.
• Ties up your capital: Investing in commercial property limits your cash flow. Properties are considered illiquid for a reason. They are not easily converted into cash when the situation calls for it, especially with commercial properties that cost millions. The limited flexibility of your capital is probably the first sacrifice you need to make to acquire your office space. However, it can soon pay off if the property you bought is in a good location that provides a consistent influx of tenants and other income streams like parking rentals.
• Mortgage concerns: The worst-case scenario for a landlord or commercial property, other than lease disputes, is experiencing negative equity. It occurs when the property value drops below the outstanding balance of the mortgage used to pay the property.

In 2008, several residential property owners experienced a negative equity crisis due to the decrease in the value of their property. Though it will less likely happen to commercial properties, it is still possible.

Things to check when buying an office space

Purchasing an office space takes a lot more steps than leasing one. As an investor, you must assess your goals about the purpose of the property and plans for it. Other factors to check are as follows:

• Location and local traffic generators: Prime locations make a building more attractive to tenants and investors. Put yourself in the shoes of your tenants and see how they can generate income by renting your space. Choosing a property close to establishments that draws traffic like universities, hospitals, and government offices can decrease your vacancy rate and a promising increase in the value of the property.
• Local commercial competition and property market: Watching how your competitor generates more tenants is a good strategy. It allows you to observe what they are doing right, what you are doing wrong, and how you can be better than them. A good example of a property business strategy is increasing the green credentials of the office space. People are now more environment-conscious and the reduction of carbon footprints is becoming more attractive to tenants.
• Potential allowances and relief for property owners: The government provides incentives to investors who chose to refurbish a rundown property in key areas of the country. The reward system aims to revitalize and bring life back to declining city centers. Commercial property owners also have a lower Stamp Duty Land Tax and some investors take advantage of it by acquiring semi-commercial properties. They rent out the top part as a flat and the lower part as a commercial or office space, producing two streams of income at a lower tax rate.
• Flexibility in the use of the property: The shift in the working patterns around the globe due to the pandemic has led to the transformation of the use of commercial properties and industrial spaces in particular. Many commercial spaces in key areas are converted into retail warehouses for online shops. Light industrial properties, on the other hand, become a hybrid center where tenants can place an office and a production floor on one site.
  
  Light industrial spaces are commercial properties intended for the assembly, packing, and storage of goods. As it becomes part of Class E in the new use class order along with office spaces, acquiring a light industrial property might just be a good alternative to traditional office spaces. Learn more about light industrial properties and the reason behind their growth for the past two to three years by clicking here.
• Risks of property investment: Investments are not bulletproof when it comes to present and future risks. Assess the potential risks around the commercial property and weigh if the risks overpower the potential of the property or vice versa. You should also assess your risk tolerance before committing to purchase a building and ensure that you have contingency plans in case things don’t go your way. 

Help us give you a full background in purchasing a commercial property before you dive deeper into the office space market in the UK. Read our commercial property purchasing guide here. 

Leasing vs. buying an office space: Frequently Asked Questions (FAQs)