Renting real estate versus owning it

Real estate is not always a good investment. Whether you're someone wanting to purchase a home,  or you're someone who wants to a place where your business calls home, there are many factors to consider.

If you're purchasing a home, here a few tips to consider.

1. Observe what the market is currently doing. Are prices increasing, decreasing, staying the same over a 12 month period.
2. Most people make money in real estate because of market appreciation. For 15 years, my market saw continuous market appreciation and people who flipped their homes made a fortune. Today, those same people are in financial difficulty because the market has been depreciating over the last 3 years.
3. Although renting may seem like money wasted, it can't be considered any different than an interest expense. Without appreciation, the small annual principal payment is more like growing a savings account.
4. Owning a home can have many incidental costs not budgetted. Repair and Maintenance is a constant surprise, whereas renting is a fixed, easily budgetted figure. 
5. If you grow tired of your space or feel like the landlord isn't taking care of your needs, you can move, without any worries about closing dates, lawyer fees and bridge financing.

Don't get me wrong owning your home can be financially rewarding under the right conditions. Just study the market and make a decision that you can live with.

The business side is a completely different story. Most business people believe that owning the real estate where the business is located is a good investment.  

There are things to consider.

1. In business, location is everything. Owning real estate in the wrong area anchors down the business from moving, which can slow business growth.
2. A building and a business are two separate businesses. Both provide cashflow. But both are mutually dependent on the success of the other. If the primary business fails and it is the main tenant, the risk of losing the real estate is probably high.
3. Owning the real estate can give you a bit more control if you own a franchise. Franchisors have less power over franchisees who own their own real estate.
4. Cash is still king. Owning a building can be a good investment. But if a business owner is in a weak cash position because of the real estate purchase, the owner is better off renting and paying away good money in rent to test the viability of the primary business. 

I love real estate but it's not always a good investment. If you're getting into business, I think the best option is to sign a lease agreement for no less than five years and no more than ten years with an option to buy. If the business is a success, an owner can put away its excess earnings to exercise the future option on the building.

There is one franchise business that I am well aware of where the majority of franchisees struggle with profit margins of 2-3%. Yet the franchisor stays in business. The mantra is that the franchise is successful when in fact it is not. The successful franchisees all own their own real estate and most have owned their business for 20 plus years.

Is the franchise a success or is the real estate a success? I will argue the real estate has been more of a success for these franchisees. I reviewed the financials of one of these successful businesses and I noticed a glaring fact. At 2% profit margin, the restaurant was making about $20,000 per year in profit. The building made $50,000 profit from the rent. But the rental income wasn't enough to service the debt repayment, let alone pay someone a reasonable management salary.

Yet someone got excited about the business and bought both the real estate and the restaurant. Over the long run, this can be a good investment. In the short run, it is a terrible one.

There's no such thing as long run, if you die in the short run. A long run investment returns money in the short run over a number of years, making the long run very lucrative. In other words, it won't matter what investments look like in 20 years, if you can't pay the bills today.

That's where business real estate and homes have something in common. Don't allow yourself to get in a position of "house poor". It's too risky.