U.S. Unemployment jumped from a record low of close to 3% last fall to the current unforeseen historic highs. Add to this that many white-collar workers are forcibly getting accustomed to working from home. And think back to your Economics 101 class to the situation where demand is falling while supply is fixed. With these ingredients, the most likely result is a temporary decrease in commercial real estate prices throughout the country.
Assuming commercial real estate prices will fall in the short-term, does it still make sense to own the real estate for your practice if you have the opportunity to do so?
Let’s look at an example with the following factors:
- You can lease your office space for a current rent of $3k per month for the next 25 years.
- Or, you can purchase an equivalent space with a monthly mortgage of $3k to be paid off over 25 years.
- The lease will be a Triple Net Lease, meaning you pay the insurance, real estate taxes, and common area maintenance for your office space – same as if you owned the property
- Your rent and other costs will increase over time with inflation.
Because rent will increase with inflation over time, the real cost to you of renting is $3k per month over the 25-year period, or $900k. Since your mortgage payment is fixed at $3k per month over time, the real cost of your mortgage payments is just $500k over the 25 years thanks to the impact of inflation (assuming 3% inflation). Remember, a dollar today is more valuable than a dollar tomorrow. Making a monthly mortgage payment of $3k in 25 years is much cheaper than making that payment this year using “today’s dollars”.
You then get to sell your commercial property when you sell your practice. Even if the property doesn’t appreciate at all, you still end up recouping all the money you paid on your mortgage less the after-tax cost of the interest paid.
Don’t forget that in 25 years, however, those dollars you receive from the sale of the real estate will purchase significantly less than they could purchase today due to the impact of inflation. Even so, receiving that big check from selling your office building or condo in addition to the money from selling your practice is a great deal for a practice owner who also owns the real estate, but would never be available to one who rents.
What if the commercial real estate market does collapse and never comes back in the next few decades? Potentially, rents will fall dramatically as landlords try to fill vacant space. As long as your property maintains some value and you hold onto the property until the mortgage is paid off, you should still end up ahead versus practice owners who rent their space.