Buy vs Lease: A Decision Framework for Commercial Property

1. Hold period. This is the biggest driver. Buying loads most of its costs into the beginning (down payment, closing costs) and the end (broker commission when you sell). The longer you stay, the more years of rent you avoid and the more mortgage principal you pay down. Short stays punish buyers; long stays reward them.

2. Total cash in and out. Compare everything, not just the monthly payment: down payment, purchase costs, mortgage payments, property tax, insurance, and maintenance on the buy side — against rent on the lease side — and then subtract what you get back when you sell.

3. Appreciation and equity. Ownership pays you back two ways. Principal paydown is slow but certain: every payment shrinks the loan. Price appreciation is faster but uncertain: it can be zero, or negative, for years.

4. Taxes. Owners can generally deduct mortgage interest and depreciate the building; tenants can generally deduct rent. Taxes usually tilt the answer slightly toward buying, but the size of the tilt depends on your entity and tax situation.

5. Flexibility and opportunity cost. Leasing lets you move, expand, or shrink. Buying ties up a large lump sum — the down payment — that could otherwise be invested. Both have a price.

A small business needs a 4,000-square-foot commercial space it will occupy itself. The choice is between buying a comparable space and leasing one.

Buy side assumptions

• Purchase price: $1,200,000
• Purchase costs (legal, title, inspection, loan fees): $36,000 — 3% of the price. Buyer-side closing costs on commercial property commonly run 3% to 5%.
• Down payment: $300,000 (25%). Conventional commercial loans typically ask for 20% to 30% down.
• Loan: $900,000 at 7.5% fixed, 25-year amortization
• Operating costs as owner (property tax, insurance, maintenance): $18,000 per year
• Selling costs: 6% of the sale price. Broker commissions on commercial sales typically run 3% to 6%, plus closing costs.

Lease side assumptions

• Gross rent: $7,500 per month ($90,000 per year), with the landlord covering operating costs inside the rent
• Annual rent escalation: 3%, compounding. Fixed annual increases of 2% to 3% are typical in US commercial leases.
• No down payment; a refundable security deposit and moving costs are ignored on both sides to keep the comparison clean.

Base case: property prices stay flat (0% appreciation). That is deliberately conservative — it shows what buying delivers without any help from the market. A sensitivity check later shows what happens if prices rise 2% a year.

Left out for now: taxes and opportunity cost. They are added back in a separate step so you can see exactly how much each one moves the answer. All figures are rounded to the nearest dollar.

Step 1: the monthly payment. The standard amortization formula is payment = loan × monthly rate ÷ (1 − (1 + monthly rate)^−number of payments). With a $900,000 loan at 7.5% over 25 years (300 payments), the monthly rate is 0.625%:

$900,000 × 0.00625 ÷ (1 − 1.00625^−300) = $6,651 per month, or $79,811 per year.

Step 2: cash out over five years.

Step 3: what you own after five years. After 60 payments the loan balance is $825,593. You have repaid $74,407 of principal and paid $324,648 of interest. The interest is the part that is gone; the principal is the part you keep.

Step 4: the sale. The property is still worth $1,200,000 (flat prices). Selling costs are 6%, or $72,000. After paying off the $825,593 loan, the cash back in your hand is:

$1,200,000 − $72,000 − $825,593 = $302,407

Step 5: net cost of buying for five years.

$825,055 cash out − $302,407 back = $522,648

Rent rises 3% a year, compounding on the prior year's rent:

There is no down payment, no sale, and no equity at the end. The total cost of leasing for five years is $477,822.

• Cost of buying for five years: $522,648
• Cost of leasing for five years: $477,822
• Leasing wins by $44,826.

The reason is transaction costs. Buying costs $36,000 to get in and $72,000 to get out — $108,000 in total. In five years you only repay $74,407 of loan principal, and with flat prices there is no appreciation to help. Ownership's gains need more time than five years to cover the cost of two transactions.

Run the identical math to year ten.

Buy side. Mortgage payments over 120 months total $798,110. The loan balance falls to $717,458, so you have repaid $182,542 of principal and paid $615,568 of interest. Total cash out is the $300,000 down payment, plus $36,000 of purchase costs, plus $798,110 of mortgage payments, plus $180,000 of operating costs — $1,314,110. Selling at the same flat $1,200,000, less 6% selling costs ($72,000) and the $717,458 payoff, returns $410,542. Net cost of buying for ten years:

$1,314,110 − $410,542 = $903,568

Lease side. Rent in years 6–10 adds $553,927, bringing the ten-year total to $1,031,749.

Ten-year verdict: buying wins by $128,181 ($1,031,749 − $903,568).

The flip happens during year 7. At the end of year 6, leasing is still ahead by $19,783. By the end of year 7, buying is ahead by $9,828, and the gap keeps widening. Two forces drive it: principal paydown ($182,542 by year 10) finally exceeds the $108,000 of transaction costs, and rent keeps compounding upward while the mortgage payment stays fixed at $6,651.

Appreciation. This is the most powerful input — and the least certain. If prices rise 2% a year instead of staying flat, the property is worth $1,324,897 after five years and $1,462,793 after ten. Re-running the sale math, the five-year cost of buying falls to $405,245, so buying wins even at five years, by $72,577. At ten years buying wins by $375,207. The lesson: if you are confident prices will rise steadily, buying wins sooner. Never count on appreciation to make a purchase work — treat it as upside, not as the plan.

Opportunity cost. The $300,000 down payment is money that cannot be invested elsewhere. At a 5% annual return it would grow to $382,884 in five years and $488,668 in ten — that is $82,884 and $188,668 of forgone returns. Add those to the buy side and the picture changes: at five years buying costs $605,532 against leasing at $477,822 (lease wins by $127,710), and at ten years buying costs $1,092,236 against $1,031,749 (lease wins by $60,487). In a flat market with a 5% alternative return, leasing wins at both horizons. Buying needs either rising prices or a low alternative return to come out ahead.

Interest rate. The rate quote matters more than most people expect. At 6.5% instead of 7.5%, the monthly payment on this loan falls to about $6,077 — roughly $574 less per month, or about $6,888 a year. Get real quotes before you decide; a single point on the rate can move the break-even year.

Down payment. A smaller down payment means less cash tied up and less opportunity cost. SBA 504 loans let qualifying owner-occupant businesses buy with about 10% down under the standard 50/40/10 structure (bank 50%, SBA-backed debenture 40%, borrower 10%), versus 20% to 30% for a conventional commercial loan. A 10% down payment on this property would be $120,000 instead of $300,000 — the framework is the same, but rerun the numbers with the smaller upfront sum and the larger loan.

The worked example ignores taxes, so here is the short version. As an owner, mortgage interest is generally deductible as a business expense, and the building (not the land) is depreciated straight-line over 39 years for nonresidential real property under IRS Publication 946 — about $30,769 a year on a $1,200,000 building if the full price were allocated to the building, less in practice once land value is split out. When you sell, the depreciation you claimed can be recaptured, which claws back some of the benefit. As a tenant, rent paid for property used in your trade or business is generally deductible as an ordinary business expense (IRS Publication 535, now superseded by Publication 334). Taxes usually tilt the answer slightly toward buying, but the size of the tilt depends on your entity type, income, and state — run your own numbers past a CPA before letting taxes decide it.

Numbers are only half the decision. A lease lets you move, expand, or shrink when the business changes, and the landlord carries the risk of a major repair, depending on the lease. The price is rent that never stops rising and no equity at the end, plus renewal risk when the term expires. Buying gives you control, stable payments, and no landlord — but selling takes months and about 6% to exit, and a downturn can leave you owning space you no longer need. The practical way to weigh flexibility is to find your break-even year — in this example, year 7 — and ask one question: am I confident I will still want this space in that year? If the answer is no, lease. If it is yes, buying deserves a serious look.