Owning vs Leasing Real Estate: Pros & Cons

The decision to own or lease real estate is a critical factor for any franchisee.

Each path presents unique advantages and disadvantages that can significantly impact a franchise's financial health and operational flexibility.

In this article and podcast, we will take a look at the pros and cons of owning vs leasing real estate along with current trends in the industry.

Pros of Owning Real Estate

Franchisees often initially lean towards purchasing real estate, and for good reason. The benefits of ownership are compelling:

• Equity and Long-Term Wealth: Owning the land and building allows you to build equity over time, contributing to long-term wealth accumulation.

• Tax and Depreciation Benefits: Real estate ownership offers attractive tax advantages and depreciation benefits that can significantly reduce your tax burden.

• Control and Customization: Owning your site provides greater control over its design and customization. You aren't restricted by a landlord's requirements or shopping center regulations, giving you the freedom to tailor the property to your exact needs.

• Operational Stability: With ownership, you eliminate concerns about lease terms expiring, unpredictable rent increases, or fair market value adjustments. This provides a stable environment for long-term planning.

• Freedom from Landlord Issues: You're not reliant on a landlord for common area maintenance, roof repairs, or other property improvements. This autonomy ensures that the upkeep and aesthetic of your site remain under your direct control.

Cons of Owning Real Estate

Now, let's take a look at the flip side of owning the real estate associated with your franchise. While attractive, ownership comes with its own set of challenges:

• High Upfront Costs: Land costs are on the rise across the nation, making the initial investment for purchasing real estate substantial. This can create significant capital constraints for franchisees, especially during the development and construction phases.

• Lower Liquidity: Tying up a significant portion of your assets in real estate can reduce your liquidity, potentially impacting your ability to fund further development or respond to unforeseen financial needs.

• Maintenance and Improvement Costs: The responsibility for all maintenance, repairs, and improvements falls squarely on the franchisee. These costs need to be accounted for and budgeted throughout the asset's lifespan.

• Limited Flexibility: If a trade area shifts or declines, reselling the asset might be challenging. This can limit your flexibility to relocate to more promising or growing areas, as your capital is tied to a specific location.

Pros of Leasing Real Estate

While ownership is often the first thought, leasing offers distinct advantages, particularly for those looking to expand rapidly. It's common for multi-unit franchisees to have a mix of owned and leased properties.

Here's why:

• Lower Upfront Costs: Leasing significantly reduces the initial capital outlay since you're not purchasing the real estate. This frees up capital for other business operations.

• Greater Opportunity in Growth Areas: Leasing can open up more opportunities in desirable or rapidly growing trade areas where land might not be for sale, but lease opportunities are abundant. Landlords often redevelop and reinvest in properties, creating new lease parcels.

• Increased Flexibility: Leases offer flexibility. As your lease term approaches its end, you have the opportunity to reevaluate your market and customer base. If the trade area has shifted, you can choose to relocate to a more suitable location, fueling your company's continued success.

• Predictability of Costs: Lease agreements typically outline predictable monthly costs, including rent and common area maintenance (CAM) or triple net (NNN) charges. This makes budgeting simpler and avoids unexpected major repair expenses.

• Tax Benefits: Leasing can also offer tax benefits related to depreciating the building and equipment, allowing for more strategic capital allocation within your business.

Cons of Leasing Real Estate

Of course, there are some cons to leasing real estate. Despite its benefits, leasing has its drawbacks:

• Lack of Equity: Unlike ownership, leasing doesn't build equity in the land, which is a significant attraction for many new franchisees.

• Limited Control: You may be subject to a landlord's design requirements or restrictions within a shopping center. While some of these might be jurisdiction-specific even with ownership, leasing generally offers less autonomy.

• Fair Market Value Increases: At the end of a lease term, rent can increase significantly based on fair market value, potentially impacting your long-term occupancy costs. Careful negotiation of option terms is crucial.

• Landlord Dependency: You are dependent on the landlord to maintain and improve the surrounding property. If the landlord fails to maintain a quality center, it could negatively impact your business.

Understanding Types of Leases

When considering leasing, it's helpful to know the common types:

• Ground Lease: This is the most common option we see in franchising, where you rent the land and construct your building on it.

• Land and Building Lease (Second-Generation/Conversion Space): In this scenario, you lease both the land and an existing building from the landlord. These often have different cost considerations due to the asset improvement value.

• Build-to-Suit Lease: Less common but an option for those with significant capital constraints, a build-to-suit lease involves a landlord or developer constructing a turnkey prototype building for you. While this comes with a higher occupancy cost, it allows you to start operating a business without the initial capital investment in construction.

Key Considerations: Location, Location, Location!

Ultimately, the decision to own or lease hinges on several factors all franchisees must consider:

• Financial Position and Capital: Evaluate how much capital you can extend without overleveraging yourself, ensuring you're capitalized for long-term operational development.

• Long-Term Goals and Risk Appetite: Understand your long-term vision for your franchise and your comfort level with risk.

• Availability of Trade Areas: Sometimes, a prime location, a "tier one" trade area, might only be available through a lease. In such cases, leasing a top-tier location could be more beneficial than owning in a less desirable area.

A diversified asset portfolio, blending both owned and leased properties, can build a stronger, more resilient business. This approach allows franchisees to balance risk as they grow and develop their pipeline of stores, strategically placing restaurants in the best possible positions for success.

Market Trends in Real Estate Costs

It's no secret that real estate costs, both for land and leases, have been on the rise across the country. While land costs increase, lease costs generally follow suit, as property owners seek a return on their investment.

However, the real estate market is cyclical. We're currently seeing shifts in the construction world that are improving negotiation power for franchisees and tenants.

Developers, facing holding costs, are becoming more flexible in their negotiations. This highlights the importance of leveraging the expertise of real estate support teams and combining it with local market knowledge to push the boundaries of negotiation, whether you're leasing or buying.

Check Out These Additional Resources

We hope this article and podcast gave you a better understanding of the pros and cons of owning vs leasing real estate for your franchise.

At Jack in the Box, we’re looking for multi-unit franchisees who are excited to bring our craveable 24/7 menu to new markets across the country.

Here are some additional online resources you may like to check out:

• Jack in the Box vs McDonalds: Which Franchise is Best?
• 5 Reasons to Purchase a Jack in the Box Franchise
• What Are the Jack in the Box Franchise Requirements?

 If you have any questions, please contact our franchise sales and support team.