The Cost of Occupancy Framework

The lease-vs-own decision is fundamentally a cost comparison: which option costs the business less, on a present-value basis, over the holding period? But "cost" is more complicated than it sounds, because lease costs and ownership costs are structured very differently.

This lesson lays out the framework — exactly what to include in each side of the comparison so you're comparing apples to apples.

The two cost stacks

Cost of leasing

+ Base rent (× annual escalations)
+ Operating expense passthroughs (CAM, taxes, insurance for NN/NNN leases)
+ Tenant improvements (TI not amortized into base rent)
+ Moving costs / fit-out costs not covered by landlord
+ Brokerage fees (if not paid by landlord)
+ Loss of flexibility cost (if you outgrow space mid-lease)
+ Renewal cost / market rent reset at lease end
= Total cost of leasing

Cost of owning

+ Down payment (opportunity cost — what could that capital have earned elsewhere?)
+ Mortgage debt service (P&I for the loan)
+ Property taxes
+ Insurance
+ Repairs & maintenance
+ Utilities (if relevant to comparison; tenants pay these too)
+ Property management (if outsourced)
+ Replacement reserves (roof, HVAC, parking)
- Tax savings from depreciation
- Tax savings from interest deduction
- Equity build-up from principal paydown
- Property appreciation
= Net cost of owning

Notice the asymmetry: leasing is mostly out-of-pocket cost. Owning has out-of-pocket costs, but also tax benefits and equity build-up that offset them.

The right horizon

The comparison only makes sense over a multi-year horizon — typically 10 years. Why?

• Year 1: Owning often looks WORSE because of high upfront down payment + closing costs
• Years 2-5: Owning starts to look better as rent escalates but mortgage payment stays flat
• Years 6-10: Owning is dramatically better because the cumulative rent growth + equity build-up have flipped the math
• Year 10 and exit: You sell the building (or refinance) and capture all the equity you've built

If you compare just Year 1, leasing always wins (no down payment). If you compare just Year 10, owning always wins (rent has compounded). The honest answer is the cumulative present value over the full holding period.

Present value — why it matters

Different cost timings can't be compared directly. A $400,000 down payment today is not equivalent to $400,000 of rent payments spread over 10 years. The down payment is worse because the dollar today is more valuable than dollars in the future.

To compare them fairly, you discount future payments back to present value at a discount rate. Typical choices for the discount rate:

• The business's cost of capital (debt rate + equity risk premium) — most accurate for the business owner
• The opportunity cost of the down payment — what they'd earn investing the cash elsewhere
• A reasonable approximation: 8-10% for most small businesses

We covered NPV and discount rates in Course 4. Same math applies here.

The opportunity cost of the down payment

This is the most-debated and most-important line in the comparison.

When a business buys a building with $200,000 down, they're committing $200,000 of capital that could have done something else. The "alternative use" determines the opportunity cost:

High opportunity cost

A business that's growing 30%+ per year has a high opportunity cost of capital. Every dollar reinvested in the business returns 30% (or more) in additional revenue. Tying up $200K in a building means losing the ability to deploy it into growth — that's worth $60K+ per year in missed business returns.

Low opportunity cost

A business that's mature, stable, and not growing has a low opportunity cost. Their excess cash is sitting in the bank earning 4%. Tying up $200K in a building means missing $8,000 per year of bank interest.

Negative opportunity cost (rare)

A business that has more cash than it can productively use. Tying up the cash in a building actually reduces their tax bill (depreciation) and gives them a real asset instead of cash they don't need.

The right opportunity cost rate to use in the model varies enormously by client. Always ask: "If you didn't put this money into the building, what would you do with it?"

What goes in each cost line

Let's drill into each line of the framework.

Lease side

Base rent + escalations The contract rent, escalated at the contractual rate (or market) each year. Use the actual escalation in the lease — typically 3% per year, sometimes CPI-linked, sometimes hard step-ups.

Operating expense passthroughs

• Gross lease: $0 (landlord absorbs)
• Modified gross: tenant pays utilities, sometimes janitorial
• NN: tenant pays property tax + insurance
• NNN: tenant pays everything (tax, insurance, CAM, all utilities)

In a NNN lease, the all-in cost is base rent + ALL operating expenses, which can effectively double the "rent" depending on the building.

Tenant improvements If the landlord gives the tenant a TI allowance to fit out the space, that's already in the rent (effectively). If the tenant pays out of pocket beyond the allowance, that's a Year-0 cash outflow that should be in the model.

Moving costs Furniture, equipment moves, IT setup, signage, branding, address changes — usually $25K-$100K depending on the size of the move. Belongs in Year 0.

Renewal / reset costs If the lease expires and the tenant has to sign a new one at market rent, that's a step-up. Build it into the model: at lease end (Year 5 or 10), reset the rent to expected market.

Own side

Mortgage debt service P&I on the loan. Stays fixed for the term of the loan. Use a real loan amortization (Course 5, Lesson 4 covered the mechanics).

Property taxes Reset to your purchase price (Course 5, Lesson 3). Don't use the seller's tax bill.

Insurance Property insurance on the building. Get a real quote during diligence.

Repairs and maintenance

• Light maintenance: 0.5-1% of value per year
• Older buildings: 1-2%
• Multi-tenant buildings (with common areas): higher

Property management For a single-tenant owner-user building, the business is its own tenant — no property management is needed. For a multi-tenant building where you occupy 60% and lease 40%, you're a landlord on the 40%, which adds management costs.

Replacement reserves Roof, HVAC, parking lot, water heater, big-ticket items. Budget 0.5-1% of value per year. Owner-occupied buildings often skip this in casual analyses, then get hit with $30K capex events that weren't budgeted.

Tax savings: depreciation The building (not the land) can be depreciated over 39 years. With cost segregation, some components depreciate over 5, 7, or 15 years instead — accelerating the deduction. The tax savings depend on the owner's marginal tax rate.

Tax savings: interest deduction The mortgage interest is deductible against business income, just like rent.

Equity build-up The principal portion of each mortgage payment increases equity in the building. It's not a cash benefit until you sell, but it's a real wealth event. Track it as an offset to the cost.

Appreciation The building's value over time. Conservative assumption: 2-3% per year. Aggressive: 4-5%. Like equity build-up, only realized at sale.

The "rent equivalent" of owning

Here's a useful intuition. Take all the cash costs of owning (mortgage P&I + taxes + insurance + maintenance + reserves), subtract the tax benefits, and divide by the building square footage. That's your rent-equivalent cost of owning.

If the rent-equivalent cost of owning is less than what you'd pay to lease comparable space, owning is cheaper on a per-year basis.

Example. A $1.5M building, 10,000 SF, with SBA 504 financing:

• Mortgage P&I: $90,000/year
• Property taxes: $18,000
• Insurance: $6,000
• Repairs/reserves: $7,500
• Management: $0 (owner-user)
• Subtotal: $121,500
• Tax savings (depreciation + interest): −$25,000
• Net cost: $96,500

Per square foot: $96,500 / 10,000 = $9.65/SF

Comparable lease space in the same area: $14/SF NNN + $3/SF op ex = $17/SF.

The rent-equivalent of owning ($9.65/SF) is dramatically lower than leasing ($17/SF). Owning saves $7.35/SF/year × 10,000 SF = $73,500/year vs. leasing.

That's the headline number. Over 10 years, that's $735,000 of savings — before counting equity buildup or appreciation.

This is why owner-user deals work financially when the math is run honestly.

When the math doesn't work

Owning isn't always cheaper. The math fails when:

• The purchase price is at the top of the market (cap rates compressed)
• The interest rate is high relative to local rents
• The building requires substantial capex you weren't expecting
• The business outgrows the building in 5 years and has to sell at a loss
• The building's location declines (path of growth moved away)

The framework will tell you when owning doesn't pencil. The key is running the framework honestly with realistic numbers — not optimistic ones.

What goes WRONG in most informal analyses

When business owners try to compare lease vs. own on the back of a napkin, they make these mistakes:

Mistake 1: They forget property taxes will reset at acquisition

The seller's tax bill is irrelevant. Always model your tax bill at the new assessed value.

Mistake 2: They forget the down payment opportunity cost

"My monthly payment is less than rent, so owning is cheaper" — but they didn't account for the $200K of capital they put down.

Mistake 3: They include appreciation but not depreciation reserves

Owners count the upside of the building going up in value. They forget to budget for the roof failing in year 8.

Mistake 4: They use pre-tax numbers

Tax effects are massive and asymmetric. Always run the comparison after-tax (Lesson 5).

Mistake 5: They use a 1-year horizon

Year 1 always favors leasing (no down payment). The owning advantage shows up over time.

Mistake 6: They forget closing costs

2-4% of the purchase price for closing costs (loan fees, title, attorney, environmental, appraisal, etc.) is real money the model has to capture.

What to take away

• The cost stacks are different: leasing is mostly cash out; owning has cash + tax + equity components
• 10-year horizon is the right comparison window
• Always discount to present value using the business's cost of capital
• Opportunity cost of the down payment is the most-debated number — talk to the client about it
• "Rent equivalent of owning" is a useful intuition for the per-SF comparison
• Most informal analyses make 4+ of the listed mistakes

Next lesson: SBA 504 financing — the special-purpose loan that makes owner-user deals work, and the single biggest reason small business buyers can compete with cash investors.