Own or lease? How do you choose?

By Martin Trundle, Director - Corporate Consulting
T: +44 (0) 20 7544 4299 or E: mtrundle@nbrealestate.co.uk 

On the face of it, buying can be an attractive proposition. If you can buy at the bottom of the market, it may be a very shrewd investment. With a few notable exceptions, there’s not much point investing for growth right now, so if you can make the business case work, maybe it’s the right time to buy.

Once you own the property, you can make your own decisions about how you use the premises, and any improvements you make will add to the value of your investment. You will have fixed costs, security of tenure and flexibility in how you use the premises. Then, when the market recovers and you need to release capital to fund investment in your business, you can go for the sale and leaseback option assuming the long term occupancy need is still there. In fact, occupiers who run a tight ship may be able to afford ownership allowing them to make tactical decisions to raise capital on a counter cyclical basis; thereby adding real value to the bottom line.

Fanciful? Maybe, but this is just one scenario and there is no open and shut case for purchase. It’s all about getting the maximum value from your Corporate Real Estate (CRE) and value can be a difficult thing to define. As the saying goes "it depends", but what exactly does it depend on, and are there any hard and fast rules to help you make your decision?

Who’s doing what?
It’s probably worth looking at a few examples to see how different companies are tackling this issue.

Let’s take the case of a UK plc. They own a unique facility. To date it has served its purpose, but given its very specific use, together with the advancement of technology, the facility needs upgrading. The existing site is too small, the cost of building a new facility is too large and the business is used to the benefits of ownership – but cash is tight.

So is there a solution? Well even though that is yet to be determined, the company has decided to take advantage of the current reduction in build costs. A site has been identified and a range of finance partners approached. This will not be a straightforward transaction – as the specialist nature of the property makes it a challenge to fund – and affordability versus necessity need to be balanced. There are many potential deal breakers, but in their case, a form of ownership is likely to be the preferred option and – with the help of NB Real Estate – they are progressing the deal.

Then there is the case of another large UK plc, with a substantial owner occupied portfolio. They operate in an industry where the major players own strategic sites as a way of exercising some control over their future expansion activities and – through shrewd choice of development sites – those of their competitors. This company has ambitious growth plans but needs cash to deliver them. So it makes sense for them to release cash through a series of sale and leasebacks in addition to raising funds from the capital markets. In this case it is all about the underlying cost of the finance as the long term need will remain. For them leasing back some of the portfolio to raise finance is a prudent option.

One other topical scenario is self build. In the USA some firms acquire land, build and retain ownership – the benefit is they keep all the developer’s profit and can recycle the capital at a later date to finance future growth. Alternatively, for UK occupiers faced with a significant requirement in the UK in a regional location, devoid of speculative development, the only option may be to buy land, build out and deal with ownership in the short term. For them leasing can still be an option for the future, but only after a considerable investment in time and associated development risk. In this situation, the occupier has to take on the role of an entrepreneur and quasi developer.

Alignment with the business
These three scenarios are all current and each has a different outcome. They may appear diverse examples, but there is a strong common theme at play here. Each decision – buy, lease or self build – has been taken in response to a specific business objective. There is a very close correlation between the management of the CRE and the strategic goals and objectives of the business.

It is true to say that the strong alignment of the property management function with the business needs is the key common factor at work here. Each company had set a clear strategy and the property management team are responding and executing in line with that strategy. That is not to say that the business strategy is necessarily the trigger for the cycle of events. Often it is specific tactical events, such as lease renewal or a break option, or signs of landlord distress that start the ball rolling. The smart property manager has one eye on the market conditions and the other on his company’s business objectives, and combines these "events" to create opportunities for the business.

Making the case
But it's not just about keeping a weather eye open to spot opportunities. There are some fundamental principles which can help guide the "buy/lease" decision making process. Take a look at the economics at work here: To create value, the return on investment in the property needs to higher than the cost of capital. And right now the relatively high cost of capital can be the major factor in the decision to buy or lease. Additionally, when a company is buying property in order to grow earnings from the business, it may not be immediately apparent whether the returns will exceed the funding cost. It is a calculated risk.

If you underestimate the true cost of capital, you could end up losing money and destroying shareholder value, whereas an overestimation could mean a wasted opportunity. This is not a trivial decision; the business case needs to stack up and in the present uncertain economic climate, some of the required data may be speculative. This is a judgement call requiring experience and a degree of expertise. However, the benefits of making the right decision may be very significant.

There are of course several other key factors at play when making your decision:

• The tax benefits of ownership
• The impact on cash flow
• Whether the property is off or on balance sheet – and the relative impact on the perceived performance of your business
• The freedom & flexibility of life without the constraints of the lease
• The management overhead and additional time of looking after the property
• Residual values and associated property risk over time and at exit
• The opportunity cost of capital tied up in property
• The availability of debt and land equity to finance any purchase

Clearly, a decision to buy in the current economy will require a robust business case that will stand up to rigorous examination by your FD/CFO. 

Summary
In summary, today's trading conditions have created another dimension in the buy/lease debate. There are opportunities to buy borne out of the reduction in property prices and pressure on some landlords to sell. However, the decision cannot be made in isolation and must be based on the corporate objectives of your business. The impact of any decision is likely to be significant and beneficial, but the risk element must be offset by sound judgement and expertise. Any decision must be accompanied by a robust and comprehensive business case.

NB Real Estate can help by providing the advice and guidance you need to help you with your decision making process. And we can provide practical help regarding the availability of the freehold, access to suitable financing, testing the market response and managing the entire project through to conclusion.

If you are in the process of assessing your options in this area, I'd be delighted to hear from you with a view to providing you with an experienced opinion and as much assistance as you would like. Why not give me a call. I'm Martin Trundle, Director - Corporate Consulting, and you can reach me on +44 (0) 20 7544 4299 or email me at mtrundle@nbrealestate.co.uk.