Lease -vs- Buy

I promised to write a post dealing with a question that comes up from time-to-time in corporate real estate practice – whether to lease or buy property.  Over the years I’ve heard many different “theories”, most of which are simply opinions that do not benefit from the support of either a rational methodology or a sufficient number of pertinent facts.  Which is how a lot of bad real estate decisions tend to get made.

There are two types of factors that a business needs to consider in a lease-versus-buy decision.  The first are quantitative criteria – chief among them metrics that relate to the company’s internal rate of return from core operations.  The second are qualitative criteria – things like the importance of highway visibility or the weight that should be given to LEED ratings.

Once identified and calculated, these metrics can be plotted into a decision matrix that will inform your decision:

In many instances, the answer will likely be to lease.  The core return that most businesses realize will generally exceed the return that can be generated through the ownership of real property.  In some instances, however, the returns from property ownership – when coupled with other strategic business criteria – will indicate that ownership is the most favorable choice.

All of this said, there are a number of common mistakes made when making a lease-or-buy real estate decision.  One is to significantly overestimate the rate of appreciation or end value of the property.  As we’ve seen most recently, property values do not always move upward.  Another is to underestimate the need for ongoing capital contributions over the period of ownership – and, as importantly, to make budgetary provisions for capital reserves to cover the replacement of roofs, mechanical systems, parking lots, and other property components.

The important thing to realize is that there are many factors – and many implications – to consider.  Shifting capital from high yield core operations to low yield – and illiquid – real estate can markedly impact earnings and retard growth.  Other parameters – like the efficiency of the local real estate market and the availability of tax and financing incentives – might create a strong argument for ownership.

It’s essential to carefully consider all of the factors in a rational and objective context.