Lecture 15: Corporate Lease vs. Own Analysis I Flashcards
Why do corporations own real estate?
- necessary for ?
- ? from core business
- retain property from previous operations
- acquire real estate for further ? and ?
etc.
Why do corporations own real estate?
- necessary for operations
- diversification from core business
- retain property from previous operations
- acquire real estate for further expansion and relocation
etc.
Pros of ownership:
- Save on ? payments
- Tax benefits from ? allowances
- Property value ? and sale
- Can ?? the property (from the new owner after sale) if the space is still needed i.e., ‘Sale-leaseback’ procedure!
Pros of ownership:
- Save on lease payments
- Tax benefits from depreciation allowances
- Property value appreciation and sale
- Can lease back the property (from the new owner after sale) if the space is still needed i.e., ‘Sale-leaseback’ procedure!
Cons of corporate real estate ownership:
- ? cost of capital
- impact on ??
- (in)ability to use space efficiently
Cons of corporate real estate ownership:
- opportunity cost of capital
- impact on financial statements
- (in)ability to use space efficiently
Lease vs Own analysis (1):
- Owning:
+ It is essentially “investing” in real estate!
+ Financed by: ?, ?, and/or ?
+ benefit from ??
Lease vs Own analysis (1):
- Owning:
+ It is essentially “investing” in real estate!
+ Financed by: mortgage, equity, and/or debt
+ benefit from value appreciation
Lease vs Own analysis (2): - Leasing: \+ No ? investment in the property \+ Free the capital for other ?? \+ Regular (and sometime expensive!!) lease ?
Lease vs Own analysis (2):
- Leasing:
+ No equity investment in the property
+ Free the capital for other investment opportunities
+ Regular (and sometime expensive!!) lease payments
Lease vs Own analysis (3):
To determine whether owning or leasing is better, conduct a ‘Lease-vs-Own’ analysis:
Step 1) Compute cashflow difference at time 0
S2) Compute annual operating cashflow difference
S3) Compute residual cashflow difference
Owning gives a residual value when the property is sold.
There is no residual value when leasing.
S4) Compute IRR of each option
Required rate of return should probably be higher than the after-tax cost of corporate debt. => ownership!
Lease vs Own analysis (3):
To determine whether owning or leasing is better, conduct a ‘Lease-vs-Own’ analysis:
Step 1) Compute cashflow difference at time 0
S2) Compute annual operating cashflow difference
S3) Compute residual cashflow difference
Owning gives a residual value when the property is sold.
There is no residual value when leasing.
S4) Compute IRR of each option (Use Excel to calculate IRR)
Required rate of return should probably be higher than the after-tax cost of corporate debt. => ownership!
Lease vs Own analysis (4):
Importance of Residual Value
Unlike leasing, ownership in the property is an “investment” in the residual value and affects the balance sheet.
What are “expected” residual value?
- Some corporate managers simply assume it is equal to the original acquisition cost minus the depreciations
- Others go to the extreme of assuming that there will be no residual value. (because the company may have to buy another property to continue operation)
Lease vs Own analysis (4):
Importance of Residual Value
Unlike leasing, ownership in the property is an “investment” in the residual value and affects the balance sheet.
What are “expected” residual value?
- Some corporate managers simply assume it is equal to the original acquisition cost minus the depreciations
- Others go to the extreme of assuming that there will be no residual value. (because the company may have to buy another property to continue operation)
Lease vs Own analysis (5):
Other factors to consider:
- Credit rating:
If the company has good credit rating, it’ll be cheaper for them to issue debt rather than financing the purchase with a mortgage.
- Space requirement
If the company needs less space than a normal building size => better to lease
- If company only use the space short-term => better to lease.
Lease vs Own analysis (5):
Other factors to consider:
- Credit rating:
If the company has good credit rating, it’ll be cheaper for them to issue debt rather than financing the purchase with a mortgage.
- Space requirement
If the company needs less space than a normal building size => better to lease
- If company only use the space short-term => better to lease.
Lease vs Own analysis (6):
Other factors to consider:
- Relative risk bearing
Larger firms can bear more risk of property owning (e.g. value fluctuations)
- Management expertise
- need Special purpose buildings => better to own
- 1986 Tax Reform Act => reduce depreciation tax shield => taxes are a less deciding factor.
Lease vs Own analysis (6):
Other factors to consider:
- Relative risk bearing
Larger firms can bear more risk of property owning (e.g. value fluctuations)
- Management expertise
- need Special purpose buildings => better to own
- 1986 Tax Reform Act => reduce depreciation tax shield => taxes are a less deciding factor.
It is estimated that corporate users control as much as ___ percent of all commercial real estate in the United States.
Answers:
A.
10
B.
25
C.
75
D.
100
It is estimated that corporate users control as much as ___ percent of all commercial real estate in the United States.
Answers:
A.
10
B.
25
Correct C.
75
D.
100
For which of the following reasons would a business prefer to own real estate rather than lease it?
Answers:
A.
If the business demands specialized or unique facilities
B.
Owning reduces operating flexibility
C.
The capital commitments with owning are lower than the capital commitments associated with leasing
D.
All of the above are reasons a business would prefer to own space rather than lease it
For which of the following reasons would a business prefer to own real estate rather than lease it?
Answers:
CorrectA.
If the business demands specialized or unique facilities
B.
Owning reduces operating flexibility
C.
The capital commitments with owning are lower than the capital commitments associated with leasing
D.
All of the above are reasons a business would prefer to own space rather than lease it
Which of the following statements is TRUE for a corporation with a high credit rating considering owning versus leasing corporate real estate?
Answers:
A.
The company should probably use a mortgage
B.
The company can probably issue corporate debt at a more favorable rate
C.
The company is probably better off leasing the property from someone with a lower credit rating
D.
The company’s credit rating does not effect the own versus lease decision
Which of the following statements is TRUE for a corporation with a high credit rating considering owning versus leasing corporate real estate?
Answers:
A.
The company should probably use a mortgage
CorrectB.
The company can probably issue corporate debt at a more favorable rate
C.
The company is probably better off leasing the property from someone with a lower credit rating
D.
The company’s credit rating does not effect the own versus lease decision
Which of the following statements is false?
Answers:
A.
For a large corporation with a good credit rating seeking to finance corporate real estate, the cost of a mortgage loan may be greater than the cost of unsecured corporate debt.
B.
Because real estate is shown on the corporation’s books at its historical cost less book depreciation, the value of corporate real estate is often considered “hidden” from shareholders.
C.
The residual value at the end of the holding period should be based on the market value of the real estate and not the book value.
D.
If a company’s space requirements are far less than what is optimal to develop on a given site, owning would tend to be more favorable.
Which of the following statements is false?
Answers:
A.
For a large corporation with a good credit rating seeking to finance corporate real estate, the cost of a mortgage loan may be greater than the cost of unsecured corporate debt.
B.
Because real estate is shown on the corporation’s books at its historical cost less book depreciation, the value of corporate real estate is often considered “hidden” from shareholders.
C.
The residual value at the end of the holding period should be based on the market value of the real estate and not the book value.
CorrectD.
If a company’s space requirements are far less than what is optimal to develop on a given site, owning would tend to be more favorable.
Which of the following factors does NOT represent an effect of corporate real estate ownership on corporate financial statements?
Answers:
A.
The unrealized source of potential gain from the sale of property is not represented on annual income statements
B.
Income represented on accounting statements may underestimate the actual cash flows provided by property
C.
The book value of property on the balance sheet may not represent the actual market value
D.
The corporation’s overall debt ratio may be reduced, and property is carried at book value but financed at market value
Which of the following factors does NOT represent an effect of corporate real estate ownership on corporate financial statements?
Answers:
A.
The unrealized source of potential gain from the sale of property is not represented on annual income statements
B.
Income represented on accounting statements may underestimate the actual cash flows provided by property
C.
The book value of property on the balance sheet may not represent the actual market value
CorrectD.
The corporation’s overall debt ratio may be reduced, and property is carried at book value but financed at market value
