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Companies ditching renting to buy buildings

Chris Lewis, Director, Deloitte U.K.
Wednesday, September 25, 2013

For decades, renting office space has been the norm for companies in the world’s major cities. Recently, though, some businesses have opted to buy buildings instead to cut what is often their second-highest outgoing expense: rent.

Here, Chris Lewis, a director at Deloitte U.K., discusses what’s behind this trend, whether it’s just a fad, and the pros and cons of ditching renting for buying.

After decades of renting being the norm, companies with offices in the world’s major cities are starting to favour buying property instead. What’s behind this move?

Many companies have responded to the difficult trading conditions over recent years by preserving their cash, waiting for the next big struggle or opportunity to occur. As a result, there has been large accumulations of cash on corporate balance sheets with little prospect of immediate release. This process has often been inflated by aggressive cost reduction programs throughout organizations. After people and technology, real estate has generally been a stand out tier one cost item, with lease commitments holding companies to big future spends. The availability of property to purchase has provided an opportunity to crystallize this cost. Linked to that is the opportunity to take control of how space works, the way it looks and what it provides. All of this provides for greater operational flexibility and can add to the positive talent story. The final piece of the puzzle is the low cost of capital that many companies with healthy balance sheets are able to call on. This puts them in very strong positions as buyers in the market.

The attractiveness of purchasing has a direct link to the opportunity to exit. When times dictate that it is right to reinvest in business growth, the options to dispose of an asset will be relatively broad, particularly if a company retains a long (10-year or more) lease on the property. At this point, the company is entering sale and leaseback territory and it is able to make the most of its covenant for the benefit of its changing balance sheet.

Is this idea of ditching renting for buying just a fad or does it actually have traction? If the latter, what factors will strengthen the case for ownership in the years to come?

Ownership of property is generally a hedge against a company’s regular activity. Whilst there are examples of owners in the cohort, there will generally come a point when it is felt that capital is better employed in allowing investment in the business rather than property. Companies are occupiers’ first, owners second. The case for ownership will only ever really stack up when there are difficult economic conditions, which lead to cash preservation, or a deal “too good to be true” presents itself. In almost all situations, property will be divested from at some point in time.

There are, of course, examples of where property is owned for a very good reason such as for a pension fund or as part of a specialist operation (for example, manufacturing); however, these remain the exception rather than the rule.

Purchasing property is not an option for all companies. Which types of companies are best in a position to buy?

Companies that retain the ability to control their own destiny are most likely to consider ownership of property. This can be a private company with little third party input or control over investment decisions, or a big corporation with strong management teams. The key criteria are the ability of the management team to be able to invest and divest without fuss or fury. This is one of the reasons partnerships can find property investment a difficult route to follow. Property investment should only ever be considered as a mechanism to employ capital for a company at a point in time. There should be a sound rationale for buying (for example, buying out a lease or undertaking a bespoke development) and a clear understanding of how to exit (for example, a five-year plan).

What are the benefits of buying property? And what are the potential drawbacks?

The pros are relatively obvious for most parties. Ownership allows a company to take control of its real estate, determine how it uses it and what a future development might look like. It gives itself the power to control its premises strategy and the opportunity to divest of an asset (and, therefore, receive cash) and, instead, invest in its core business activities.

There are, of course, potential pitfalls that can beset a company as an owner. The first is the market. By entering the owning sphere, a company is inadvertently becoming a “player” in the real estate market. The liquidity of its owned asset will be variable and certainly subject to the nuances of market conditions. This can be unsettling and even embarrassing. For example, if an asset is sold for less than it was bought, what might the implications be for the leadership team? Clearly, each case will have its own story but it is something for consideration. The other implication is that a company becomes a landlord, either to itself or to other parties if surplus space is leased out. For most, this is an unwelcome administrative side effect of owning.

The critical thing is for companies to look at property for what it is: A facilitator for business activities, client engagement, talent attraction and differentiation. At times, it can also serve as a safe haven for cash or an opportunity to liquidate. Whatever the reason, one thing is certain: Companies will continue to trade in and trade out of real estate for some time to come.

Chris Lewis is a director at Deloitte U.K. He leads the occupier advisory team and has a special focus on technology, media and telecommunications (TMT) practices and private clients.

One thought on “Companies ditching renting to buy buildings

  1. Loved your article on renting versus buying. In 1970, we started a business and rented for 5 years. With excess capital we decided to purchase our own building. Ten years later we purchased another buildiing and moved to this new building. In 2011, we sold our first purchase at a profit and used the proceeds to build a brand new building. We moved into this new modern building a couple of months ago, and we still have the second purchase that we rent out to others. We are a player in the real estate market. It has been a good ride so far.

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