Economic Factors: Buy or Lease?

First the good news-the economy’s rate of decline in the first quarter of 2009 slowed a bit from the fourth quarter of 2008 (6.1 percent vs. 6.3 percent) and dramatic reductions in price points for big-ticket items such as cars, appliances and furniture bolstered consumer confidence by around 9 percent. The stage is now set, we hope, for a bounce-back fueled by renewed optimism, despite the fact that the construction market remains soft in a number of critical areas. (The housing index continues to decline, for example, but it has declined at a diminishing rate, and housing is usually slower to bounce back after a recession.)In this atmosphere, we’ve seen some interesting innovations. The opportunity to purchase with extended credit and guaranteed buy-backs-witness the Hyundai and General Motors deals in the consumer markets-have allowed consumers to lower their risk. Buyers are demanding unique promotions and financing deals, and new sales approaches are required to move consumers to purchase, even with products that are traditionally high-demand. Successful retailers are finding that the right kinds of deals still stimulate interest, and those deals are bringing consumers to the table-albeit not at a satisfying rate.

On the international front, Federal Chairman Ben Bernanke has continued to promote hope in the world markets that the recession will be winding down by the close of 2009 as a result of improvements in consumer spending.

While consumer confidence has been damaged by the economic downturn, new and unique approaches to purchases and leasing are helping spur modest signs of recovery. However, companies that insist on running their businesses as usual-relying on layoffs and cost-cutting measures, instead of seeking new approaches-are going to have a harder time rebounding.

Leasing Advantage

What does all this mean for the construction market? For starters, the old adage that “cash is king” has never been truer. Companies are always balancing the need to acquire assets with the need to maintain sufficient cash reserve levels, but when the market tightens, as in recent months, the instinctive reaction is to hoard cash, even if it means postponing other critical initiatives.

Lessors can help tip that balance back in their favor. If a leasing agreement provides a construction business with flexible terms and the opportunity to trade that lease for new and improved equipment down the road, the higher overall cost of leasing versus buying nearly disappears. Business owners can now upgrade equipment without unduly endangering their cash flow.

Operational flexibility is also key. Since the construction market is expected to remain in a state of flux for some time, it behooves businesses and their executives to be adaptive. Companies that have been successful in markets that are now suffering, for example, may need to consider shifting to more profitable areas of the economy. This is especially true given the Obama administration’s intent to invest in infrastructure initiatives. Companies that have been in the home building industry might find more productive going in road construction, for instance. Homebuilding and highway construction require different equipment, though, so companies looking at leasing vs. buying will need to consider strategies that best enable the transition and position them for the long term.

These businesses should be exploring new and improved leasing options that help their customers quickly and powerfully react to the changing economy. The automobile industry, oddly enough, provides a helpful example. Automotive companies have developed compelling new strategies for attracting and serving customers. It’s true that they have resisted change in the past and are partly to blame for their own predicament, but there’s no denying the inventiveness of the previously mentioned Hyundai Assurance Program. According to The New York Times, the unprecedented “walkaway” program helped the company nearly double its market share in January, with sales jumping 14 percent.

Advantages to Buying

Some companies do have cash, although in this economy they’re the exception rather than the rule. If you’re one of these businesses and have longer range plans that could be affected by extending credit, then buying may be a better answer for you. As always, careful business planning and evaluation is essential, and now this requires closer-than-usual attention to the variables. On the one hand, for instance, caution counsels a strong cash position. On the other, down markets often represent an opportunity for smart companies with strong visions to outplay their competition. Another concern-from what assumptions are you working? If you assume, for example, that inflation will remain steady, then that favors maintaining cash-on-hand. But if the Federal Reserve chooses to inflate the economy, then cash begins losing value, and you’d be better off owning assets that retain their value.

If you’ve been a successful business historically, then there may be some wisdom to the old adage that you “dance with who brung you,” and this is especially true if you’ve succeeded by out-innovating your competitors. Make sure your planning accounts for both short- and long-term scenarios, though. Your overall asset management strategy must weigh a variety of risks, but in the end you have to play to win. Innovate, yes, but do so with the same spirit that led to your success in the first place.

Tax Incentives

Currently there are tax incentives that help companies purchasing new business assets. Bonus depreciation (IRC Section 168(k)) and IRS Form 4562 on qualifying new property in the 2008 Economic Stimulus Act were extended through December of 2009. Section 179 has been extended through December of 2009, as well. In addition, Senators Max Baucus and Olympia Snowe have introduced a bill (S823) that would extend net operating loss carryback for five years (essentially restoring the provisions contained in the original version of the American Recovery and Reinvestment Act of 2009), and if this passes into law, construction and equipment companies will have a significant new tool in hand for retaining and managing their cash.

Many states also have tax incentives, exemptions, grants and credits for companies making steps toward greening their equipment fleets and operational processes. Going green is not only a positive step for the environment, it has become an operational reality for businesses everywhere and when all the incentives and cost savings are added up, it begins to make better and better business sense.

Additionally, 1031 Exchanges, which have been around since 1921, provide significant relief for companies facing “bonus depreciation hangover”-the point where the deferred gain must be recognized. Also known as “like-kind exchanges,” 1031 Exchanges allow deferral of tax gain recognized on the sale of capitalized assets when the proceeds (which can be in excess of 40 percent of the sale price, depending on tax rates in your area) are then reinvested in replacement property. And companies looking to refocus their efforts into areas that require different equipment sets, as noted above, can make productive use of “reverse exchanges,” which allow you to acquire replacement property prior to selling your current property, thereby you transition your fleet without having to shut down operations while equipment is swapped out.

We’re currently in the “mother” of all buyers’ markets, and while companies are trying to innovate new and better ways of earning your business, there’s no rule that says the buyer can’t drive the innovation. If you’d like to buy or lease, and the dealers and manufacturers you’re talking to aren’t offering the kinds of deals that you need, feel free to suggest the program you want to them. If they’re genuinely interested in your business-and they probably are-they’ll find a way to work with you. And if your idea is good enough, they may make it part of their regular suite of offerings.

Construction Business Owner, June 2009