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Rail News Home Mechanical

February 2007



Rail News: Mechanical

Lease or buy? For fleet managers, the answer might be less than obvious



 
Toby Kolstad
If railroads start to buy cars
instead of leasing them or
encouraging their shipper or
short-line connections to do so,
lessors’ growth prospects will
diminish right along with the
market for their existing cars.
For the past 30 years, most railroads have answered the “buy or lease new rail cars” question by leasing cars. Some might argue that it was a moot question, considering railroads did not have sufficient capital or borrowing authority to buy cars.

If they opted to lease based on economic factors, they made a wise choice. That choice enabled a small group of leasing companies that owned less than 20 percent of the national fleet to grow into a major industry that now controls more than 80 percent of all U.S. rail cars. But the question of whether to lease or buy is once again under review, and the answer may not be as obvious.

Winds of change
Hindsight is always 20/20, and it’s doubtful anyone in 1975 could have foreseen that interest rates would peak in 1982 and then begin a 25-year decline — or that rail-car surpluses would be more common than shortages.

Fleet managers who bought cars between 1975 and 1985 soon discovered their car ownership costs were higher than costs incurred by managers who had leased the same type of equipment in short-term operating arrangements.

The same could be said for almost any period until just a few years ago, when long-term interest rates began to level out. Between 1981 and 2005, interest rates fell 70 percent, offsetting the 70 percent increase in new car prices. Between 1980 and 2005, short-term net lease rates on new equipment were relatively constant, generally around $450 per car per month for an average car.

For the next 30 years, economic conditions will be different — and leasing may not be such a clear-cut choice.

At best, interest rates will remain constant, but probably rise a little above today’s exceptionally low rates. Car prices will also rise in the coming years. Historically, prices have increased 1.75 percent per year, although prices have tended to stay flat for a while and then jump rather than increase gradually.

Lease rates to rise
When you combine flat or increasing interest rates with increasing car prices, the inevitable result is higher lease rates. By 2020, short-term operating lease rates could average $700 to $900 per month for the average car. At some point, fleet managers may have a different perspective on the “lease or buy” issue, and that could have profound implications for the leasing industry.

Lessors will be greatly affected if there are any changes in the current fleet ownership arrangement. If railroads start to buy cars instead of leasing them or encouraging their shipper or short-line connections to do so, lessors’ growth prospects will diminish right along with the market for their existing cars. But railroads have not started buying cars yet.

Not just one solution
Although railroad fleet managers have said repeatedly that they want to own a core fleet that would enable them to meet shippers’ needs, they have seldom acted on these statements. Comparatively few of the 900,500 freight cars built between 1981 and 2005 are registered in UMLER with railroad ownership marks.

Moreover, except for a multi-year purchasing program BNSF Railway Co. launched a year ago that could amount to more than 21,000 cars, no other U.S. railroad has signaled any intent to replace their existing core fleets in the next few years. Even many of the new BNSF cars eventually may be financed and leased by operating lessors.

Leasing companies might try to make operating lease rates commensurate with financial lease rates, but this would be risky. It has worked for some companies and for some special car types, but it has not been a common industry practice.

In short: There’ll be no one-size-fits-all solution for every railroad or car type during the next three decades. The importance of risk assessment and asset management will only increase as the investment decisions become more costly.

Toby Kolstad has been in the railroad industry for more than 30 years, with stints at Illinois Central Gulf Railroad, Denver & Rio Grande Western Railroad, a car builder and lessor. Currently a consultant on rail-car matters and president of Rail Theory Forecasts L.L.C.



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