The death fallacy

Have you ever heard this from someone bit by the land-leasing bug? “In 55 years I’ll be dead anyway, so who cares if I don’t actually own the land?”

Unfortunately, the tyranny of finance reaches even beyond the grave, and the financial aspects of a lease vs. an outright purchase are a lot more than meets the eye at first glance.

Let’s say you’re considering leasing land on which to build your castle in paradise, on a 55 year lease. If you’re going to consider the financial aspects of the deal, then you’ll need to pick some point in the future for your time horizon on which you’ll pin your expectation for what your asset will be worth. In this case, the asset is the lease and the home. And in this case we’ll consider a 10 year time horizon.

The issue, then, is what you think somebody in 10 years will be willing to pay for this asset of yours–a home on the leased land. We’ll say this “somebody,” your theoretical buyer, is Mr. A.

In 10 years, when you’re trying to unload your lease on Mr. A, assume that he also has a 10 year horizon. Mr. A–in order to place a value on the lease–will want to know what Mr. B will be willing to pay in 10 years from 2009. Extending this into the future, we’ve got–who else?– Mr. C in the year 2029, who bases his value of the asset on what he thinks Mr. D will pay in 2039.

And along comes Mr. E. Mr. E, in the year 2049, will only have five years remaining on the lease. How much is he going to be willing to pay? Not much. In a scant 60 months the whole enchilada will be worth nada to him.

If we work the problem backwards, taking this chain of valuation from Mr. E back to today’s lessor, we’ll find that a lease on the land is far different than ownership. At each step in the backwards chain of valuation, the diminishing value of the lease–and its ultimate value of zero– will be taken into account. The chain is profoundly indifferent to your mortality (sorry, sport).

In sum, you can’t hide from the fact that the lease becomes less and less valuable every day (on its own merits, at least, leaving aside substantial moves in real estate or rental price levels). Like all other assets, a lease’s current value is directly linked (along with other factors) to its expected value in the future.

Along with a lease comes a degree of risk. If you’re a mere renter of a house or apartment, you’re not exposed to any risk of property values falling. And, with the CNMI’s thin job market, you’d be able to join the suitcase squad and head for greener pastures if necessary. By contrast, with a long term lease and the money you’d pour into home construction, liquidating things here would become a far stickier proposition.

Of course, building a house might be the only way for some folks to live the way they want to live. It’s a lifestyle gig. But it’s also a sticky financial gig, and the “death fallacy” can blind side the unsuspecting. A lease is not the same financial animal as a purchase. If, like most of us, you have to be careful with your money, you’ll want to carefully evaluate any leasing deal that crosses your desk.