Lease rates are obviously a primary driver of lease performance, but the contract terms of the lease agreement are often what actually makes or breaks the lease's performance. Yet, all too frequently, lessees make easily avoidable lease agreement mistakes that can dramatically escalate their lease cost.
1. Failing to maintain leverage at end of lease.
Lessors will naturally seek to retain leverage over return rights in the lease agreement. Lessees place themselves at considerable risk if they give away this leverage.
Return policies should include a structure that gives lessees the option at the end of the lease to renew the lease at a capped reduced amount or purchase the equipment at a well defined fair market value. Businesses should avoid leases where the only options are return or renewal with no fair market valuation.
The option for capped renewal or buy at fair market value prevents the lessor from having all the leverage at end of lease. Businesses that give away their leverage can find themselves in a crisis situation if they still need the equipment when the lease expires.
2. Signing contracts that aren’t transparent.
End-of-lease risk can be mitigated by insisting on contract transparency. Businesses should develop a comprehensive list of pertinent lease details, including items such as up front or end of lease fees or charges, end-of-lease options, and return conditions. All of the options—and all of the obligations of both the lessee or lessor—should be explicitly stated. Otherwise, a lessee may be in for a shock at lease’s end.
For each pertinent detail not included or adequately specified in the lease documentation, an element of risk is added. At the end of lease, these items can be difficult to determine and establish if they’re not clear in the lease agreement. A business may find that what they expect isn’t what they’re getting.
3. Failure to perform a financial lease analysis.
A lease vs. buy analysis is important, but there’s more to a complete financial lease analysis. Businesses need to measure the total economic transfer between the lessor and lessee. They need to determine the “all-in” costs of leasing, including interim rent, extensions, buyout costs, and any other costs in addition to the basic rent.
Making Lease Decisions
Once the total cost of a lease is understood, all necessary contract details are finalized, and end-of-lease options are secured, a lessee can be relatively confident that it’s entering into a lease in which risk has been minimized. But for many businesses, this lease management is beyond what internal resources can handle. Realizing the bottom-line importance of lease agreements, many businesses turn to leasing specialists to assist with lease agreement review, risk rating, and financial lease analysis, as well as the development of leasing strategy.
