Leasing commercial equipment is often the most cost-efficient equipment procurement method for enterprises. But commercial equipment lease agreements are complex documents—full of terms which generate material risks that enterprises that lack experience in commercial equipment leasing often accept.
The risks are plentiful, but when reviewing lease agreements, an enterprise can begin by paying close attention to these five common leasing pitfalls.
1. Failing to do a lease vs. buy analysis.
Before entering into any lease, an enterprise should first determine whether leasing is indeed less expensive than purchasing or other forms of debt. To make this determination, it’s necessary to analyze past leasing costs—all costs, not just the rent payments. Most leases contain a substantial amount of risk, and the historical financial impact of these risks must be integrated into the lease vs. buy analysis.
This analysis is a detailed, specialized process, but once it’s done, an enterprise can project future costs for each element of risk—thereby enabling a valid comparison of lease vs. buy. It may very well be that leasing isn’t the best option.
2. Ignoring non-rent costs.
Identifying and quantifying non-rent costs isn’t just a matter of setting a baseline for cost-estimating purposes. Once non-rent costs are understood, they can be negotiated out of lease agreements, or at the very least, compensated for in price negotiations.
Typical non-rent costs include:
- Interim rent (charged for the period between equipment acceptance and the lease’s official commencement).
- Recurring fees (service, usage, restocking, documentation, etc.).
- End-of-lease costs (buyout, transition costs, lease extensions, etc.).
3. Agreeing to terms that make non-compliance likely.
An insidious risk in many commercial lease agreements is language that makes it virtually impossible for the lessee to meet notice and return requirements. The lease agreement might stipulate extremely onerous conditions for compliance (e.g., recurring notices for routine events; manufacturer-inspected and packaged returns), and if the lessee fails to meet those, then it is faced with penalties, loss of negotiating leverage, and possibly even default.
4. Giving away end-of-lease leverage.
Lessee non-compliance is just one way that lessors gain leverage at the end of the lease. Another is by maintaining control over the asset valuation at the end of the lease.
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If equipment return isn’t feasible for the lessee, then it’s faced with either extending the lease or buying the equipment, an option that is often allowed for “fair market value.” But if the lessee wasn’t careful in its lease negotiations, the lessor probably essentially retained the power to name the price, using concepts such as “in-place” value to escalate the contract fair market value far above actual market value. This can leave the lessee with little recourse but to extend the lease, adding to total equipment cost.
Even if the lessee negotiates “mutual agreement” for FMV, the lessor still has leverage because full rent almost continues during negotiations.
5. Assuming a well-negotiated master lease controls risk.
A crucial point for lessees to grasp is that the language in lease schedules trumps the language in the master lease. Diligence to reducing risk in the master lease agreement isn’t sufficient; continued evaluation of each lease schedule is imperative.
Conclusion
Commercial equipment leases should not be entered into without an in-depth understanding of the many pitfalls that can occur. Being able to identify and quantify the costs of these pitfalls will enable an enterprise to negotiate less risk, minimize risk during operations, and more-reliably forecast leasing costs to make wise decisions.
