For many enterprises, leasing is an attractive option for procuring necessary commercial equipment. When comparing a lease vs purchase, leasing can be enticing because it offers the potential for some substantial benefits, including:
- Lower total cost for the equipment.
- Avoidance of the risk of technical obsolescence (a particularly acute risk with fast-changing information technology equipment).
- Favorable accounting treatment (operating leases are kept off the balance sheet, positively impacting key financial ratios such as return on assets).
But the benefits of equipment leasing can only be achieved if the lessee negotiates lease agreements with appropriate rates and terms.
The Risks of Leasing
Obviously, businesses looking for the best equipment procurement option will be concerned with rates—and stated rental rates for many leases (Lease Rate Factors) are lower than the stated rates for other procurement alternatives. However, "the lower the rate, the higher the risk" is an axiom that certainly holds true in commercial equipment procurement.
Lower lease rates do not necessarily—and very often don’t—translate into lower “all-in” cost for the equipment.
Commercial loans and higher-rate, bargain-buyout “rent to own” capital leases usually have higher periodic rates than high-risk operating leases, but when making a decision about lease vs purchase, it’s short-sighted not to also account for the risk that’s inherent in the terms of most operating leases.
These risks include:
- Interim rent.
- Onerous notice requirements.
- Unreasonable casualty rates.
- Default provisions that make default likely.
- Return conditions that are almost impossible to comply with.
- Ambiguous definition of fair market value for the purchase option at end of lease.
The low rental rate may look great upfront, but there’s usually a cost for that low rate—the assumption of substantial risk.
Getting the Best Value
To get the best rate and terms, it’s first necessary to identify all the risks associated with equipment leasing and then analyze past leases to determine the historical cost of each risk. With this information, a business comparing lease vs purchase can put an accurate cost on the leasing option based on actual past performance, rather than relying on overly optimistic presumptions about the ability to mitigate risk in operations (e.g., assuming equipment will be ready, or able, to be returned at end of lease).
Until the historical costs of leasing are understood, an astute choice about lease vs purchase simply isn’t possible.
Knowing historical leasing costs also gives a lessee much needed leverage in negotiations. If risk can be quantified, then pressure can be put on the lessor to remove the risky language from the lease agreement or to adjust rates accordingly to compensate for the risk.
Knowledge of Leasing Agreement Language Is Essential
It’s a given that equipment leasing companies are intimately familiar with the terms in lease agreements that add risk to lessees and so increase lessor profitability. In many cases, their business models are largely predicated on the failure of lessees to cap their risk in lease agreements.
Many potential lessees, on the other hand, don’t have sufficient knowledge of how equipment lease agreements are structured. Even lawyers aren’t usually able to identify the full scope of the business risk if equipment leasing isn’t one of their specialties.
For this reason, it’s often a cost-saving move to work with equipment leasing experts to ensure the risk in lease agreements is sufficiently accounted for and capped. With this equipment leasing proficiency, businesses can ensure they won’t be at a disadvantage in negotiations, and they will be better able to quantify the total all-in costs involved in the lease vs purchase decision.
