by Bob Rowland, ICX Corporation
Leasing equipment can be cost-effective, or it can be costly. The difference can depend on your knowledge of leasing terms and conditions and, perhaps more importantly, selecting the right leasing company.
Having worked in the leasing industry for nearly 30 years, I have learned some basic rules-of-thumb to ensure the best value when preparing and comparing lease proposals.
Details, timing are critical for cost cutting
Quality is the name of the game. The more time and research you put into developing a request for quotation (RFQ), the more quality quotes you receive. More detailed information can pay off in favorable lease rates and beneficial lessor/lessee relations.
On the other hand, omitted details in your RFQ can translate to vague and conservative residual estimates on your requested equipment, confused comparative lease proposals, and costly mistakes in the lease commencement timetables and lease-end options. To avoid these pitfalls, request clear, “apples-to-apples” quote comparisons.
To get a clear estimate of what you’re going to pay for material handling equipment, start your RFQ by offering a detailed description of the desired equipment. If you need lift trucks, for example, state exactly how many lift trucks, what make and model, and when you will need them. Also important are the estimated annual hours of usage and the environment in which the equipment is to be used — such as indoor, outdoor, in a foundry or a warehouse.
It is surprising how general lessees can be on information that leaves the lessor to guess at the details and be less aggressive in its lease suppositions. The greater the knowledge the leasing company has about the equipment you wish to acquire and its use, the better the position lessors are in assuming an appropriate residual at lease-end, which ultimately reduces overall effective cost. Detailed information can also reduce monthly or quarterly rental payments.
For example, if you can provide prospective lessors a detailed equipment description such as:
10 Hyster Model E120XL2;
15 Yale Model GLP050RFN;
15 Toyota Model 5FD70;
10 Caterpillar Model GC.18;
... they may be willing to take a residual assumption of 30 percent of the equipment’s original cost, but with a very generic equipment description assume only a 20 percent residual. The difference in monthly payments based on $1,000,000 of new handling equipment for a five-year lease would be $1,484.65. Over 60 months, that adds up to a savings of $89,079.
Here’s another important fact. You can save money depending on the time of year you want the equipment delivered. Delivering the equipment later in the year generally offers a lower lease payment, because the lessor receives a more timely receipt of tax benefits.
For example, based on $1,000,000 of equipment for a five-year lease, if the equipment is delivered in December vs. January, the lease payment difference could be lower by $309 per month or a savings of $18,540.
Payments are important
State in your RFQ how you wish to make payments (monthly, quarterly, in advance, after usage), and establish your own current index rate for all quotes. These steps let you be sure you are comparing “apples-to-apples” on quotes you receive. Without your standard current index rate, lease companies could quote payments based on a current index that may differ by as much as one to 100 basis points from other lease quotes you receive. Occasionally a lessor intentionally selects an attractively low index rate that is not realistic to the market. The low rate ultimately increases when the lease commences. Avoid the costly surprise by determining a realistic rate and setting that as the standard for all quotes.
If a lessor uses an artificially low index rate, then what appears to be an economic savings with an apparent lower monthly lease payment may, in fact, end up being more costly.
The actual interest rate at the start of lease is 7 percent. Both Lessors A and B adjust their pricing to the current rate of 7 percent. Lessor A used an artificially low index rate by 0.50 percent that appeared to be less expensive by $232 per month. However, when the final rental adjustment took place at lease commencement, Lessor A was actually more expensive by $6 per month. The total difference over 60 months would be $14,280 ($238 x 60).
Pay attention to the language of the lease contract. Request copies of any documentation required for the lease. Ask if you are required to pay any extra fees up front, during the lease or at lease-end. Be sure documentation includes a copy of the master lease agreement and lease schedule, including maintenance and return provisions, and specific lease-end options available in the lease.
Not all lease options are alike. For example, watch out for the wording “purchase at lease-end will be at a mutually agreed upon price.” It is difficult to “mutually agree” on the price of used equipment when a lessor thinks the equipment is worth 40 percent of the original cost and you, after some research, find the fair price is more like 20 percent. To make matters worse, lessors using this language generally state that if you cannot come to a “mutually agreed upon price,” the lease is automatically extended for 12 months at the same base lease terms.
A reasonable lease-end option allows you to return equipment to the lessor, subject to fair maintenance and return provisions, or purchase the equipment at its fair-market value as determined by independent appraisals. Renewing the lease at fair-market value rental rates is also a reasonable option.
For example, using the same $1million equipment cost and a five-year lease term, the monthly lease payments are $15,662 per month (see Table 3). At the end of the base five-year term, a “fair market” renewal rate may be $11,128 per month. By having a “fair market value renewal” option rather than having to renew at the same rate you paid for the base lease term, you would generate an annual savings of $54,408.
To avoid lease-end option nightmares, always ask prospective lessors for at least five references from customers who have had lease schedules reach full maturity.
Remember, all lease agreements require you to notify the lessor prior to lease maturity of your intent to buy or return the equipment or renew the lease. This is fair and reasonable, as the leasing company needs to know whether it needs to remarket the equipment. It is important for you to notify the lessor of your intent. Failure to do so in a timely manner could saddle you with an unwanted automatic renewal of the lease for an extended period of time, even if you wanted to return the equipment at lease-end. MHM
About the author
Bob Rowland is senior vice president of ICX Corporation, a wholly owned subsidiary of Charter One Bank, F.S.B. Rowland has worked in the leasing industry since 1972. Reach him at [email protected] or phone (216) 328-8700.