Is there a difference?
In material handling, is there a difference between a lease and a long term rental (LTR)? The answer is “yes” and “no.” The correct answer depends on whose viewpoint is used—the dealer’s or the material handing end-user’s. We will look at this subject from both points of view to get a clearer picture of the differences. Two distinct types of financing are used for most lift truck transactions: loans and leases.
Loans are made to buyers so that they can purchase the asset. Ownership (title) passes upon execution of the documents such as with a Conditional Sales Contract. The sale is made conditional to the customer making all the payments according to the terms of the contract. The customer accounts for a Conditional Sales Contract by capitalizing asset (putting it on his balance sheet) and depreciating it while expensing the interest cost. The dealer recognizes a sale on his books without any future obligations. With a Conditional Sales Contract, maintenance is usually done through the use of a completely separate agreement, due to the transfer of ownership to the customer.
Leases are usually structured based on the use of the equipment. The customer’s intent is not to own the equipment but to use the equipment with a lease. The customer (lessee) just wants to use it, give it back when the term has expired, get a new one, use it, etc. Leases may have purchase options, but it must be just that, an option. Ownership of the asset remains with the lessor. When the dealer documents a lease, the leasing company is the lessor and thus owns the asset. The dealer recognizes a sale on his books to the leasing company and is no longer involved in the transaction, unless maintenance is part of the transaction. When the dealer leases the equipment, he has sold the transaction and all the rights under the contract to the leasing company (lessor). The leasing company now owns the asset and controls the customer. The dealer records a sale to the leasing company on his books, thus recognizing gross profit and a reduction in inventory. He gives up all the tax benefits (depreciation and deferred taxes) and any future rent extensions, as well as future profits from the sale of the unit as used equipment.
Long Term Rental
The real difference between a lease and a long term rental is that the dealer owns the rental asset. The dealer retains the LTR asset on his books and is the lessor. The dealership retains all the tax benefits. It should be noted that maintenance may be included in either type of contract and is strongly recommended.
Whether the dealer uses a lease or rental document, the customer really does not notice a difference. Both vehicles are based on use of the asset, not ownership of the asset. A proper term (period) for either type of contract is based on the lessee’s particular operating environment (or application) such that the lessee (customer) will get the optimum useful life of the equipment in that application. The lessee, under normal circumstances, merely expenses the monthly lease payment.
If the customer does not see a difference between a lease and LTR, then who does? The dealer does. Which way is best for the dealer? Why both, of course! It depends on the equipment, the customer’s operating environment and the dealer’s financial position.
Simply put, the dealer rents his assets (dealer-owned) and leases somebody else’s (the leasing company’s). The decision to sell or rent units is a dynamic strategic decision made by the dealership. Because of the different financial and operational ramifications of each financing vehicle, using a combination of the two types will benefit most dealerships. Each program has its uses; and each one fills a different need of the dealership. Remember, “There is a time and a place for everything.” Leasing and LTR are both strategic weapons in the battle for dealership profitability.
The issue is actually one of control. The dealer can have greater control of the asset, profits, cash flow and especially control of the customer using LTR. The proper use of each vehicle is instrumental to the dealer’s profitability.
Viewing this transaction as a rental, the dealer’s perspective is as follows: The lessor is the dealer; he controls the asset and the deal. The dealer shows an increase in rental fleet and decrease in the inventory for sale. Gross profit is recognized over the term of the contract, further reducing taxes. Depreciation benefits are retained by the dealer to reduce taxable income while creating cash flow. Control of the asset and the customer assures the ability to extend the rents and/or sell the equipment at a later date and generate additional profit.
A dealer needs a good supply of quality used equipment. The best source of good quality, used equipment is the rental fleet. You know this equipment inside and out. You know which are the good forklifts and which are not. This is where control of the asset comes in to play. You want to own (or control) the units with the proper specifications in the good operating environments with good paying customers. You will probably want to sell off (lease) the less desirable specifications, less-than-perfect operating conditions or slightly questionable customers.
Remember, a rental is the dealer’s asset. Do you really want that forklift back after 36 months in a “normal, clean and dry pickle-foundry”? Probably not. An application that sounds like this probably sounds like a lease deal. In this case, let the operating environment determine who gets the control. Obviously, the dealer wants to control the forklifts in the better environments, affording a better opportunity to profit from the forklift as a future used equipment sale. The more abusive environments would indicate a lease (selling off the deal to the leasing company).
The dealer’s own financial situation can also help determine whether to lease or rent. If the dealership is operating well and generating profits, retaining those deals as LTRs may potentially capture the tax benefits. The depreciation and interest (if financed) will lower taxable income. It is important to stay abreast of your Alternative Minimum Tax (AMT) situation, however, as AMT could possibly cost the dealership more in taxes. It would be in your best interest to consult your tax advisors.
The criteria used by the dealer can be any combination of the above depending on the dealer’s current situation. The choice is yours. In addition, the strategies may switch from time to time as the situation changes.
The customer wants the highest possible productivity, efficiency and equipment utilization in his operating environment, resulting in a better bottom line for his business. If the customer wants ownership, he needs a loan to buy the equipment. On the other hand, if ownership is not a requirement, the dealer has the option of offering leasing or long term rental based upon the dealer’s needs at that point in time.
The most common business considerations are the equipment specifications, operating environment and dealer tax position. Rental and LTR offer more dealer flexibility to expand profit levels.
Yes, there is a difference between leasing and LTR. It is the material handling dealer’s choice.
|Meet the Author
Rick Kwiatkowski is vice president with CitiCapital Dealer Finance (formerly Associates Commercial Corporation) in Irving, Texas.