How Equipment Leasing Companies Make Money
When making lease vs. buy decisions about equipment procurement, it’s crucial for enterprises to understand how equipment leasing companies earn profit. This knowledge also is indispensable when selecting an equipment leasing company.
Most equipment leasing companies do not make much on the spread between the lease rate and their cost of funds. Instead, they eliminate their residual exposure and earn profit through interim rent, retained deposits, fees, lease extensions, non-compliant return charges, fair market value definitions and end-of-lease buyouts for equipment that can’t be returned.
When equipment leasing companies provide equipment before the commencement date of the lease, lease agreements often permit them to charge full rent (pro-rated) for the period between delivery and the lease commencement date. Lessees need to be aware that if the amount of this interim rent isn’t capped in the lease agreement, they can be exposed to budget-busting additional costs.
Leases often require deposits and other upfront fees (commitment fees or restocking fees) and lease agreements typically include language that makes these deposits nonrefundable under predictable circumstances. Lessee should attempt to guarantee reasonable deposit refunds, but if a lessee almost never get deposits back, this expense should be included in the all-in cost of leasing.
Equipment leasing companies seek to structure lease agreements so that lease extensions are almost a certainty. They accomplish this goal with provisions that make it extremely difficult for lessors to comply with notice and return requirements, with non-compliance often resulting in automatic lease extensions.
Non-Compliant Return Charges
Equipment leasing companies often include “all-but-not-less-than-all” return conditions, which stipulate that rent for an entire schedule of equipment will continue in full force until every piece of equipment on the schedule is returned. Lessees should approach all-but-not-less-than-all conditions with extreme caution, because in addition to leading to lease extensions, they can result in substantial fees. Other types of return conditions can also be costly, so it’s imperative that lessees carefully examine lease agreements for the risks posed by non-compliant return.
Fair Market Value Definitions
Another pitfall for lessees is a failure to adequately define the fair market value (FMV) at the end of the lease, which is what lessees must pay if equipment return is unfeasible and they don’t want to extend the lease. If the lease agreement essentially allows the equipment leasing company to name FMV, lessees who can’t return the equipment will most likely either have to pay an inflated FMV or continue to pay.
Even if mutual agreement on FMV is required, a lessee can find itself in the same position because lease rents will continue until mutual agreement is settled on.
When lessees are put in a spot where they must either extend leases or pay the often-excessive FMV for the equipment, they sometimes chose the latter. While equipment leasing companies generally prefer lessees to extend leases, they can also profit on the sale of the equipment at a price favorable to them.
Lease agreements are complex, and successful negotiation of terms requires expertise in the industry—particularly an in-depth understanding of how equipment leasing companies make money. Expertise enables the attainment of favorable terms and a minimization of the risks often couched in lease agreements.
Many enterprises don’t have this necessary leasing experience in-house and so hire leasing consultants.