How to Perform an Accurate Lease vs. Buy Analysis
Having a well-designed lease versus buy analysis is fundamental to an efficient equipment leasing program.
A lease vs. buy analysis provides two crucial benefits:
- Helps to determine whether to lease or buy a specific piece or set of equipment.
- Helps to project the future all-in costs of leasing.
The key to success is the structure of the analysis. If not properly designed—with all leasing cost elements included—a lease vs. buy analysis not only won’t help an enterprise make smarter choices; it could lead to poor, potentially disastrous decisions.
To be effective the lease vs. buy analysis structure should include estimates based on historical leasing costs and/or costs likely to incurred based on lease structure and lease contract language. Without an accurate projection of future costs, the usefulness of the lease vs. buy analysis is essentially doomed from the start.
Projections that Depend on Past Performance or Contract Language
It’s little problem to calculate the cost of future rental payments adjusted for the time value of money. But that’s only part of the lease vs. buy calculation, because equipment leases typically contain numerous terms that escalate the total cost of leasing far above the cost of rent.
Pre-Lease Costs: Before a lease period starts, lessees can experience additional costs in the form of interim rent (charged for equipment delivered and accepted before official lease commencement), retainable deposits, commitment fees, processing fees, restocking fees, and other fees.
Ongoing fees: Lease agreements often allow lessors to continually charge various forms of service fees with the execution of future lease schedules, such as for restocking or documentation.
Extensions and Renewals: These are costly traps for lessees. Most leases begin with a a lessee’s commitment to return equipment at end of lease but in most cases the lessee ends up paying additional extension payments.
Asset Purchases: Improperly structured lease agreements can result in buyout valuations that are far above market value. It’s not unusual for the buyout to be nearly 50 percent of the asset’s original equipment cost, even though an asset may be virtually worthless on the open market. Such costs should not be ignored in the lease vs. buy analysis.
Equipment Damages: This can be a costly non-rent expense for lessees, and there are crucial variations in how aggressively each lessor charges for damages (e.g., lessors that don’t have their own equipment return and resell operations will tend to attempt to collect more for damages).
Using the Historical Data
For each cost bucket, historical costs can be expressed as a percentage of original equipment cost and then applied to current lease scenarios. For a lease vs. buy analysis to have a structure that produces useful comparisons, such historical data must be incorporated.
Collecting and analyzing all the relevant data for each leasing-related cost bucket is a difficult, complex process that is often assisted by equipment leasing specialists. But once this process is completed, an enterprise can develop meaningful, performance-based metrics for use in its lease vs. buy analysis.