Lease Myth Busting: Lease extensions are uncommon and should not be considered in a lease versus buy analysis
The fundamental myth is that end of lease (month-to-month and longer) extensions are in any way unusual. In fact most lessees struggle to return leased equipment and end up paying some version of extension rents on the majority of their equipment leases. Lessors know, at lease inception, that some extensions are likely. Lessees – if they have evaluated the all-in cost of leasing would also know this and could include an estimate of extensions in their lease versus buy analysis. However each lease extension is commonly viewed as a one-off unique event – which is a costly mistake.
Returning equipment per the terms and conditions of the master lease is usually difficult and extensions are common . When lease extensions are considered at end of lease they often make short-term, or budgetary good sense, since prior payments are sunk costs and these should not be considered in a financial analysis to support a decision at the current time zero. The decision is usually driven by either the desire to give more time to operations to find the gear and return it, to give IT or another asset owner more time to make an upgrade or some other business decision, because notice provisions were not met or because it will take more time and effort to meet contractual return requirements. For all these reasons any individual equipment lease extension are often easily justified.
However there are three key issues to evaluate when extending a lease.
– Although the monthly budget impact may be relatively minor, an all-in cost analysis may show that extensions rapidly change the economics of the lease. Looking at the extensions as part of a whole rather than on their own may cause a company to reevaluate the relative importance of the short-term budgetary impact of the extensions.
– Long extensions or rolling the remaining unreturned equipment into a new lease should be analyzed closely since at end of lease the equipment still must be returned or purchased.
– Regardless of the business decision or other driver at the end of the extension period, the up-front lease versus buy analysis used to evaluate future leases should be updated taking the likelihood of future extensions into account.
Example: In the example below an analysis of the all in cost of leasing showed that due largely to a track record of consistently extending and rolling leases the lease program was far more expensive than expected. Each individual extension decision may have had a sound rationale but in the end this pattern of decision making created an expensive program.
Conclusion: A detailed analysis of the all-in cost of leasing to date should be performed. The lease versus buy analysis should be modified to include extensions and other costs that are likely to occur as shown by the analysis.