Leasing

Leasing is a process by which a firm can obtain the use of a certain fixed assets for which it must pay a series of contractual, periodic, tax deductible payments. The lessee is the receiver of the services or the assets under the lease contract and the lessor is the owner of the assets. The relationship between the tenant and the landlord is called a tenancy, and can be for a fixed or an indefinite period of time (called theterm of the lease). The consideration for the lease is called rent. A gross lease is when the tenant pays a flat rental amount and the landlord pays for all property charges regularly incurred by the ownership from lawnmowers and washing machines to handbags and jewellry. Under normal circumstances, a freehold owner of property is at liberty to do what they want with their property, including destroy it or hand over possession of the property to a tenant. However, if the owner has surrendered possession to another (the tenant) then any interference with the quiet enjoyment of the property by the tenant in lawful possession is unlawful. Similar principles apply to real property as well as to personal property, though the terminology would be different. Similar principles apply to sub-leasing, that is the leasing by a tenant in possession to a sub-tenant. The right to sub-lease can be expressly prohibited by the main lease.

Comparison of buying and leasing There are many distinct differences between buying and leasing, regardless if such a transaction or agreement applies to property, machinery, equipment or other assets. The difference lies in that a lease is conceptually very similar to the principle of borrowing. The ownership of the leased property (be it land, equipment, merchandise, or etc.) is not transferred under the terms of the lease agreement. The lease gives the lessee the right to use the assets covered under the agreement for the duration of the contracted term, however, upon the completion of said term the lessee is required to return the assets in question to the lessor, thereby completing the terms of the agreement. In a general example having to do with an automobile lease, the vehicle is due back to the dealership at the conclusion of the lease term. Once the vehicle is returned, the automobile lease agreement is completed and the parties (lessor and lessee) separate with no further obligations to each other (assuming there is no damage on the vehicle entitling the dealer to some further compensation). The lessee has no further claim or right to use the vehicle and the lessor, or car dealer no longer collects any payment from the former lessee the previous driver. Many lease agreements contain clauses and addendums that outline additional rights, or options for the lessee, to be exercised at will upon the conclusion of the lease (there are numerous equipment lease types[2] with individual features). In automobile leases[3] as a general example, a lessee may have an option to purchase the vehicle, thereby restructuring the agreement and ultimately obtain the ownership of the asset previously leased. In the example of a property lease, the renter (or lessee) may have the option to extend the lease, under pre-determined terms. Such scenarios are numerous and are typically pre-set during the initial creation and negotiation of the agreement between the parties. Purchasing, on the other hand, involves an agreement that outlines the terms under which the purchaser acquires ownership of the desired item, property or asset. The purchase agreement delineates the purchase price and the terms under which it is to be paid for by the buyer. The overall purchase price can be amortized over a period of time as in the case of financing, or it can be paid in full, resulting in the instant transfer of ownership to the purchaser. In the event that the purchase is financed over a period of time, the ultimate price paid for the item or asset can be greater than the original price due to interest. For an individual deciding between buying or leasing, it is crucial to understand the pros and cons of each.

Responsibility: In a scenario involving business entities that typically rely on functional equipment for ongoing operations and to stay ahead of competitors, responsibility is a key factor. In a purchase, the responsibility for the equipment falls solely on the shoulders of the business owner. While there are various insurance plans and warranties available to protect the owners, in case of damage or faulty manufacturing, the ultimate responsibility for the life of the equipment, after a purchase is complete, falls on the buyer. In a lease scenario, a lessee is only responsible for the equipment for the duration of the lease and while he or she remains in possession. Resale value: In case of a purchase, the full value of the asset is transferred to the purchaser, as the new owner. This means that in case of resale at a subsequent time, the full price for which the asset is resold can be collected by the new owner. In case of an automobile purchase, for example, an individual can, at a later date freely resell the vehicle and collect its value, albeit a depreciated amount from the original purchase price. In a lease, the lessor has no claim to the asset upon the conclusion of a lease, thereby the monies that were paid in the course of the lease cannot be, in part or in whole be recouped through a resale of the asset. Depreciation: Depreciation is a major consideration for individuals deciding between buying and leasing. For assets that suffer from significant depreciation, either as a result of regular wear and tear or through becoming obsolete upon the release of newer versions of the same materials (particularly applicable in the case of technology) leasing can prevent a significant loss of value. In business, there exists a basic rule of thumb: If it appreciates, buy it. If it depreciates, lease it. Leasing could permit the use of the equipment while it is new and upon the completion of the lease, it can be simple to upgrade by virtue of a new lease. In case of a purchase, however, an individual may be stuck with an obsolete asset with no means of recouping the cost of its acquisition. Maintenance: Because in the instance of a lease the ultimate ownership is retained by the lessor, it is in the lessors best interest to maintain the asset in its best working order. Therefore, lessees can often benefit from comprehensive maintenance programs offered by lessors while still paying a discounted premium due to the fact that the asset is being leased, not purchased. Cost: In the event of a purchase, the full value of the asset must be paid to the seller. In the event of a lease, however, only a portion of the full value is assessed, typically around 50%, however the figure varies based on the duration and type of lease. As a consequence, a lessor can gain the use of a much needed asset for a fraction of the full price of ownership. In many instances, this can better serve the lessee that an outright purchase would. As a corollary, a lessor could be granted the use of an asset that could otherwise be cost prohibitive.

Advantages:For businesses, leasing property may have significant financial benefits:

Leasing is less capital-intensive than purchasing, so if a business has constraints on its capital, it can grow more rapidly by leasing property than by purchasing property. Capital assets may fluctuate in value. Leasing shifts risks to the lessor, but if the property market has shown steady growth over time, a business that depends on leased property is sacrificing capital gains. Depreciation of capital assets has different tax and financial reporting treatment from ordinary business expenses. Lease payments are considered expenses rather than assets, which can be set off against revenue when calculating taxable profit at the end of the relevant tax accounting period.[4] In some cases a lease may be the only practical option; for example, a small business may wish to open a location in a large office building within tight locational parameters. Leasing may provide more flexibility to a business which expects to grow or move in the relatively short term, because a lessee is not usually obliged to renew a lease at the end of its term. Disadvantages:-

For businesses, leasing property may have significant drawbacks:

A net lease may shift some or all of the maintenance costs onto the tenant. If circumstances dictate that a business must change its operations significantly, it may be expensive or otherwise difficult to terminate a lease before the end of the term. In some cases, a business may be able to sublet property no longer required, but this may not recoup the costs of the original lease, and, in any event, usually requires the consent of the original lessor. Tactical legal considerations usually make it expedient for lessees to default on their leases. The loss of book value is small and any litigation can usually be settled on advantageous terms. This is an improvement on the position for those companies owning their own property. Although it can be easier for a business to sell property if it has the time, forced sales frequently realise lower prices and can seriously affect book value. If the business is successful, lessors may demand higher rental payments when leases come up for renewal. If the value of the business is tied to the use of that particular property, the lessor has a significant advantage over the lessee in negotiations.

Types of Lease:
On the basis of above dimensions, leases are classified into following: Finance Lease and Operating Lease: Finance lease, also known as Full Payout Lease, is a type of lease wherein the lessor transfers substantially all the risks and rewards related to the asset to the lessee. Generally, the ownership is transferred to the lessee at the end of the economic life of the asset. Lease term is spread over the major part of the asset life. Here, lessor is only a financier. Example of a finance lease is big industrial equipment. On the contrary, in operating lease, risk and rewards are not transferred completely to the lessee. The term of lease is very small compared to finance lease. The lessor depends on many different lessees for recovering his cost. Ownership along with its risks and rewards lies with the lessor. Here, lessor is not only acting as a financier but he also provides additional services required in the course of using the asset or equipment. Example of an operating lease is music system leased on rent with the respective technicians. Sale And Lease Back and Direct Lease: In the arrangement of sale and lease back, the lessee sells his asset or equipment to the lessor (financier) with an advanced agreement of leasing back to the lessee for a fixed lease rental per period. It is exercised by the entrepreneur when he wants to free his money, invested in the equipment or asset, to utilize it at whatsoever place for any reason. On the other hand, direct lease is a simple lease where the asset is either owned by the lessor or he acquires it. In the former case, the lessor and equipment supplier are one and the same person and this case is called bipartite lease. In bipartite lease, there are two parties. Whereas, in the latter case, there are three different parties viz. equipment supplier, lessor, and lessee and it is called tripartite lease. Here, equipment supplier and lessor are two different parties. Single Investor Lease and Leveraged Lease: In single investor lease, there are two parties - lessor and lessee. The lessor arranges the money to finance the asset or equipment by way of equity or debt. The lender is entitled to recover money from the lessor only and not from the lessee in case of default by lessor. Lessee is entitled to pay the lease rentals only to the lessor. Leveraged lease, on the other hand, has three parties lessor, lessee and the financier or lender. Equity is arranged by the lessor and debt is financed by the lender or financier. Here, there is a direct connection of the lender with the lessee and in case of default by the lessor; the lender is also entitled to receive money from lessee. Such transactions are generally routed through a trustee. Domestic and International Lease: When all the parties of the lease agreement reside in the same country, it is called domestic lease. International lease are of two types Import Lease and Cross Border Lease. When lessor and lessee reside in same country and equipment supplier stays in different country, the lease arrangement is called import lease. When the lessor and lessee are residing in two different countries and no matter where the equipment supplier stays, the lease is called cross border lease.

Benefits of Leasing Asset finance (leasing and hire purchase) is a very flexible way of raising funds. The advantages include:

To buy a new piece of machinery or equipment can be costly and requires substantial capital. Leasing enables businesses to preserve precious cash reserves. The smaller, regular payments required by a lease agreement enable businesses with limited capital to manage their cash flow more effectively and adapt quickly to changing economic conditions. Leasing also allows businesses to upgrade assets more frequently ensuring they have the latest equipment without having to make further capital outlays. It offers the flexibility of the repayment period being matched to the useful life of the equipment. It gives businesses certainty because asset finance agreements cannot be cancelled by the lenders and repayments are generally fixed. However, they can also be structured to include additional benefits such as servicing of equipment or variable monthly payments depending on a businesss needs. It is easy to access because it is secured largely or entirely on the asset being financed, rather than on other personal or business assets.