Lease, rent or buy?

Photo © Adobestock

Should a wholesale greenhouse or nursery buy, lease or rent its equipment, vehicles or buildings? Not too surprisingly, the answer depends on the operation’s situation. The question gets even more complex when you add new rules governing the accounting treatment of leases that make them more transparent to potential lenders and investors.

Leasing equipment can be a good option for growers with limited capital that need equipment that must be replaced or upgraded every few years. Purchasing equipment might be a better option for an established business for equipment that has a long, usable life. Obviously, the decision to buy or lease should be made on a case-by-case basis.

The buy or lease basics

When it comes to acquiring things such as automation, soil processing equipment, vehicles and even the greenhouse or the building that houses an operation, every grower has the option to lease or buy. But leasing might be a good option for a business with limited capital.

Leasing requires less commitment than buying and makes it easier to upgrade when the lease term ends. There may, however, be significant lease restrictions covering what can and can’t be done with the leased property.

Buying means the grower purchases and owns the buildings, equipment and vehicles outright. If funds are tight, there are financing tools available, including the many offerings of dealers and distributors. Plus, there is also bank financing with or without SBA guarantees to help overcome the reluctance of many lenders in today’s economy.

Buying means more commitment, since the property can’t simply be returned at the end of the lease term. But an outright purchase also means the growing operation can alter, modify and use the property without restrictions.

Delving into the leasing option

Today, almost every type of vehicle, equipment or property can be leased, with the specific term dependent on the lessor, the type of property, the length of the lease and more. In general, equipment lease terms include:

• Contract periods between six months to seven years.
• Down payments that are usually low or non-existent.
• Lease payments on a monthly, quarterly, semi-annual or annual basis. Payments may start low and escalate later in the lease term.
• Collateral usually consists of the leased property, which can be repossessed if the operation falls behind on payments.
• End of the lease may require the return of the leased property, a renewal option or the right to buy the equipment.

All leases are not equal

Among the various types of leases that a grower is likely to encounter is a so-called “master lease,” which lets the operation lease additional pieces of equipment from a lessor without negotiating new contracts for each one. A master lease might be a good choice for any grower anticipating near-term growth.

A recent change in the way leases are treated for accounting purposes changed the way leases are classified and recognized. Before the rule change, leases were either “capital” or “operating” leases. With the new accounting standard, capital leases are now called “finance” leases. Operating leases remain the same, although they are recognized in a different way for accounting purposes.

Operating leases work much like a rental agreement. While the lessor continues to bear all ownership risk, changes in the accounting rules have changed the liability reporting requirements for balance sheets.

Operating leases, unlike an outright purchase, are usually for shorter periods than the asset’s useful life. In other words, operating leases are used for limited-term leasing of assets and include traditional renting relationships.

The former “capital” lease is no longer specific to one type of lease because most leases will not have to be capitalized for accounting purposes, except for those with a term of 12 months or less.

The new term “finance lease” is used under the new ASC 842 accounting rules. With a finance lease, the lessee bears the bulk of the risk associated with owning the leased asset. A finance lease is an acquisition of an asset that is financed through debt financing and usually for a period comparable to the asset’s expected life.

A brief explanation of ASC 842

Thanks to a change in the accounting rules, both private and nonprofit companies are now required to report leases (and subleases) on their balance sheets. Before ASC 842, operating leases were not included on an operation’s balance sheet, with the result that potential investors and lenders didn’t have a clear picture of the operation’s liabilities.

The new lease accounting standard requires including all leases longer than 12 months to be recorded on balance sheets as assets and liabilities, increasing visibility of leasing costs and arrangements.

ASC 842 does not change how leases are treated for federal income tax purposes, but it does make accounting for leases more difficult. However, although the federal income tax treatment of leases isn’t impacted by ASC 842, the same can’t be said for state-based franchise taxes, sales and use taxes and net worth taxes, all of which might be impacted.

Getting technical with operating leases

Equipment operating leases can be structured in a number of ways.

In a fair market value lease, payments are made, and the equipment is used during the lease. At the end of the lease, the grower has the option of buying the equipment at its fair market value, returning it or renewing the lease. It is most often used for equipment that quickly loses its value.

10% option leases let the lessee make payments and purchase the equipment for 10% of its initial value or walk away at the end of the lease.

Terminal rental adjustment clause (TRAC) leases are typically used for trucks and other vehicles. A TRAC lease comes with the option to purchase the vehicle for the agreed-upon residual amount, or the lessor will sell the vehicle to a third party. If the vehicle is sold for less than the residual amount, the lessee will owe the difference.

Equipment rentals

Renting equipment offers a grower unmatched flexibility by paying for an asset when it is needed. Renting benefits smaller operations that can’t afford equipment maintenance costs.

Renting and leasing work pretty much the same way, except with renting, the operation signs a contract for a shorter time (usually a year or less and not requiring a large down payment) and is not responsible for maintenance costs.

Rental payments are often considered a tax-deductible operating expense, greatly simplifying accounting. The same might not be true with leases, thanks to a recent change in the accounting rules and its impact on an operation’s taxes.

Funding to lease or buy

Regardless of the path eventually chosen, funding will be needed for both purchases and leasing. Fortunately, there are options.

Traditional bank loans are difficult and expensive today but more accessible and affordable with an SBA guarantee.

Alternative lenders, including specialty lenders, equipment dealers and distributors and online lenders, are often more readily available but are also usually more costly.

Other options include utilizing a line of credit that every wholesale growing operation should already have in place or using a business credit card, which is quick but can be quite expensive.

The decision

Answering the question of whether it is cheaper to lease or to buy depends on a number of factors, such as the cost of the equipment or other property, the length of time it will be used and, of course, the financial health of the operation.

Both loans and leases allow a grower to immediately access equipment and other property, making it possible to generate revenue while the operation makes small periodic payments.

Leasing may be more affordable in the short term because of lower monthly payments. Buying can be more cost-effective in the long run, as the operation will own the equipment outright after making all payments.

Renting, on the other hand, is best for a business that needs equipment for a short time or is uncertain about its future use, especially for one-time or seasonal use.

A loan to purchase the equipment or property might be better if the operation has the funds for a down payment and hopes to keep the equipment for a long time. A lease is better if the operation doesn’t have sufficient funds to put down, the equipment is only needed for a specific project or if there is a risk of it becoming outdated.

Choosing whether to rent, buy or lease equipment or property requires careful evaluation as well as professional advice to help growers make a decision that’s best for their circumstances and operations.

Mark Battersby is a financial writer who resides in Ardmore, Pennsylvania. mebatt12@earthlink.net