BY WILLIAM ATKINSON
Special to CONTRACTOR
WHEN IT COMES to paying for the use of equipment on a job, you can consider outright purchase, lease or rent. The decision is rarely a simple one. Many people in the industry believe the choice should be based on a combination of factors that are carefully weighed.
“Much of the decision on whether to purchase or lease equipment is based on advice we receive from our accountants and auditors,” says David A. Nelson, president and treasurer of Nelson Piping Co. in Rockford, Ill. “They tend to help us manage our money relative to tax savings, based on current laws. In some cases, lease is the clear choice. In others, it’s marginal. In still others, it just doesn’t work.”
For the most part, though, leasing makes the most sense for his company, Nelson adds. The question you ultimately need to ask yourself is, “Which one will be the cheaper?”
One of the first considerations is the financing needed to acquire the equipment that you need for a project.
“Whether a contractor buys or rents equipment from a rental company or directly from the manufacturer, it is always nice to have access to financing offered by the supplier simply as an alternative means of financing,” says Mike Backes, vice president of Genie Industries, which manufactures aerial work platforms. Genie Financial Services is a wholly owned subsidiary of Genie Industries. “In making a lease vs. buy decision, a contractor should consider how he is going to employ the equipment and how long he plans to keep it.”
For example, if you only need the equipment for a short period of time, it may make the most sense to rent.
“However, if you plan to keep it for a longer period of time, this is where you have to decide between lease and buy,” Backes says. “At this point, you have to consider the tax and other accounting issues.”
At the end of the day, though, he suggests that the most important questions are: “What are my payments?” and “How does it affect my cash flow?”
“If you buy the equipment, you can depreciate it over five to seven years,” Backes says. “You can compare that to leasing, but you have to compare it to either a capital lease, which is on balance sheet (similar to purchasing), or an operating lease, which is off balance sheet.
“Operating leases are often more appealing near the end of the year when you need more equipment but have exhausted your capital budget.”
Flexibility is also an important consideration. When you own a piece of equipment, Backes notes, you have less flexibility than if you lease it.
“When you purchase equipment, you are using your own capital or taking out a loan, which ties up a source of capital,” says Joe Apuzzo, president of Terex Financial Services. “You do get the tax benefits if you need them, but you also end up taking ownership of the equipment and all that entails.”
With a lease, you are paying for less than 100% of the equipment, so payments are lower, and you have more flexibility with the equipment at the end of the lease term.
“That is, you can buy it or return it,” he explains. “Returning it allows you to keep your fleet refreshed by bringing in new equipment.”
From a cash-flow standpoint, leasing can better match your cash flow with the contracts you win because the lease payments are more flexible, Apuzzo says. Leasing also preserves liquidity and working capital.
And if you are working with a captive finance company, you also have the advantage of working with a one-stop source of equipment, finance and service. Apuzzo delineates some additional considerations in selecting among rental, leasing or purchase:
- In terms of flexibility, renting is the best because you can return the equipment at any time. “However, it is also the highest cost,” he notes.
- “Next highest flexibility is leasing because you are paying for less than 100% of the equipment since you are amortizing it down to maybe 30% or some residual value,” he says. “However, you’re not building up equity in the equipment.”
- When you purchase, you have the least flexibility because you end up owning the equipment and you pay more over time as you build up equity at the end vs. paying down equity.
Striking a balance
Overall, though, you should create a balance of equipment financing. Decide what the optimum mix is of owned, leased and rented equipment to fulfill your needs based on the contracts you’re winning.
“You should base this decision on a combination of current economic conditions, the size of your business, fleet age, your financial strength, your ‘tax appetite,’ which is whether you can use the tax benefits or not, and what your business expectations are for the future,” Apuzzo adds.
Frederick Oyer, vice president of mechanical contractor International Piping Systems in Schaumburg, Ill., adds: “I personally approach a buy vs. lease decision by whether or not the equipment is going to be full utilization for 52 weeks a year. If I do plan to use it for the full year, then I’m going to consider buying the equipment.
“I have a prejudice that goes like this: My cost of money is probably about the same as it is for a leasing company. As such, I look carefully at the cost of money. Since I generally don’t have a problem borrowing money and have a balance sheet that will carry debt, 50% of the time I will buy and 50% of the time I will lease.”
Oyer adds that his decision will be based on the cost of interest and the lease fee. Since International Piping is not an underground contractor, it doesn’t have excavation equipment. It is also not a general contractor, so it doesn’t own cranes.
“If we need a forklift or some other piece of equipment we don’t normally use, we will lease it as needed,” he says.
About eight or 10 years ago, International Piping Systems decided to lease scaffolding and scissor lifts.
“These are $10,000 to $30,000 pieces of equipment, and there is a lot of competition in this area for leasing, so lease prices are competitive,” Oyer explains. “In addition, maintenance and training in order to comply with OSHA requirements is rather significant. As such, almost without exception, we lease this equipment.
Dave Nelson says he usually favors leasing large equipment for Nelson Piping.
“For example, if you do underground jobs occasionally and need to de-water a pit, you will need a large diaphragm pump,” he says. “For just a few jobs, it doesn’t pay to purchase one of them and keep it in your inventory.”
Nelson says that his company used to own its own man-lifts but OSHA-required safety inspections ended that practice.
“We lease these now because they receive periodic inspection and maintenance by the leasing company,” he says.
If you plan to use special equipment for a long period of time, you should ask the leasing company if you can apply a certain amount of the lease to a purchase, Nelson says. If the leasing company won’t agree to those terms, he suggests that you go to your bank and have the bank finance it for you. Explain that you want to lease the $50,000 piece equipment for a year, and at the end of the year you’ll have half of it paid for in leasing expenses.
Between banks and equipment finance companies, it’s a good idea to shop for loans today, Nelson says.
Another good idea is to ask the company from which you are leasing the equipment if you can work out a monthly payment deal, he says. The company may say that 50% of the leasing fee will go toward the purchase of the equipment. For example, if the equipment costs $50,000 and you’re paying $25,000 for the year, $12,500 of that will apply to the purchase price.
“You can counter by saying that you consider it a lease-purchase deal, and all of your payments should be applied toward the purchase price,” he says.
Then check with your accountants to see how the IRS construes the lease-purchase agreement. This information will affect whether you capitalize the cost of the equipment.
Another important note on equipment rental is to check with your insurance company to make sure you have rental insurance, Nelson says.
“A friend of mine in the contracting business rented a man-lift with an articulating boom,” he recalls. “In the course of the project, the boom was stretched too far, dropped a wheel into a hole and tipped over.”
The equipment was damaged, and the employee was severely injured. His insurance didn’t cover the incident, so he had to cover the costs out of pocket.
Many of the same economic considerations that enter into options for using jobsite equipment apply to fleet vehicles as well.
Sometimes, cash flow will determine whether you should lease or buy company vehicles, says David A. Nelson of Nelson Piping Co. in Rockford, Ill. This is especially true for someone just starting out in business.
It may make more sense to lease the vehicles over the long term, he adds. Besides saving money, you will probably be able to get better equipment than you would be able to afford to buy.
“For example, vans today should really be rolling billboards,” he says. “A guy just starting out doesn’t want to be driving around in a ‘Bubba’ truck. In fact, I saw a bumper sticker once that said: ‘More trucks for your bucks. Lease today.’”
Upfront costs are another consideration when looking at vehicles. Sometimes, Nelson points out, leasing companies may require a deposit of a certain percentage of the vehicle cost.
Consider mileage as well. If your lease has a 15,000-mile cap on it, the term of your lease will need to be short.
“If you run over your miles, you will get stuck paying a ‘cents per mile’ deal, which can be expensive,” he says.
When considering mileage, also think about the size of the truck. It often makes sense to lease small trucks and vans. With larger trucks, leasing often doesn’t make as much sense because you may end up putting a lot of miles on them, or not many miles at all.
“We prefer open-ended three- or four-year leases,” Nelson says. “We usually know if we will be putting 30,000 miles on them or 100,000 miles in four years. As such, we will agree on a price that the truck will be worth at the end of the lease, assuming it is still in good condition. At that point, we have the option to allow the leasing company to sell it, or we can buy it.”
Nelson says he usually chooses not to buy the older vehicles but to get new trucks instead because the maintenance and downtime are much less. This provides for a trouble-free trade-in.
Even though Nelson uses a leasing company in Chicago, he leases his trucks from a dealer in Rockford, which is 90 miles northwest of Chicago, so his employees don’t have to drive far for maintenance and repair.
A number of different leasing programs should be examined before a final decision is made. Some cover all maintenance; others even cover oil changes and fuel.
But in the end, it’s the same story of buyer, renter or leaser beware. You have to decide what fits your own business needs.
“I think auto and truck leasing companies substantially exaggerate tax savings as a result of leasing,” he says. “People then begin to make decisions for tax reasons without truly understanding them.”
How rentals, leases differ
Although the words rent and lease sometimes are used interchangeably, here is how they’re defined:
- Rent. Payment, usually short term or monthly, for the use or property or space.
- Pure lease. An equipment lease, usually for a short term, in which the lessee does not have any purchase or renewal option. Also called a “true lease.”
- Operating lease. A lease for which the lessee acquires the property for only a small portion of its useful life. An operating lease is commonly used to acquire equipment on a short-term basis. Any lease that is not a capital lease is an operating lease.
- Capital lease. A lease that meets one or more of the following criteria, meaning that the lessee classifies it as a purchase:
- The lease term is greater than 75% of the property’s estimated economic life.
- The lease contains an option to purchase the property for less than fair market value.
- Ownership of the property is transferred to the lessee at the end of the lease term.
- The present value of the lease payments exceeds 90% of the fair market value of the property.