By / par Ron Coleman
Buy or lease? I wish there was a simple answer but there isn’t. One size does not fill all. The answer is not a simple yes or no. There are several factors to consider. You need to understand these before making the commitment.
The first thing I would like to clarify is that there are two totally separate types of “lease” for vehicles and equipment. There is a “capital” lease and an “operating” lease.
Traditionally, vehicles have operating leases while items such as forklift trucks, machinery, or equipment normally use capital leases. However, even that is changing as leasing is getting more sophisticated. There is a trend towards using capital leases for commercial vehicles.
The criteria for a capital lease can be any one of the following four options:
• Ownership. The ownership of the asset is shifted from the lessor to the lessee by the end of the lease period.
• Bargain purchase option. The lessee can buy the asset from the lessor at the end of the lease term for a below- market price.
• Lease term. The period of the lease encompasses at least 75% of the useful life of the asset (and the lease is non- cancellable during that time).
• Present value. The present value of the minimum lease payments required under the lease is at least 90% of the fair value of the asset at the inception of the lease.
If a lease agreement contains any one of the preceding four criteria, the lessee records it as a capital lease. Otherwise, the lease is recorded as an operating lease. Your external accountants will set this up in your year-end financial statements if you don’t have the in-house expertise.
The original intent behind the capital lease is that you are likely to keep the asset to the end of its useful life. Now that commercial vehicles are also being leased as capital leases this is changing. Either way, you are responsible for all the repairs and associated costs. The advantage of the capital lease is that the asset will show up on your balance sheet as an asset.
A truck lease that is set up as an operating lease does not have any of the above criteria and therefore there is no balance sheet entry—no asset value.
It is generally easier to lease as you often don’t have to put any money down and the monthly payments are lower. If that were the end of the story, then there would be no problem; but, there are always two sides to a coin. Does “no money down” mean no security deposit? You may have to pay a deposit, plus the first month’s rental and related fees. The GST/HST on each payment is fully recoverable as an input tax credit. I often see newspaper ads for leases that look too good to be true and then, literally using a magnifying glass, I see that significant deposits are required. So, don’t get fooled by the ads.
Even where there is no deposit and lower monthly payments, you should remember that you don’t end up owning the vehicle at the end of the lease. If cash flow is a major issue then leasing is an attractive option, provided the deposit, the security deposit, and any other fees do not outweigh a purchase. If profit and equity build-up are important then buy the vehicle using a loan.
There is no preferential tax treatment when comparing a lease to a purchase—you get to write off the actual expense. If this is a commercial vehicle used 100% for business, then there is no personal tax benefit. In a lease, you write off the full monthly payment whereas in a purchase you only write off the interest and write off the depreciation.
Because you are purchasing the asset, the expense portion of your cash flow is lower than in a lease. In a lease 100% of the cash flow is an expense, no equity; in a purchase your equity portion is a depreciation write-off over the life of the asset. When you sell the asset, you may get more than the book value for it, and therefore you have over-claimed depreciation, so you will have to write back the difference to profit.
Naturally, all your operating expenses—fuel, repairs, insurance, etc.—are expensed whether it is a purchase or a lease. If you do modifications and repaint the vehicle you could likely expense those in one year or write them off over several years, depending on the amount. Review this with your accountant.
Normal wear and tear are expected when you return a vehicle at the end of the lease. In a lease you don’t have ownership, so you are accountable to the owner for any damage, beyond normal wear and tear, and accountable for excess mileage. There have been recent cases where dealers have been very aggressive in this area because the residual value of the vehicle is lower than anticipated. When the dealer takes back the vehicle, he wants to make a profit on the resale. He can do this in two ways: one by selling the vehicle for more than the buy-back allowance and secondly by hitting up the lessee for charges for excess damage and excess wear and tear— and commercial vehicles do take quite a pounding over the years. You will also likely have to return the vehicle to its previous condition, less normal wear and tear. That means you may have to have it repainted to get rid of your branding and you will have to dismantle any racking and shelving. And of course, there is the excess mileage charge, which can range from 10 cents to 20 cents per km.
One strategy is to consider buying out the vehicle at the end of the lease so that you don’t have to comply with any of those conditions. You can then use the vehicle for a while longer or resell it. Reselling it with the modifications should make it more valuable to another contractor.
Getting out of a lease is extremely difficult. Go to the website www.leasebusters.com and see the number of people trying to get out of their leases. Last time I checked there were 140 trucks, excluding mini-vans and SUVs, trying to get out of their leases across Canada. Some have no mileage restrictions others have up to 20 cents per kilometre charge for excess mileage. This could be a good source for acquiring a vehicle that is already on lease or getting out of a lease you are stuck in.
Usually businesses are clear on their need for commercial vehicles and less likely to need to get out of a commercial lease than a car lease; however, you do want to be aware of all the implications of what is required when you return the vehicle or if you need to terminate the lease early.
Developing a relationship with the company you are acquiring the vehicle from will help mitigate any negatives. Also, many construction associations have arrangements with dealers and other providers of vehicles that avoid dealers. We will explore this in detail in part two of this article.
Another factor that we will address in part two of this article is where to go to get the best deals on purchasing or leasing commercial vehicles and what to watch for when returning a leased vehicle. We will also identify the times when a capital lease is a better option than an operating lease.
In part one of this article we explored many of the issues regarding buying versus leasing commercial vehicles. There was no clear winner and each business needs to make its own decision. One deciding factor could be cash flow. If your business is tight for cash, you will likely find leasing an easier option. However, review our comments in part one of this article.
Two of my very successful HVAC contractors take opposing positions on this issue. One leases the other purchases.
The arguments for the lease: We do three-year leases on new vehicles. We do not do excessive mileage. Our vehicles always look new, we have very few repair bills (as they are under full warranty), and we have virtually no downtime due to vehicle failure. We use our cash to generate profits in our business as it is not tied up in our vehicles. At the end of the lease we are not stuck with a vehicle we don’t want so we don’t have the hassle of selling it.
The arguments for purchasing: We keep our vehicles for a minimum of five years. We do excessive mileage. We maintain the vehicles well. We get five years out of outfitting our vehicles. We put our branding on them and racking and shelving. We have an asset at the end of the day. We believe that this is significantly cheaper than leasing because we commit to five years and of course we have the option of continuing at our convenience. We trade the vehicles at a time of our choosing.
Fleet management businesses are growing. They provide businesses with an array of services such as capital leases for vehicles, seasonal leases, step-up leases, vehicle purchases and a host of other fleet management services. Rather than going directly to an auto dealership there is the option of going to a fleet management company. They work directly with the auto manufacturers to get deals for their clients. For example, Heating, Refrigeration and Air Conditioning Institute of Canada (HRAI) has a member partner program for fleet management and vehicle leasing with Addison Fleet. MCA also has a similar program for their members. Mechanical Contractors Association (MCA) Canada works with Chrysler to get benefits for their members. Check with your Association to see what they offer. Fleet management businesses also provide solutions for operating costs. So, do a comparison between them and going directly to dealerships. Also, at your next association meeting talk to some of the other contractors and see what they are doing.
Whichever way you go, developing a relationship with one supplier is your best bet. They will be more flexible with end of lease charges and with changes to lease agreements. They want to retain your business by making the relationship win- win.
If you do decide to lease, make sure that you negotiate the payments. Historically dealers get higher prices when they make a lease rather than when they sell a vehicle. That additional $20 per month, tagged on to a lease payment that you don’t try to negotiate down, adds up to almost $1,000 over a 48-month lease. Leasing contracts are not standard documents; you need to understand the fine print on each lease. A common clause in lease agreements is the number of kilometres you can drive and the penalty for exceeding that limit. Can you live within the mileage limit? Build in an allowance for exceeding the limit. A 20,000 km excess over a four-year lease @ 20 cents will cost you an additional $4,000.
When you purchase a vehicle, the dealer will usually try to get you to let them finance it. Unless they are offering a very attractive promotion you will generally be better off using bank financing. Compare the cash price to the financed price.
Some don’ts
- Don’t get into a lease unless you are sure that you need the vehicle for the full term of the lease.
- Don’t get into a lease unless you understand and accept all the terms of the contract.
- Don’t get into a lease if you intend to make major modifications to the vehicle.
- Don’t get into a lease if you are likely to damage the vehicle because of the type of work you do.
- Don’t get into a lease unless the residual (“buy back”) value is defined and reasonable.
- Don’t pay list price.
- Don’t pay an excessive interest rate.
Some Dos
- Once you decide what vehicle you want to shop around for the best deal (dealership/fleet management company).
- Make sure you know the charge for excess mileage (try to get it waived).
- Know the buy-out value at the end of the lease.
- Be aware of any restrictions and what you must do at the end of the lease before returning the vehicle.
- Check with your Association. Maybe they have a preferred program with certain dealers or fleet management companies for their members.
- If at the end of the lease your vehicle is in good condition consider renewing the lease or buying it out. That way you will get extended value for any modifications or branding.
- When returning a vehicle at the end of the lease make sure you return all the bits and pieces that you got with it. Try to get a checklist from the dealer. A missing key fob can cost you $800. Floor mats, cargo mats, any GPS equipment, owner manuals, luggage crossbars, cargo covers, and wheel rims are examples of items that you may have to return or pay for.
- If you are leasing a replacement vehicle you should find the dealership easier to deal with as they will see the benefit in the continued relationship.
To make your decision-making process clearer here are some key elements of a capital lease.
- If you are a high mileage user there is no penalty.
- If there is going to be excessive wear and tear on the vehicle there is no penalty.
- Lessee retains full equity.
- The lessee can use the equity at the end of the lease towards a replacement vehicle.
- There is no early termination penalty, thus allowing more flexibility on an ongoing basis.
- The biggest risk for the lessor is that the market value of the vehicle at the termination of the lease is the residual value. This is where the early termination, the high mileage and the excess wear and tear come into play.
Do check with your accountant before signing a capital lease. Ultimately the decision to buy or lease is a trade-off decision that you must make depending on your specific circumstances. Weigh up the pros and cons and go with whichever route makes the most sense for your business and your drivers. The differences in whether to buy or lease is not a decision that is going to have a huge impact on your business. However, you should always negotiate the best deal and make sure you are managing your operating costs effectively. Paying too much never makes sense. The longer-term financing for purchasing vehicles that are now available can make the financing difference between a lease and a purchase a lot smaller.
Your Plan of Action
- Understand the implications of all documents you sign.
- Be clear on the outcomes you need for your vehicle.▪
