Believe it or not, the leasing industry has many sneaky tricks that are still in use today. I want you to know what they are so you can protect yourself from paying WAY too much.
In this second part of a three-part series, I will cover:
Sneaky Trick #5 — Software Fair Market Value: Set-Up for a Nasty Surprise,
Sneaky Trick #6 — Interim Rent: Extra Fees that Would Make a Pickpocket Envious.
Moral
Fore-warned is fore-armed. Your best defense against sneaky tricks is your own expertise. The next best thing is to work with a computer source (yes, like Source Data Products) that knows all the tricks and has a built-in incentive to protect you from them…because they depend on your loyalty over the long term — lease after lease. Beware of “strategic partners” that are more interested in quick bucks than in long-term business relationships. You might be thinking “partnership” but they are pursuing their own strategy. Guess who is going to “get the business.”
Sneaky Trick #5 — The Leasing Company WANTS to Lease Your Software.
You just finalized a $500,000 license for new software to transform your business. You get a “great finance deal” to lease your software for five years, with an FMV lease providing lower rates than a fixed buyout lease.
At the end of the lease, who owns the software? Hint: You don’t. The leasing company does. So what’s the fair market value for this software that is now critical to your operation and to your competitive stance in the market? Well, now the software company wants $1 million for the software. Do you think it is close to worthless because you had to customize it, making your version of little value to another buyer? In fact, there is generally no secondary market for used software because it is licensed to your enterprise. The leasing company may suggest that the FMV is $500,000 to $1 million because that’s the fair price you would have to pay now. And while you haggle over that, the lease auto-renews. Gotcha!
Sneaky Trick #6 – Interim Rent (aka “Stub” Rent)
You have arranged for lease financing for a $150,000 project. You will be receiving equipment and software over a period of three months due to various lead times from your different suppliers. The leasing company has a tricky provision for such an interim.
Many lessees enter into lease transactions that they believe are competitive, based on faulty rate assumptions. Most lease rate calculations don’t take interim rent into consideration. Interim rent is a trap door that allows lessors to receive increases in lease pricing. It is unpredictable and the amount can be arbitrary. By understanding how interim rent can impact your lease, you can close this trap door and enjoy the lease pricing you thought you had negotiated.
What is Interim Rent? Interim rent — also known as stub rent — is the rent that a lessor charges a lessee from the time the lessee accepts the leased equipment until the official lease start date. Most leases start on the first day of the month following equipment acceptance. In a lease with monthly payments, interim rent is calculated as follows: multiply the number of days in the interim period by the monthly payment amount and divide the product by 30. In the extreme case, interim rent can add almost a full periodic payment to the lease. In these cases it lifts the effective lease rate dramatically.
The impact of interim rent can be seen in the following example. Assume you accept a 36-month lease for equipment that cost $100,000. Also assume that the monthly payment is $3,113 per month, paid on the first of each month, and that the lease allows you to acquire ownership of the equipment for $1 at lease end. Therefore, your effective lease rate is 8%. Now assume that the interim lease period is 29 days. For the sake of simplicity, we will round the period to a full month and add it to the lease. The new effective rate for 37 payments of $3,113 is 9.7%. The new rate is more than 20% higher than the rate originally quoted by the lessor. This higher rate represents a trap door in your lease that produces more cost for you and a higher return for the lessor.
Many lessors justify interim rent as compensation for obligating themselves to pay equipment vendors on behalf of lessees in connection with lease transactions. As further justification, these lessors point out that lessees have use of the equipment during the interim period. But there are two flaws in this reasoning. First, interim rent is exorbitant because it is based on the periodic lease payment instead of on the lessee’s borrowing rate. Since each lease payment has a return-of-capital component, the periodic payment is not an appropriate standard to use for interim rent calculations. A calculation based on the lessee’s borrowing rate is probably a fairer measure.
The second flaw in the reasoning is that lessors often have not paid for the equipment during the interim period. In fact, they may not have incurred any additional cost at all during this period. The net result is that lessees incur significant increases in their effective lease rates while lessors are able to sneak in extra yield through a trap door in the lease. Interim rent can turn a competitive lease into a relatively high-rate transaction.
Savvy lessees look for ways to limit or eliminate interim rent. They try to ensure that they receive the lease deal for which they bargained. Here are five strategies to blunt the impact of interim rent:
Solutions
1. Eliminate interim rent. Try to negotiate a lease that excludes it. One way to do this is to have the interim period count as a partial payment period. Another partial payment period can be added at the end of the lease, such that the two periods constitute one full payment period.
2. Pay interest instead of interim rent. Instead of paying interim rent based on the periodic payment, base it on the implicit transaction rate or your borrowing rate. This method will eliminate the return-of-capital component that plagues most interim rent calculations.
3. Limit or fix the amount of interim rent. If you cannot eliminate interim rent, you can try to negotiate a limit on it, offering the lessor a fixed interim period, regardless of the equipment acceptance date.
4. Manage equipment deliveries. The strategy is to coordinate with the equipment vendor to schedule equipment delivery and acceptance towards the end of the month. End-of-the-month acceptances would ensure a reduction in interim rent since the interim periods would be short.
5. Sale-leaseback at month end. As a last strategy, if allowed by the lessor, you could schedule a sale-leaseback of newly acquired equipment at month end. This strategy would also guarantee a short interim period.
It is important to understand the impact of interim rent on your lease. Rather than assume that you will receive the lease rate quoted, review the lease carefully. If your lease includes interim rent, plan to negotiate this feature. Use one of the strategies above to reduce this potentially costly aspect of your lease. Even if you cannot eliminate the interim-rent trap door, you may be able to ameliorate it.
P.S. The final part of the series will cover Last Minutes Addenda (You May Be Getting Tricked); and What Happens When the Leasing Company Takes a Big Residual (You May Really Be the One Holding the Bag)
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