The growth in leasing indicates that it often has some genuine advantages over owning property, such as:
1. 100% Financing at Fixed Rates. Leases are often signed without requiring any money down from the lessee. This helps the lessee conserve scarce cash—an especially desirable feature for new and developing companies. In addition, lease payments often remain fixed, which protects the lessee against inflation and increases in the cost of money.
2. Protection Against Obsolescence. Leasing equipment reduces risk of obsolescence to the lessee, and in many cases passes the risk of residual value to the lessor. Naturally, the lessor also protects itself by requiring the lessee to pay higher rental payments or provide additional payments if the lessee does not maintain the asset.
3. Flexibility. Lease agreements may contain less restrictive provisions than other debt agreements. Innovative lessors can tailor a lease agreement to the lessee’s special needs. For instance, the duration of the lease—the lease term—may be anything from a short period of time to the entire expected economic life of the asset. The rental payments may be level from year to year, or they may increase or decrease in amount. The payment amount may be predetermined or may vary with sales, the prime interest rate, the Consumer Price Index, or some other factor. In most cases the rent is set to enable the lessor to recover the cost of the asset plus a fair return over the life of the lease.
4. Less Costly Financing. Some companies find leasing cheaper than other forms of financing. For example, start-up companies in depressed industries or companies in low tax brackets may lease to claim tax benefits that they might otherwise lose. Depreciation deductions offer no benefit to companies that have little if any taxable income. Through leasing, the leasing companies or financial institutions use these tax benefits. They can then pass some of these tax benefits back to the user of the asset in the form of lower rental payments.
5. Tax Advantages. In some cases, companies can “have their cake and eat it too” with tax advantages that leases offer. That is, for financial reporting purposes companies do not report an asset or a liability for the lease arrangement. For tax purposes, however, companies can capitalize and depreciate the leased asset.
As a result, a company takes deductions earlier rather than later and also reduces its taxes.
6. Off–Balance-Sheet Financing. Certain leases do not add debt on a balance sheet or affect financial ratios. In fact, they may add to borrowing capacity.1 Such off–balance-sheet financing is critical to some companies.