What's a Lease?

Tessa Author

Leases are a standard way for businesses to use resources without the hefty upfront cash payment that comes with a purchase.

What's a Lease?

A lease is a financial transaction between [usually] two parties, a lessor and a lessee. In a lease arrangement, a lessee obtains the right to use the goods or property in exchange for a consideration given to the lessor. Consideration is something of value, typically a monthly rent check; occasionally, it's a lump-sum payment or services.

In a real estate lease transaction, we refer to the lessor and the lessee as the landlord and the tenant, respectively. The landlord carries the cost of building operations and maintenance, while the tenant pays rent for the right to use the space and reimburses the landlord for the care, taxes and, insurance as negotiated in the lease terms.

There are many different lease structures, making space and equipment rental an excellent strategy for companies that desire flexibility, expense stability, and prefer to focus on their core business instead of the property upkeep.

How are leases used in business?

The most common type of rental engagement is an Operating Lease, where the rights to use the asset do not represent a significant portion of the asset's value. This strategy is perfect when buying is unnecessary.

For example, consider a boutique store that signed up for a 3-year lease of retail space to test the market. Three years isn't significant to the building's life, while the store-owners aren't even thinking of purchasing a site before they know the market.

Leases can also be a form of long-term financing when structured as a Finance Lease or another similar special-purpose arrangement. Here, the tenant would not officially hold title to the property but will have other ownership-like benefits, like tax deductions.

What can you lease?

You can lease practically anything. If you can buy it, you can likely rent it, from the short-term rental of designer purses to the long-term rental of prestige buildings and everything in between.

Personal property, usually movable, includes a range of equipment that serves all from the office to the construction site and vehicles, such as cars, vans, and busses, to name a few.

Real estate property and buildings also have classes that vary between residential and commercial. The commercial properties have several subgroups based on space use types, such as office space, retail store, or a distribution center.

Many lease provisions apply universally to all lease agreements, regardless of the leased asset. However, each asset class has its unique clauses and provisions. Be on the lookout for use-specific items.

Not all leases are created equal.

The purpose of a lease engagement is to reduce the cost of resources by only paying for the use. Although the lessee doesn't hold the legal title to the property, they are frequently not responsible for the sometimes-hefty cost of repair, insurance, and taxes, either. The inclusion of service charges in the lease depends on the leased property type and demand.

Surprisingly, borrowing someone else's stuff in exchange for payment doesn't always constitute a lease, even if it is in writing (best that it is). A contract must meet specific characteristics to be a lease for legal purposes and financial reporting.

Contractual Obligations

Besides following the terms set out in the contract, leases between private individuals are governed by the states' laws. In contrast, all commercial leases for personal property must follow the guidance in the Uniformed Commercial Code (UCC). Personal property excludes real estate property regulated by a separate set of state and federal laws.

The two main characteristics of a lease from a legal standpoint are that title of the property must remain with the lessor, and possession by the lessee is temporary.

Financial Instrument

In addition to being a legally binding contract, leasing is an excellent financial strategy that preserves cash flow and often reduces financial statement impact.

From the lease administrator's view, a lease [record] creates a financial obligation, extinguished by the payment issued during the monthly rent roll. However, just because there's a rental fee, it doesn't mean that it's a lease per the financial reporting standards set by the Financial Accounting Standards Board (FASB) for U.S. companies.

Financial reporting standards guide how both landlord and tenant should properly report lease engagements on their books. And the answer here would differ based on the purpose, property type, and materiality of the arrangement.

However, the standards are clear on the two conditions for an arrangement to be considered a lease. There has to be an identified asset, and the lessee needs to have complete control over that asset during the lease term. Overwise, it's not a lease for accounting purposes.

Is leasing better than ownership?

Whether leasing is better than ownership depends on many different variables, including your financial position, time commitment, and space availability to start. Each item you lease will have its challenges and benefits to own and lease - it's just the way of the world.

Here are a few questions to consider as you ponder the benefits of leasing vs. owning in your situation:

• Why do you need to use this property? Can you substitute with something you already have?
• How long do you plan to use it? A need for a short-term use justifies leasing, while a purchase is better for something you plan on using for a long time.
• Can you store, operate and maintain it? Are you able to do it all by yourself, or do you need to enlist additional resources and costs?
• Can you fix it? It's OK if you don't. Many rental places will take care of service and repair, whereas you'll carry those costs with ownership.
• Can you afford to buy it? And if so, is it worth it? What is the opportunity cost of the money you spent, meaning the next-best alternative use for it?

With ownership, you have more control over the use and benefit derived from the property. Alternatively, the cost to lease is generally less than the installment payments to purchase, making it a more affordable option in most cases.

Final Thoughts

Which is better is hard to say and largely depends on your circumstances and strategy. Leasing offers the flexibility that's hard to negotiate with a purchase. Also, as your situation changes, so should your attitude towards leasing.

It's just another tool in the business toolkit to provide resources for your team without the significant capital outlay upfront. There are plenty of other ways to use leases in your business. Although it's easy to manage a few, as the portfolio grows with the company, the process may become more complex.

Does your business use leases in its operation? If yes, please share whether you have a lease admin team, or is the function dispersed amongst many groups? Otherwise, what's stopping you from leasing? Please leave your comments on social media (LinkedIn or Facebook) or email the team.

Categories: : Lease Data