The following article appears in the journal JOM, 53 (8) (2001), p. 48. JOM is a publication of The Minerals, Metals & Materials Society

If It Appreciates, Buy It. If It Depreciates, Lease It

Leasing or buying—which is better? Isn’t it always better to be an owner? The answer: sometimes. According to oil baron Paul Getty, “If it appreciates, buy it. If it depreciates, lease it.” Getty’s thoughts are words to live by for the metalworking industry. There are many benefits to both buying and leasing, depending on the type of property involved.

Businesses have two property types— real and personal. Real property encompasses buildings and other permanent structures, and the land on which they stand. Personal property includes furniture, fixtures, and equipment—everything from shelving to desks. Buying is often most beneficial when financing real property, because it will appreciate and gain value over time. Owning real estate—and the structures on it—is almost always a good investment for the long haul. Property owners build equity and reap the benefits of the property’s increasing value.

However, shops are heavily comprised of machinery—which is in the category of personal property and, therefore, depreciates in value over time. What’s more, technology is always changing, systems are always improving, and the equipment needs to be updated and replaced every few years. For everything that needs to be replaced every few years, therefore, leasing is very often the best option.

Another decision facing the metal-working industry is trust. Can a lender be trusted to help with crucial buying-versus-leasing decisions? Which lender is the most qualified to tailor the best financing solution for a particular business?

Many important factors must be considered before deciding upon a lender. Among them:

• Is the lender committed to your industry?
  Although local banks may be more familiar, a commercial lender that knows your industry can make the documentation and review process run a lot more smoothly. Find out how many industrial transactions your lender has completed.
  
  
• How much industrial finance experience does your account representative have?
  While it is important for a financial institution to be committed to your industry, it is also important that the person working on your account knows the intricacies of your market. Your account representative’s working knowledge of environmental-compliance issues, unique labor-force needs, and the challenges of running a metalworking shop will likely prove helpful during all stages of the financing process.
  
  
• If the bond market slips, will your lender be able to fulfill your financing?
  In late 1998, when the bond market dipped severely, a number of securitization lenders backed out of commitments in the 11th hour. Now, the Wall Street Journal, Barron’s, and countless other publications have reported that the situation may be recurring. If your lender is a securitizer, it depends on the strength of the bond market to close deals, because it sells your loan off to a third party after it closes. An investment-grade lender that holds its own paper and services its own loan accounts is the safest bet, particularly during fluctuating business cycles.
  
  
• Does your lender offer a turnkey product?
  Turnkey financing for land, building, and equipment is the most convenient way to finance the entire package. The turnkey option is best whether you are buying or leasing, recapitalizing, or refinancing to maximize your company’s growth.
  
  
• How long has the lender been in business?
  The economy has been booming, and as a result, many lenders have entered the market in recent years. Avoid fly-by-night lenders by investigating how long a financial institution has been in business.

Buying land and buildings is a very traditional, natural process, and purchasing equipment, especially large, capital items, has historically been the main—or only—option available. However, leasing equipment is becoming the mainstay in the industrial sector, and progressive businesses are reaping the benefits.

One of the main advantages to leasing is it allows businesses to upgrade or improve without making a substantial, upfront investment. The large down payment traditionally required for a property purchase can be prohibitive. Leasing eliminates that burden by providing 100 percent financing, which facilitates making upgrades or changes on a regular basis. By freeing up working capital, shops can invest in their businesses as desired.

From a management perspective, leasing simplifies budgeting because if offers a set payment every month. In addition, lease financing may be structured to appear off balance sheets, so it eliminates liability associated with property. Therefore, leasing, which provides a viable alternative to bank financing, helps businesses manage their bank-leverage ratios.

Another advantage to leasing is its flexibility—a lease can be modified as often as necessary for a business to remain competitive. In addition, leasing terms are developed based on the useful life of the asset. These terms are advantageous because at the end of the agreement, the property can be returned or replaced for new equipment.

Virtually all kinds of equipment can be leased—from production equipment to office computers. Several types of leases are available, and they can be combined or mixed and matched, based on needs.

A capital lease, which is recorded on the books as debt, falls under liabilities. A capital lease allows 100% of the cost of new equipment to be financed, and it can be extremely useful for many asset types— especially soft assets.

Unlike a capital lease, an operating lease is not recorded on the balance sheet; it is not a liability but can be used as an asset. It is recorded in the notes of a company’s financial statement. This kind of lease helps enhance return on equity.

With a true lease, the lessor takes the depreciation benefit associated with purchased equipment. In turn, the lessee may benefit with a lower annual percentage rate. A non-true lease, however, allows the lessor to retain the tax benefits of the equipment, but the financing rates may be higher.

So whether your goal is to acquire, build, upgrade, refinance, or grow, simply remember Paul Getty’s rule of thumb. At the end of the day, smart financial decisions today will help to strategically position your enterprise for the uncertain economic future.

Karen Pomazal is assistant vice president of Heller Financial.

For more information, contact Karen Pomazal, Heller Commercial Equipment Finance, 500 West Monroe Street, Chicago, IL 60661; (866) 243-5537; e-mail KPomazal@hellerfin.com.