Direct Lease

Article byGayatri Ailani
Edited byRaisa Ali
Reviewed byDheeraj Vaidya, CFA, FRM

Direct Lease Meaning

A direct lease is a contractual agreement under which the lessor uses the existing asset or purchases it directly to lease it to the lessor. The lessor’s business is to purchase the specific asset, lease it to customers, and make a profit.

Direct Lease

In a direct lease, the lessor performs the role of a third-party owner, like a bank or an investment entity that buys and owns the leased asset. The lessee can secure and satisfy the expensive machinery and equipment needs essential for achieving the forecasted production without actually investing in the procurement of machinery and equipment. In a business scenario, it benefits many enterprises, especially startup companies. Businesses might save money in this way to satisfy their needs for working capital.

Key Takeaways

  • The direct lease definition portrays it as a lease in which the lessor purchases the asset and leases it out to the lessee outright.
  • It is generally categorized into the bipartite lease and tripartite lease. A bipartite lease involves only two parties, supplier-cum-lessor, and the lessee. A tripartite lease involves three parties, the supplier, the lessor, and the lessee. 
  • Its element is also seen in true tax financing, operating lease financing, and master lease financing.
  • Operating leases and sales-type leases are different concepts. An operating lease occurs when the lessor retains the ownership and grants the right to use the property to the lessee. In a sales-type lease, the right to ownership is transferred to the lessee.

How Does Direct Lease Work?

Direct lease is divided into two types: bipartite and tripartite. A bipartite lease involves only two parties, the lessor and the lessee. Significantly, the lessor owns the equipment and leases the equipment directly to the lessee. In contrast, a tripartite lease contains three parties, the supplier, the lessor, and the lessee. The equipment moves from supplier to lessor to lessee. In other words, the lessor obtains the equipment from the supplier and leases it to the lessee.  

Banks and equipment leasing companies or direct leasing companies usually offer direct leases. An equipment leasing company is an NBFC (Non-Banking Financial Firm) specializing in leasing equipment or financing a lease. In the case of any financial lease arrangement, usually, the lease length cannot be fixed for less than three years, and equipment leasing businesses are prohibited from trading, holding, and conducting real estate activity. The only exception to this rule pertains to computers and IT accessories.

Banks and other lending institutions, such as equipment leasing companies, frequently provide direct lease financing. Direct leasing operates under an accounting premise that records losses but not gains. Therefore, the lessor should examine the estimated value of the leased property annually. The lessor will recognize the depreciation as a loss in the current period if the residual value has decreased and the decline appears to be permanent. At the same time, the gain is not recognized if the residual value has grown.

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Examples

Let us look at direct lease examples to understand the concept better: 

Example #1

Numerous firms need printing tools, such as large-format printers and printing presses, which may be costly to buy and operate. Also, purchasing the most recent equipment might be difficult because print technology constantly evolves.

XYZ is a startup printing business that requires extra printing equipment to grow its business operations. The printing machine they wanted to buy had a market price of $50,000. So they decided to lease the machine from ABC Capital to save more for working capital.

ABC Capital (Supplier-cum-lessor) provides direct lease and financing options for printing equipment for companies in the print, sign, and graphic sectors. Hence ABC capital direct leasing solutions to both small and large businesses enable XYZ (Lessee) to swiftly and conveniently get the equipment needed without using up vast amounts of money, thus allowing them to conserve more for working capital. 

Example #2

A bank or bank affiliate that offers leasing as a part of its product mix is an example of a bank lessor. Banks control a significant portion of the leasing industry worldwide and engage in different types of leasing. 

A bank’s customer can rent a safe deposit box or safe deposit locker from the bank for a specific period. When it happens, the two parties are in a lessor and lessee relationship. The customer who rents a safe deposit locker is the lessee, while the bank is the lessor.

Direct Financing Lease vs Operating Lease vs Sales Type Lease

The difference between them is as follows:

  • A direct lease generally describes a circumstance in which the lessor leases the asset to the lessee. The lessor owns the leased asset or purchases it from the supplier.
  • An operating lease is a contract that grants the right to use the property but not the right to own it. In an operating lease, the lessor retains ownership. Ownership of the leased asset remains with the lessor when the operational lease expires, but the lessee can return it, extend the lease, or buy the item outright.
  • In a sales-type lease, it is considered that the lessor is really selling the leasing item to the lessee, necessitating the reporting of a profit or loss on the transaction.

Frequently Asked Questions (FAQs)

What are direct leases?

In a direct financing lease, the lessor leases their existing assets or purchases assets from a business to lease to its customers and generate profit from the interest payments.

What are the types of the direct lease?

There are two distinct contract types for direct leasing: bipartite leasing and tripartite leasing. In the first, a bipartite arrangement, the lessor already owns the property (equipment), and the lessor leases it to the lessee directly. The second kind of contract is a tripartite one, where the lessor—often a bank or lending institution—purchases the asset from a third party and leases it to the lessee.

What are the advantages of the direct lease?

It is helpful to many businesses, specifically startups, because the entities can obtain and meet the expensive machinery and equipment requirements necessary to meet the estimated output without actually spending on its purchases. It helps businesses to save funds for meeting working capital requirements.

This article has been a guide to Direct Lease and its meaning. We explain its examples and comparison with operating leases and sales-type leases. You may also find some helpful articles here –