What is the Lease Rate?
Lease rate is defined as the interest rate associated with leasing the asset during the period of the lease and can also be considered as the compensating amount which otherwise the lender would have earned if the same property/equipment/vehicle would have been put in some other use. E.g., suppose a person leases a vehicle. The leasing company, usually a bank, will buy the vehicle from the dealer and lease it to the user of the vehicle for a specific period till the user pays back the purchase price plus some extra money. This extra sum of money is termed as the leasing interest or lease rate.
Leasing also has another factor involved, which is called the lease rate factorThe Lease Rate FactorThe lease rate factor is the regular payment that one needs to make when an asset is taken under the lease agreement and is usually expressed as a percentage of the total price of the equipment leased.. It can be explained as the periodical payback, which is further expressed as a percentage of the original cost of the leased object, i.e., equipment, vehicle, building, etc.
Primarily the two widely used lease rate or lease factor, which is very common is the car lease rate and space lease rate.
Example of Lease Rate Calculation
Suppose equipment to be used in production is leased for an expected short term demand for the upcoming 3 years with equipment value $50,000. Thus lease term set is three years or monthly payments required for 36 months. If the current interest rate is 5%, then the lease rate factor is calculated as (0.05/36) or 0.0014. The depreciated value of the product stands at $15,000 after 3 years, and thus the equipment value for the tenant company will be ($50,000 – $15,000) =$35,000.
Taking the impact of the depreciated value, the monthly lease paymentMonthly Lease PaymentLease payments are the payments where the lessee under the lease agreement has to pay monthly fixed rental for using the asset to the lessor. The ownership of such an asset is generally taken back by the owner after the lease term expiration. will be ($35,000/36) = $972/month. Thus taking into account the lease rate factor, the interest will be calculated as ($50,000+$15,000)*0.0014 = $91. This monthly payment which the company has to make for leasing the particular equipment stands as $972+$91 = $1063.
How to Calculate a Lease Rate? (Commercial Leasing)
Lease rate is primarily applicable for two widely known leasing practices i.e.
- Real Estate/Space leasing
- Cars and Equipment leasing;
#1 – Space Leasing
In space leasing, it is the price paid for the occupancy cost, generally determined as a monetary amount on a square feet basis for a year. It is an agreement which is required to determine whether the amount needs to be paid monthly or yearly.
The leasing agreement will be as such that it will clearly state the terms of the leasing and till what period the rate of leasing is applicable. It may also include a policy of incremental leasing rate when the agreement states that the lease is for multiple years, and the rate will increase with every year.
The tenant can formulate the actual pricing for the lease by calculating the cost of renting a space. In addition to the lease rate, it also needs to be decided whether the lessorLessorA lessor is an individual or entity that leases out an asset such as land, house or machinery to another person or organization for a certain period. or lessee will have to bear extra cost such as maintenance and tax on property. Generally, commercial lease rates are available on a square foot basis, which further makes it convenient for the lessee to have a comparison of leasing rates of various available properties.
#2 – Car and Equipment Leasing
When it comes to car/vehicle or equipment leasing, the payment made per month for the vehicle is dependant is based on the depreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. the vehicle undergoes and the sunk costSunk CostSunk costs are all costs incurred by the firm in the past with no hope of recovery in the future and are not considered while making any decisions since these costs will not change regardless of the decision's outcome. after the period of leasing. It is also dependant on the lease rate.
Based on paying monthly, the lessee reimburses the car/vehicle provider on dual grounds, i.e., the depreciation which the vehicle undergoes and for the opportunity cost, which is lost by engaging the money in automobiles instead and not utilizing it somewhere else.
When it comes to car or equipment leasingEquipment LeasingEquipment Lease is where the equipment owner allows another party to use it in exchange of periodic rentals with no transfer of ownership and has the right to cancel the lease right away in case of breach of the lease agreement., the lease factor is almost like an interest rate. The repayments comprise of the factor of leasing, which is also known as the money factor that entraps the financing perspective of car/equipment leasing.
Difference Between Car and Space Lease Rates
In-car and equipment leasing the company which leases out the objects primarily purchases the car or equipment from third-party dealers or agents and provides us the same on rent. It means that we are paying for the loan which the lessor has borne to purchase the item by lending money upfront to buy the car/equipment.
At times both the car provider and lessor can be the single entity where a third-party contract provides the car provider to sell stock to the lessor. Further, this is used to produce revenue on these assets/objects before transferring back the car/equipment back to its provider as used items. The lessee, on the other hand, gets the object which can be used even without being the owner or bearing the pressure of owning it.
When it comes to real estate, the prime purpose of it is to generate rental income from the tenants. Thus, only two parties get involved in this mode of execution, and any reimbursement for the inceptive application of funds into the real estate is covered up in the rate of leasing as the strategy of the entire business setup.
When to Lease?
- There is a constant on-going debate about when to lease space/equipment and when to own the entire thing as a whole. The main factor which plays importance in leasing is the concept of time and time value of moneyTime And Time Value Of MoneyThe Time Value of Money (TVM) principle states that money received in the present is of higher worth than money received in the future because money received now can be invested and used to generate cash flows to the enterprise in the future in the form of interest or from future investment appreciation and reinvestment.. In simple words, we need to take into account how long we are going to use the leased property.
- To minimize the residual/sunk cost when the demand for certain equipment is only meant for a short term basis, leasing is considered to be the ideal decision. These can be cases of operational requirements needed for expansion or growth coupled with temporary market conditions. At this point, leasing is an idle scenario because it reduces the burden of owning the equipment as a whole and thus ending up with a huge sunk cost at the end.
- When the requirement or demand for certain equipment is considered to be a long term purpose, owning or ownership is the best decision. Also, in the case of real estate, the value appreciates, which can add value to the initial investment made.
- Also, when a company does not want to focus on non-core business issues like equipment and property maintenance, leasing can be an option as it removes the burden of owning the same and again maintaining it too.
The lease rate is very important to understand and estimate the overall payment, which needs to be made for the lease or else the lessor can easily add few extra amounts, and the lesseeLesseeA Lessee, also called a Tenant, is an individual (or entity) who rents the land or property (generally immovable) from a lessor (property owner) under a legal lease agreement. will not even come to know about it. A small extra amount added every month unknowingly can turn out to be a big number at the end of the lease period. Thus the lease rate helps us to understand the overall cost of leasing.
This article has been a guide to what is the Lease Rate. Here we discuss the example of the lease rate calculation along with two leasing practices – car lease and space lease. You can learn more about accounting and financing from the following articles –