A lessee is basically a person (or party) who under a contractual agreement rents land or property (usually immovable property) from a lessor (owner of the property) and the arrangement between the two when entered into a lease agreement becomes a legal contract.
That means the lessee is a tenant who has to fulfill all the imposed obligations as per lease agreement. The major obligation includes timely payment of periodical lease rents.
Components of Lease
#1 – Lease Agreement: It is a legal document between both the parties that authorize lessee to use the property under the agreement against a predetermined consideration to be paid periodically on time. It also includes all the terms and conditions, including the tenure of the lease.
#2 – The Lessor: LessorLessorA lessor is an individual who legally owns the asset granted on a lease (rented for a long tenure) to the lessee who pays a single lump sum amount or regular payments for using that asset. is the lawful owner of the property that the lessee takes into temporary possession to use for a specific purpose and a predetermined period against a predetermined consideration. During the lease agreement, the lessor retains the right of ownership of the property and has the right to receive periodic payments from the tenant based on the agreement.
#3 – The Lessee: The person who takes the property on leaseLeaseLeasing is an arrangement in which the asset's right is transferred to another person without transferring the ownership. In simple terms, it means giving the asset on hire or rent. The person who gives the asset is “Lessor,” the person who takes the asset on rent is “Lessee.” or rent.
Examples of Lessee
Example #1 – Standard Lease
Let’s say Wayne Manufacturers Pvt. Ltd wants to start a new production unit in the industrial area of South Dakota State.
However, it can’t afford to purchase a land and construct a factory premise; rather, it wants to lease out a factory premise where it can install its machinery and begins production as soon as possible.
Wayne approaches ABC Rental Company that informs Wayne that Stark Industries has recently winded up their business, and their property, including factory premises, is available for leasing.
Wayne signs a lease agreement of 10 years with Stark for a consideration of $12000 per month. Where Wayne (Lessee) gains possession of the property, and in turn, it gives Stark (Lessor) a periodical lease rent.
Example #2 – Violation of Lease Agreement
If the tenant does not fulfill the lease terms, then he can face untimely termination of contract and evacuation from the property. For example, let’s say Wayne (lessee) conducted illegal activities on the property of the Stark (lessor), then Stark has the right to take necessary actions under the law, which includes the right to cancel the contract and evicting Wayne from the property.
Advantages and Disadvantages of Leasing for the Lessee
- Leasing or renting an asset for a specific period is a more economical option compared to purchasing an actual asset that requires high capital investmentCapital InvestmentCapital Investment refers to any investments made into the business with the objective of enhancing the operations. It could be long term acquisition by the business such as real estates, machinery, industries, etc..
- The lessee can finance 100% from lease financing and is able to avoid even initial investment in margin money as required under loan financing in order to purchase the asset.
- The technologies are changing rapidly; lessee has to bear the risk of obsolescence if it purchases the asset. But with the lease, he can easily shift this risk upon the lessor.
- The tenant only uses the asset without owning it; therefore, such an asset does not become a part of the balance sheetThe Balance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.. It implies a higher rate of return on capital employedReturn On Capital EmployedReturn on Capital Employed (ROCE) is a metric that analyses how effectively a company uses its capital and, as a result, indicates long-term profitability. ROCE=EBIT/Capital Employed. and higher earnings against capital employedCapital EmployedCapital employed indicates the company's investment in the business, i.e., the total amount of funds used for expansion or acquisition and the entire value of assets engaged in business operations. "Capital Employed = Total Assets - Current Liabilities" or "Capital Employed = Non-Current Assets + Working Capital.".
- A lessee under a “finance lease” has an option where the ownership of the leased asset can be transferred in the name of the tenant at the end of the lease term.
- The lease rents can go higher if it includes a cost of risk of obsolescence; thus, it takes the financing of the asset to higher cost.
- The tenant may be deprived of the use of the leased asset in case of winding up of the leasing company;
- The tenant cannot make substantial changes to the asset as he is not the legal owner of the property. It is not a case if he buys the asset.
- The lessee has to pay some penalties, in case he terminates the lease contract before the expiry of the lease period.
Limitations for a Lessee
#1- Movable Properties
If the property is movable, for example, a vehicle under a lease, the lessee must keep its usage within certain mileage limits. The lessee has to pay extra fees if the mileage usage of the property (vehicle) exceeds the limits, as mentioned in the lease agreement. Any permanent or temporary damage to the vehicle may cause penalties to the lessee as per the lease agreement. However, the lessee has the right to service the vehicle from time to time and transfer the vehicle in its name at the end of the lease period.
#2 – Immovable Properties
A lessee for a commercial or residential property is imposed with other types of restrictions based on the usage of such immovable properties.
- A tenant cannot damage the property, or he has to bear the cost to damage.
- Lessee is not allowed to perform any illegal activities in the premise owned by the lessor.
- A tenant cannot sublet premises under lease or a part of it without lessor’s permission.
- A lessor has the right to obtain the possession of the property in case he needs to carry out repairs, alterations, or additions to the property, which can only be carried in a vacated property. However, after the repairs, the tenant can repossess the property.
#3 – Commercial Properties
However, with the permission of lessor, he can remodel the occupied property according to their business requirement. It can include repainting of walls, installing furniture and fixtures, installing machinery or plants, installing equipment that will be used during the course of business, or adding signage associated with the company’s brand.
#4 – Residential Properties
The lessee at residential properties is not usually allowed to make any permanent modification to the property like repainting of the property. Also, they might not be allowed to add any permanent decorations that can damage the property. However, tenant enjoys the right to privacy as a residential tenant, along with other basic requirements such as water, electricity, heat, etc.
A lessee is a party or a person that pays a consideration against using an asset or a property that is owned by the lessor. By signing a lease agreement, he saves a large sum of money to be invested in business activities.
This article has been a guide to who is a Lessee and its meaning. Here we discuss what role does lessee have in a lease agreement with the help of an example, advantages, disadvantages, and limitations. You can learn more from the following articles –