Lease Calculator

What is a Lease?

A lease is a contract in which the owner of an asset, the lessor, lets someone else, the lessee, use it for a set period in exchange for regular payments. The lessee gets the use of the asset without buying it outright, and the lessor keeps ownership and earns a return. At the end of the term the asset goes back to the lessor unless the lease gives the lessee an option to buy it.

Almost anything durable can be leased: cars, apartments, office space, farmland, aircraft, medical and construction equipment, computers and software. Leases differ in who handles maintenance and insurance, whether there are mileage or usage limits, whether the lessee can buy the asset at the end, and how much it costs to end the lease early.

Financially, a lease resembles a loan for only part of an asset's value. The lessee pays for the portion of value used up during the term, plus a charge for the lessor's money, which is why lease payments are usually lower than loan payments on the same item.

Residual Value

Residual value is the asset's estimated worth at the end of the lease. It is the single biggest factor in a lease payment, because the lessee pays mainly for the difference between the starting value and the residual. With the defaults, a $20,000 asset that will be worth $8,000 in three years loses $12,000 in value, and at 6% the monthly payment is $405.06.

For vehicles, leasing companies set residuals as a percentage of the manufacturer's suggested retail price, based on forecasts of used-car values. Models that hold their value well get higher residuals and therefore cheaper leases. For equipment, residuals depend on expected wear and obsolescence. A higher residual lowers the payment but, in a lease with a purchase option, raises the price of buying the asset at the end.

PMT = [V − R ÷ (1 + r)ⁿ] × r ÷ [1 − (1 + r)⁻ⁿ]

V

asset value (for a car, the negotiated price or capitalized cost)

R

residual value at the end of the lease

r

monthly interest rate (annual rate ÷ 12)

n

number of monthly payments

The payment repays the drop in value, V − R, plus interest on the full value, because the lessor's money is tied up in the whole asset until it is returned.

Leasing a Car

Car leases are the most familiar consumer leases. Terms usually run 24 to 48 months, with 36 months the most common, and include an annual mileage allowance, often 10,000 to 15,000 miles. Driving more triggers a per-mile charge at turn-in, typically 15 to 30 cents, and excess wear and tear is billed too.

Several terms are specific to auto leases. The capitalized cost is the negotiated price of the car plus any fees rolled in; a capitalized cost reduction is a down payment or trade-in that lowers it. The money factor expresses the lease rate as a small decimal; multiply it by 2,400 to get an approximate annual rate, so a money factor of 0.0025 is about 6%. Lessors often charge an acquisition fee at signing and a disposition fee at the end, and in most states sales tax is applied to each monthly payment rather than the full price.

Leasing appeals to drivers who want a new car every few years, lower monthly payments and coverage under the factory warranty for the whole term. The drawbacks are that you build no equity, mileage and modification limits apply, and ending early can be expensive. Buying usually costs less over the long run for drivers who keep cars for many years. As with buying, the price of the car is negotiable, and lowering the capitalized cost lowers the payment.

Before signing, ask for the capitalized cost, residual value, money factor, fees and mileage allowance in writing, and use the calculator to check that the payment matches. The federal Consumer Leasing Act requires lessors to disclose these key terms.

Business Leasing

Businesses lease equipment, vehicles, technology and property to preserve cash and credit lines for other uses, to match costs with the revenue an asset produces, and to avoid owning things that quickly become obsolete. Leasing can also bundle in maintenance and upgrades.

Business leases generally fall into two groups. An operating lease covers use of an asset for part of its life, with the lessor keeping the risks and rewards of ownership; computers and vehicles are typical examples. A finance lease, sometimes called a capital lease, transfers substantially all of the risks and rewards to the lessee, often with a bargain purchase option, and works much like buying with a loan.

Accounting rules now put most leases on the balance sheet. Under the U.S. standard ASC 842 and the international IFRS 16, lessees record a right-of-use asset and a matching lease liability for leases longer than 12 months, which affects reported debt and financial ratios.

Tax treatment differs from accounting treatment. For U.S. federal tax purposes, payments on a true lease are generally deductible as a business expense, while a lease that is really a purchase is treated as a financed acquisition, with depreciation and interest deductions instead. Businesses should weigh the after-tax cost of leasing against buying, possibly with Section 179 expensing, before deciding.

Leasing Real Estate

Real estate leases come in many forms. Residential leases for apartments and houses usually run 12 months, though month-to-month and longer terms are common. Commercial leases for offices, shops and industrial space typically run 3 to 10 years or more and are far more negotiable.

For residential tenants, the main terms to understand are the rent and due date, the length of the lease, the security deposit and the conditions for its return, the rules on pets and alterations, who pays which utilities and how repairs are requested. Renters can use the rent calculator to check whether a lease fits their budget.

Before signing a commercial lease, compare the effective rent over the full term, including escalations, operating cost pass-throughs and concessions, rather than just the starting rate. Because commercial leases are long and complex, having a real estate attorney review the terms is usually money well spent.

Commercial leases differ mainly in who pays the property's operating costs, and they contain several other terms worth negotiating:

• Gross lease: the tenant pays a single rent and the landlord pays property taxes, insurance and maintenance. Common for offices and residential rentals.
• Modified gross lease: a middle ground in which some costs, such as utilities or janitorial service, are passed to the tenant.
• Net lease: the tenant pays rent plus a share of the property expenses. In a single net lease the tenant pays property taxes; in a double net lease, taxes and insurance; in a triple net (NNN) lease, taxes, insurance and maintenance. NNN leases are common for freestanding retail and industrial buildings.
• Percentage lease: used in shopping centers, the tenant pays base rent plus a percentage of sales above a set level.
• Ground lease: the tenant leases land, often for 50 to 99 years, and builds on it. The improvements usually revert to the landowner at the end.
• Rent escalation: most multi-year leases raise rent annually, either by a fixed percentage, typically 2% to 3%, or in line with an inflation index such as the Consumer Price Index.
• Tenant improvements: landlords often contribute an allowance per square foot toward building out the space, recovered through the rent.
• Concessions: free rent at the start of the lease is a common incentive in soft markets.
• Renewal and expansion options give the tenant the right to extend the lease or take more space on preset terms.
• Personal guarantees: small-business tenants are often asked to guarantee the lease personally, putting their own assets at risk if the business cannot pay.
• Subleasing and assignment clauses determine whether you can transfer space you no longer need.
• Security deposits for commercial space are often larger than for residential leases and may be replaced by a letter of credit.

Frequently asked questions

Sources

• CFPB – Consumer Leasing (Regulation M)
• FTC – Financing or leasing a car