September 2010, Business Fleet - Cover Story
Leasing and the Price of Risk
By Chris Brown
As CEO, bookkeeper, accountant, chief cook and bottlewasher and - Oh, yeah - small fleet operator, you have enough on your business plate. Choosing the right lease for your fleet vehicles shouldn't add to your concerns.
For this reason, many small fleet operators find the simplicity of a closed-end commercial lease appealing. You make a uniform payment for a set term and, providing you're under the mileage cap and the vehicle is in good shape, you drop it back off at the dealer and walk away.
The other type of commercial lease is called an open-end lease. On the face of it, this one is a bit more complicated, as the lessee is on the hook for any unexpected difference in the vehicle's residual value at end of term. Are you willing to risk having to write a check to your lessor when you return the vehicle?
Many small fleet operators are. In return, they enjoy the flexibility, absence of lease restrictions and greater lessee control afforded by an open-end lease.
Assuming Risk
If you need to know exactly what you'll owe on a lease from beginning to end, the closed-end lease is the more appropriate solution for you. If the used-car market tumbles, you have the peace of mind that you're protected.
However, "For the leasing company to assume the risk of the residual, there has to be a cost," says C.J. Sutton, vice president of Sutton Leasing, a national fleet leasing company based in Warren, Mich. The company writes both types of leases, but most of Sutton's clients are on open-end leases.
The leasing company needs to protect itself in the event the vehicle is worth less than anticipated. The lessor will build this exposure into the monthly rate but, should a good used-car market boost your fleet vehicles' values, you're not going to get a check for the difference.
"You're automatically assuming the cost of that [residual value] risk even when used-car values are going up, as they have recently," Sutton says. On the flip side, "The open-end lease will give you the ability to capitalize on a good used-car market when you're done with the units," he adds.
Sutton points out that the values for used trucks have improved considerably from two years ago, when the fuel crunch was in full effect.
When an open-end lease reaches end of term, the leasing company will sell the vehicle for you and the proceeds will be applied to the termination balance. If the lessee is not comfortable with the expected sale price, the lessee has the right to sell it himself for a better return.
"It happens a lot," says Jeff Barron, president of San Francisco-based Ellis Brooks Leasing, a company that primarily writes open-end leases. "[The lessee] sells it to a driver, employee or a neighbor."
Know Your Usage Patterns
There is nothing stopping you from asking your lessor to write an open- or closed-end lease for any type of vehicle or situation, though each lease type has a better "fit" for certain usage patterns.
Sedans with set routes and predictable wear and tear are fine candidates for closed-end leasing, says Barron, as are executive vehicles used primarily for commuting. Lessees may even be able to take advantage of manufacturers' subvented lease programs in these situations - if they have the discipline to stay under the low mileage cap.
But for vehicles running high miles and getting heavy wear in unpredictable industries, open-end leases are often the preferred choice. Vans and pickup trucks, especially those used in construction and contracting, fall into this category. These vehicles tend to accrue high mileage under heavy duress, increasing the chances for fluctuation from a set mileage cap and the possibility of damage.
However, the construction industry is extremely susceptible to economic volatility: "One year you're slammed, the next two years, you're not," says Justin Harmon, general manager at Caldwell Leasing, an independent commercial leasing company based in Ohio. Caldwell writes 80 percent closed-end leases and 20 percent open.