The term “TRAC” is an acronym for “terminal rental adjustment clause.” In a TRAC lease a vehicle’s original cost (called “capitalized cost”) is amortized in equal monthly installments. This is called “reserve for depreciation.” After a minimum required term (usually 12 months), the lessee may terminate the lease at any time.
Upon termination, the lessor (or sometimes the lessee) sells the vehicle. The proceeds are then applied to the unamortized balance of the original cost, called “book value.” Any excess of the book value is returned to the lessee from the lessor. The lessee pays the lessor any shortfall from the book value.
Here’s an example of how this mechanism works:
The vehicle’s capitalized cost is $18,000. The lessee opts for a reserve for depreciation of two percent of the capitalized cost per month, or $360. The lessee retires the vehicle after 30 months. Total built-up reserve for depreciation over the 30 months is $10,800, leaving a book value of $7,200.
Assume in one case that either the lessor or the lessee sells the vehicle for $8,000. This exceeds the book value by $800, so the $800 is returned to the lessee from the lessor.
Assume in a second case that the vehicle is sold for only $6,400. This amount is $800 short of the remaining book value, therefore the lessee then owes the lessor $800.
Master Lease Agreement
A TRAC lease can be negotiated individually or governed by a document known as the “master lease agreement.” The agreement spells out the details of the lease. It covers and defines things as ownership of the vehicles, the term of leases and the surrender of vehicles.
The agreement also covers the payment of rental, how vehicle delivery dates affect rental payments, the operation of leased vehicles, improvements to leased vehicles, insurance coverage required by the lessee, additional or replacement vehicles, and the disposition of terminated leased vehicles by the lessor and the lessee.
Legal aspects are also discussed such as lessor financing and what happens in the event of default.
Once an officer of your company and an officer of the lessor sign the master lease, the lessee can then execute individual vehicle lease orders at will. Whether you draw up a master lease agreement or individual leases, you should keep in mind what is negotiable and what is not.
Vehicle’s Capitalized Cost
The first item to negotiate is the vehicle’s capitalized cost. This cost is a function of dealer invoice cost (for most smaller fleets) and factory invoice cost (for large fleets). The cap cost includes “holdback,” an amount usually equal to three percent of MSRP (Manufacturers Suggested Retail Price).
Pricing is most often expressed as “factory invoice less X dollars,” with the “X” coming out of the holdback. Again, the amount of holdback available is dependent on the MSRP of the vehicles you intend to lease. Therefore, a wise move on your part would be to price out your intended vehicles at MSRP and calculate the amount of holdback available to the lessor on those vehicles.
For example, if you intend to lease a fleet of Chevy Malibus the available holdback would be somewhat less than if you intend to lease a fleet of TrailBlazers. In order to intelligently negotiate a “factory invoice less X amount of dollars” you need to have a good idea of the total amount of holdback on the table.
Holdback money is not always available to the lessee. Fleet-leasing companies that cater to the smaller fleets may have less “wiggle room” because the selling dealer in this instance gets a bigger piece of holdback. In cases where the lease is written by the fleet department at a dealership the dealer may be reluctant to part with any of the holdback money to a potential small-fleet lessee.
The Lease Rate Factor
The lease rate factor, expressed as a percentage applied to the capitalized cost, consists of three parts: depreciation reserve, money cost and the lessor’s administrative fee. The lessor works with the lessee to establish an appropriate depreciation reserve that best reflects actual vehicle market value and the lessee’s cash-flow needs. Ultimately the depreciation reserve is the purview of the lessee.
Money costs can be either fixed or floating. In the recent past fleets benefited from starting with a floating rate and then fixing money cost at some time of their choosing during the vehicle’s term in service. With interest rates on the rise today, this may not be advisable.
Various rate bases are available, including prime rate, commercial paper, treasury issues and LIBOR (London Interbank Offering Rate). Research these options carefully, choose the one least costly, and negotiate the lowest markup possible.
Finally, the lessor’s administrative fee is added into the rate factor. When negotiating this fee it is most important to familiarize yourself with the fleet market and know what level of fee is available to your size fleet. The administrative fee is most often expressed as a percentage of the vehicle’s capitalized cost. For small-fleet leases, administrative services are generally not broken out into a fee but are built-in to the monthly payment.
Minimum Time in Service
Fleet lease contracts require that the lessee keep the vehicle in service for a minimum number of months, usually 12. The lease triggers a financial penalty if the lessee does not meet the minimum requirement on any vehicle. This requirement is not subject to negotiation as it determines the tax and accounting treatment of the lease.
Other factors pertaining to the lease of vehicles should be agreed on by the lessor and the lessee prior to the signing of an agreement.
How and in what form is the lessee able to place and track the status of new vehicle orders?
How will delivering dealers be selected? Is there a charge for drop-shipping the vehicle? What is the flow of documents required for the tax/title/registration and delivery confirmation?
Vehicles that are leased under a master lease contract require that for each vehicle leased the lessor provide the lessee with documentation of the vehicle capitalized cost, and the application of the rate in a payment schedule (usually called a “Schedule A”). Also required is documentation of the final accounting for vehicles sold (usually called a “Schedule B”).
Sale of Off-Lease Vehicles
How are vehicles relinquished for sale? How are condition reports handled? When is billing stopped? Make certain that billing is stopped on any vehicle being replaced at the point that the billing on the new vehicle starts.
Negotiating a fleet lease agreement is, above all else, a matter of common sense. Keep in mind that all fees and costs are negotiable, that the contract should outline the responsibilities of each party, and that performance targets should be included.