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Choosing between a finance or an operating lease

On Behalf of | Jan 3, 2023 | Landlord/Tenant

Businesses often lease property or equipment as they expand. This arrangement allows them to grow without cutting deeply into their profits. The company’s goals will determine whether a finance or operating lease is the best option.

Obtaining assets through an operating lease

An operating lease is a contract that gives the lessee the right to use the assets the lessor provides. While it can apply to real estate, it is an arrangement that businesses can leverage to have access to vehicles, other machinery and technology.

Like a standard landlord/tenant relationship, the lessor retains ownership of the property throughout the contract. This ownership also means that the lessor is typically responsible for the maintenance of the asset during everyday use.

Operating leases often last one year or less. A seasonal business might only need access to a property for a few months. A building company may only need a piece of equipment for a few weeks.

The disadvantages of an operating lease revolve around the length of the contract. If lessees hold onto an asset long enough, they may pay more than its market value.

Acquiring property through a finance lease

A finance lease involves a different lessor/lessee relationship. At the end of the lease’s term, the lessee takes formal ownership of the asset. The lessee may also have the opportunity to purchase the property at a reduced price during the leasing period.

This rent-to-own option gives businesses time to increase profitability while providing equipment and space for growth. During the lease, the lessee acts as the de facto owner of the asset and is typically responsible for its maintenance.

Finance leases are long-term contracts. They extend beyond 75% of the useful life of the asset to make the arrangement profitable for the lessor.

When entering any financial arrangement, it is critical to understand how it fits into your long-term business goals. Planning how you will use an asset will help you make an informed decision between finance and operating leases.