Buy or Lease?
Originally published: 10.01.06 by Peter Strozniak
For fleet management, there is no one-size-fits-all solution.
Part 1: This article is the first in a three-part series on fleet management. Next month’s article will look at cost-saving fleet maintenance ideas. In the December issue, we’ll report on how to maximize GPS devices and other fleet-monitoring technology.
Terry Mitchell, owner of Mitchell’s One Hour Heating and Air Conditioning of Elyria, Ohio, has always purchased his 14 service vans and box trucks. “We feel it’s a better deal to buy them,” he says. “In mst cases we can take a depreciation deduction in the first year that we purchase our trucks. This quick write-off is the best option for our company.”
Frank Jones, vice president of operations for Mallory and Evans Service in Atlanta, finds that leasing the company’s 20 trucks is the better option. “For financial reasons, we don’t pay cash or finance vehicles, so leasing is a better option for us,” he says. “We work with a dealer who we know and trust is giving us a good deal. This allows us not to worry so much about our fleet and focus on what we do best — servicing our customers and selling contracts.”
Hugh E. Joyce, president of James River Heating and Air Conditioning Co. in Richmond, Va., does both. He says the approach improves his company’s bottom line: “We’ve found it’s effective to lease our trucks for fours years, then buy them and run them for two or three years. The maintenance costs are higher, but I don’t have a lease payment on those trucks.”
Which executive made the right decision? The truth is, they all did. Each option, as Mitchell, Jones, Joyce, and other contractors have found, provides different benefits in terms of cost savings, cash-flow management, and tax advantages. In addition, leasing companies and bankers are continually enhancing their offerings to make the option they’re offering more appealing. Ultimately, the decision to buy or lease depends on your business philosophy and strategic objective.
Asking the right questions
The decision also depends on the answers to some very basic questions. Though it may seem simplistic, before making a decision you should first ask yourself: How do you use, or expect to use your fleet? How many miles will you put on each truck? Do you expect your truck to take on a lot of wear and tear? If so, how will that affect the market value when it comes time to sell it? Is the appearance of your fleet important to your public image and your marketing strategy?
“There are some business owners who use their fleet to project a certain image,” says Robert Minton, a spokesman for General Motor Corp.’s Commercial Fleet Division in Detroit. “The fleet is another way to market the company because they are on the road all the time, and this rolling advertising can attract new customers.” Still, two contractors who expect their trucks to market their companies can make different decisions, depending on other factors that are important to them.
For Mallory and Evans Service, leasing provides the surest way to maintain a new and modern-looking fleet to protect its image. “The appearance of the fleet is significant for us,” Jones says. “If you present yourself as a professional outfit, it sends the right message to customers and prospects. If you have a truck for more than five years, it doesn’t look good.” Leasing provides a cost effective way to maintain a fleet when driving newer vehicles is important to you, or if you perceive that maintaining older vehicles is a bother or distraction from providing service.
Mitchell, however, chooses to buy and maintain trucks, though he too, expects his vehicles to project an image and advertise his company. For him, however, saving money by maintaining a vehicle after it’s paid off trumps the need to drive newer vehicles. He contends that you can keep a purchased vehicle looking good for years after it’s paid off. He and other fleet owners point out that after you pay for your trucks in full, maintenance is the only expense. Mitchell spends about $20,000 — or $1,500 for each vehicle — a year on maintenance and repair. Keeping on top of his fleet’s maintenance needs allows him to run service vans for about six to eight years or 150,000 miles, and his installation, or box trucks, will roll on the road for about 10 years, or 120,000 miles.
When purchasing trucks, Mitchell combines paying cash with taking advantage of low-interest loans and other incentives offered by dealers. He also saves money by buying used trucks that have low mileage and are in good condition.
Mitchell adds that taking loans to buy some of his trucks helps him maintain a good relationship with the bank. He believes this tactic helps keep his financing options open for other business needs.
When cash flow counts
Your approach to cash management also will influence your decision. While Mitchell and other fleet owners focus on saving money and reducing costs over the life of a purchased vehicle, others like the level payments of leasing.
Mike Brit, chief financial officer for Shumate Mechanical of Duluth, Ga., says his company switched from buying to leasing its 200-truck fleet about 15 years ago. “Leasing provided a better use of our cash flow,” Brit says. “We are able to structure the financing of our leasing so that we wouldn’t have to lay out so much cash for our vehicles at any one time.”
Leasing doesn’t require a large down payment that loan financing does, and the leasing payments are generally less than monthly loan payments, Brit says. This frees up cash to support growth plans or pay down business debts.
Brit also prefers the tax benefits of leasing to buying. “When you buy a vehicle, you can take a depreciation deduction for five years, but we don’t have many vehicles for five years because we’ve found that the useful life of a vehicle isn’t that long,” Brit explains. “So instead, we sign up our vehicles to a 36-month lease, which tends to maximize the usage of the truck to its actual expense because lease payments are fully deductible as a business expense.”
Purchasing vehicles, though, offers different tax advantages. In addition to the depreciation deduction, you can deduct the interest payment on the loan. What’s more, when you buy a truck weighing over 6,000 pounds, you get an additional tax break. To determine whether leasing or buying will provide you with the best tax benefit for your company’s specific needs, consult your tax accountant.
Open-end lease contracts allow hvacr companies to set the number of miles per year for each vehicle and avoid the cost of excessive wear-and-tear provisions at the end of the lease. The open-end lease, however, requires you to pay your dealer a residual value, or what would be the market value of the vehicle at the end of the lease. Establishing the final value of the vehicle at the end of the lease is important, says Lee Gross of Ford Motor Credit in Dearborn, Mich. You need to make sure that the final value of the vehicle is more than, or equal to, what you would get for it on the open market. If you don’t, you could end up paying more. For example, if you set the final value at $4,000, but can get only $2,000 for it, you still owe the dealer $2,000. The final value will depend mostly on the truck’s mileage and its overall condition. You can negotiate the residual value with your dealer.
Another advantage of leasing is off-balance sheet financing, Gross says. Because leasing is considered an expense, it doesn’t appear on your books as a liability as a typical loan would. This could be important for hvacr owners who need to maintain a good line of credit with the bank.
For many contractors, the decision to buy or lease may simply come down to what they feel is easier to manage. Fleet owners tend to see the efforts to project usage or negotiate residual value as complications they’d rather avoid, and are happy to do the maintenance to keep their vehicles running longer. Contractors who lease tend to see maintaining older vehicles as the bigger distraction, and feel it’s easier to negotiate leases.
Lease, then buy
At the end of the lease, you can opt to buy your vehicles, which works well for Hugh Joyce of James River. After paying the truck’s final residual value to his leasing company, he runs it for about two or three more years. The annual maintenance cost for an after-lease truck is about $2,800, compared with $1,400 for a newer truck. But Joyce says he’s still saving money.
Joyce explains that if he would lease a new truck at $400 a month, or $4,800 a year, plus $1,400 for annual maintenance, it would cost his company $6,200 a year. But because he no longer has a monthly payment on the after-lease truck, his cost is $2,800 a year for maintenance. That means his total bottom- line savings is $3,400 a year.
“If you take care of your trucks, they most likely will last you another two or three years after the lease is done,” Joyce says. “But if we do come across a truck that is giving us trouble, we just take it out and shoot it.”
Look at services
Whether you decide to buy or lease, many dealers and leasing companies also offer maintenance and repair services as well as fuel-management programs. Such services add to your monthly leasing or buying costs, but they may help you save money and time. For example, John Deris, vice president of sales and marketing for Ryder’s central region in Chicago, says Ryder buys high volumes of maintenance supplies and replacement parts, as well as gas. That means Ryder can pass along a portion of those savings to fleet operators. Deris says the fuel savings can be substantial especially in today’s high gas price environment. Because of competitive reasons, he declined to provide specific numbers on cost savings.
“Obviously, it depends on how much fuel your fleet consumes,” Deris says. “The higher the volume, the deeper the discount.” What’s more, you don’t have to lease your trucks from Ryder to enroll in its maintenance or fuel program. But you are required to go to Ryder’s facilities, which can create logistics problems for your fleet.
Some leasing companies and dealers offer software analysis tools that can help you compare whether it’s better for you to buy or lease. “We can take your cost of operating your fleet and compare it to how much it would cost you to lease your fleet,” Deris says. “We offer this service free to our clients as well as prospects.”
Resources at Your Fingertips
Before you make the decision to lease or buy, check out the following Web sites and evaluate the company’s specific offers, including manufacturers’ 2007 incentives.
Questions to Ask
Questions to help you make a better decision to buy or lease:
• How will these trucks be used and for how long?
• How many miles will be put on each truck?
• Will my trucks get a lot of wear and tear? If so, how will that affect the trucks’ residual or resale value?
• Does my dealer or leasing company understand my business and what I need?
Things to do if you decide to buy:
• Leverage your good credit for zero-percent financing. Even in today’s rising interest-rate environment, some dealers will offer it to gain customers.
• If zero-percent financing is not available, shop around for the lowest interest rate. Community banks and credit unions often offer the lowest rates.
Things to do if you decide to lease:
• Negotiate the “money factor,” which is a leasing term that calculates the interest rate on your lease. Naturally, your goal is to obtain the lowest interest rate or money factor.
• Be wary of the dealer who says the price of the vehicle doesn’t matter when you lease. Even for leasing, you want to get the lowest possible price.
• If you don’t want to buy the truck at the end of the lease, it may benefit you to get the highest residual value, or how much the vehicle will be worth at the end of the lease. Generally, the higher residual value means a lower monthly lease payment.
• Ask your accountant to review the lease agreement to make sure there are no surprises.
Things to do whether you decide to buy or lease
• Make sure you know exactly what kind of vehicle you want and the price you’re willing to pay.
• Have up to four dealers compete for your business.
• Ask about special discounts, especially if you’re buying or leasing more than one truck.
• Review all incentive, cash-back, or rebate offers.
• Inquire about discounts your trade association may provide.