Lease

Leasing is an arrangement in which the right to use the asset is transferred to another person by the asset owner without transferring the asset's ownership. Thus, it means giving the asset on hire or rent for use in simple terms.

The person who gives the asset is the "Lessor," and the person who takes the asset on rent is the "Lessee." Various types of assets may be given out for use on the basis of this agreement which may again be of different types. It offers cost efficiency as well as flexibility to both the parties along with usage of the asset, provided both the parties abide by the contract terms.

A lease is an agreement that explains the terms and conditions under which two parties agree to deal with an asset for the purpose of renting. The owner or the asset, which is primarily a property, is called the lesser, and the party taking it on rent is the lessee. There is a regular payment of a fixed amount involved in the process.

The terms and conditions of the lease agreement is binding on both parties. The landlord or the owner continues getting the amount in the form of fixed payments for a specified period of time. The process may be for residential property or for commercial purposes. In case of residences, the terms are mostly same for all. But for commercial property, the types are different.

There are legal consequences that the parties to the contract may face in case they do not abide by it or there is any damage to the property. The terms include responsibilities of both, the rent amount, the deposit amount, due date of length of the agreement, any points related to keeping of pets, result or legal issues related to not following the terms, etc.

Mostly lease agreements have common rules and features for all, bit sometimes may be different depending on the type of asset or property. The commercial property contracts may be complex in nature.  

An arrangement of lease rental agreement ensures the lessee with the right to use an asset without paying the purchase price for the same. The arrangement ensures periodic receipt of lease rentals as against the right to use the asset for the lessor.

Here are the important components of the agreement which are common for all but the content of each varies, depending on the property type or other complex issues and rights or responsibilities that has to be noted in such cases.  

• Parties: Two parties are involved in this arrangement, known as Lessor and Lessee.
• Property under Lease: This agreement will specify the property which the lessor is leasing to the lessee.
• Duration: The right to use a particular property or an asset in the lease agreement will be transferred under lease for a particular period. The period for which the right is transferred will have to be mentioned in the agreement.
• Lease Rentals: They may be fixed, variable, or both. Also, the agreement will specify the frequency of the payment of rentals.

Entering into an arrangement involves negotiation from both parties. Thus, terms need to be finalized between the parties before a lease agreement is finally signed. Finalizing a lease is a subjective matter; however, it takes 2-3 days in most cases.

An arrangement of lease rental agreement may be of following types:

• Financial: It is a kind of arrangement that is not eligible for cancellation, and the rentals must be paid until the end of the lease duration. In such a type, the duration is generally equal to the useful life of the asset.
  Thus, the lessor shall show the finance lease as a sale of the asset, the lessee shall show such a leased asset in his balance sheet, and the present value of future rentals shall be shown as a liability.
• Operating: This agreement can be canceled before the expiry of the lease period by providing prior notice. Also, the duration is less than the useful life of the asset. Thus, the lessor cannot recover the full cost of the asset during the lease period. In such an arrangement, the lessor is also liable to bear the maintenance costs.
• Sale and Leaseback: In such an arrangement, an asset is first sold by a company to another party, who then leases it back to the first party. Thus, the company receives consideration against the sale, and also, the right to use the asset is retained. This arrangement is entered when the company faces a short-term liquidity crisis.
• Leveraged Leasing: This arrangement involves three parties, known as the lessor, lessee, and lender. The lessor is financing the asset with the financial assistance of the lender who invests in the asset.

Leasing allows the lessee to enjoy the right to use an asset without actually owning it. To enjoy such a right to use the asset, the lessee is required to make lease payments to the lessor. The frequency of such payment can be monthly, quarterly, or yearly, depending on the contract. The ownership of the asset remains with the lessor only.

Let us understand the concept of lease estimator with the help of a suitable example. We assume that AB Ltd is a startup requiring office space in a busy city to expand the business. AB Ltd agreed with X Developers who are in the business of making buildings for the purpose of renting them out for commercial purposes.

So, in this case, X Developers is the lessor and AB Ltd is the lessee. It is an agreement for 10 years, in which AB Ltd, agrees to pay a monthly sum of $8000 as rent. As pee the agreement terms, the lessor will not take any responsibility of the internal areas of the space since it is being used by the lessee. Therefore, in case of any damage in those areas, the lessee will have to compensate the lessor. The agreement also specifies that AB Ltd will not get any property ownership, and that X Developers will continue to remain the owner, even after the ending of lease period. 

Thus, this is a typical example of such an agreement. However, the terms may have some other complex details, as per the property type and other specifications

Let us try to understand the renewal process of the concept of lease deals in details.

The term renewal refers to the process followed to extend or continue an original agreement, which provides certain specifications and regulation. It is very common in lease related contracts because it is often beneficial for the parties to continue with the contact for longer term. However, it is not binding upon the lessee to go for a renewal.

In case of a new business, which has taken an office space on lease can use this opportunity to continue using it for more time period, thus saving the cost and time of searching for new spaces. Sometimes, it also gives some room for negotiation of the previous terms so that both the lesser and the lessee may get more flexibility.

Typically a new contract is drafted for the process, that will contain the previous rules as well as the changes made, if any. The lesser may require to give some intimation or notification to the lessee a few days or months prior to renewal, There may be some specific process that is required to be followed for renewal.

It is to be noted that this process of lease estimator also allows the lesser to run a check on the credit position of the lessee and ensure that they are still financially capable of continuing with the contact and payment of rent.

Thus, the contract renewal process is both beneficial and complex, but there is not obligation on the part of the lessee to go ahead with it.

Some important advantages of the lease deals concept as given below.

• A company can enjoy the right to use high-cost assets without investing in them, which otherwise it could not have afforded.
• Lease rentals can be claimed as expenses in the financial statements, a tax-deductible expense.
• The company can manage its cash flows since rentals are spread over the lease contract term.
• The funds are saved for other business activities, which otherwise would have been blocked in the assets.
• The company is saved from the risk of an asset becoming obsolete as the company is not investing in the said asset.
• An option is available to the company at the end of the lease period to buy the asset.

Here are the disadvantages of the process.

• Periodic payments are to be made, and funds need to be made available for the same.
• Ownership of the asset is not available to the lessee.
• The benefits of capital appreciation are not available to the lessee.
• The present value of future obligations will be considered as a debt of the company.

An entity should consider various facts such as the availability of funds, the nature of the asset, and the period for which the asset is required. Then only a decision can be taken on whether leasing will be beneficial.

Both the above terms are closely associated with property dealings and related to each other in the real estate market. But there are some important differences between them as follows:

This article has been a guide to Lease and its meaning. We explain its renewal process, differences with rent, with example, components, types & advantages. You can learn more from the following articles –

• Leveraged Lease
• Ground Lease
• Modified Gross Lease
• Gross Lease Definition