Lease Rate

The lease rate is defined as the interest rate associated with leasing the asset during the lease period and can also be considered as the compensating amount which otherwise the lender would have earned if the same property/equipment/vehicle had been put in some other use. E.g., suppose a person leases a vehicle. The leasing company, usually a bank, will buy the vehicle from the dealer and lease it to the vehicle used for a specific period until the user pays back the purchase price plus some extra money. This extra sum of money is termed the leasing interest or lease rate.

Leasing also has another factor called the lease rate factor. It can be explained as the periodical payback, which is further expressed as a percentage of the original cost of the leased object, i.e., equipment, vehicle, building, etc.

Primarily the two widely used lease rates or lease factors that are very common are the car lease rate and space lease rate.

Suppose equipment used in production is leased for expected short-term demand for the upcoming three years with an equipment value of $50,000. Thus lease term set is three years, or monthly payments are required for 36 months. If the current interest rate is 5%, the lease rate factor is calculated as (0.05/36) or 0.0014. The depreciated value of the product stands at $15,000 after three years, and thus the equipment value for the tenant company will be ($50,000 – $15,000) =$35,000.

Taking the impact of the depreciated value, the monthly lease payment will be ($35,000/36) = $972/month. Thus, considering the lease rate factor, the interest will be calculated as ($50,000+$15,000)*0.0014 = $91.  This monthly payment the company has to make for leasing the particular equipment stands as $972+$91 = $1063.

The lease rate is primarily applicable for two widely known leasing practices, i.e.,

1. Real Estate/Space leasing
2. Cars and Equipment leasing;

#1 - Space Leasing

In space leasing, the price paid for the occupancy cost is generally determined as a monetary amount on a square feet basis for a year. An agreement is required to determine whether the amount needs to be paid monthly or yearly.

The leasing agreement will be as such that it will clearly state the terms of the leasing and till what period the rate of leasing is applicable. It may also include a policy of incremental leasing rate when the agreement states that the lease is for multiple years, and the rate will increase with every year.

Generally, commercial lease rates are available on a square foot basis, making it convenient for the lessee to compare leasing rates of various available properties. The tenant can formulate the actual pricing for the lease by calculating the cost of renting a space. In addition to the lease rate, it also needs to be decided whether the lessor or lessee will have to bear extra costs such as maintenance and tax on property.

#2 - Car and Equipment Leasing

When it comes to car/vehicle or equipment leasing, the payment made per month for the vehicle is dependent on the depreciation the vehicle undergoes and the sunk cost after the leasing period. It is also dependent on the lease rate.

Based on paying monthly, the lessee reimburses the car/vehicle provider on dual grounds, i.e., the depreciation the vehicle undergoes and for the opportunity cost, which is lost by engaging the money in automobiles instead and not utilizing it somewhere else.

Regarding car or equipment leasing, the lease factor is almost like an interest rate. The repayments comprise the factor of leasing, also known as the money factor that entraps the financing perspective of car/equipment leasing.

In-car and equipment leasing, the company which leases out the objects primarily purchases the car or equipment from third-party dealers or agents and provides us the same on rent. It means that we are paying for the loan the lessor has borne to purchase the item by lending money upfront to buy the car/equipment.

At times, the car provider and lessor can be a single entity where a third-party contract allows the car provider to sell stock to the lessor. Further, this is used to produce revenue on these assets/objects before transferring the car/equipment back to its provider as used items. On the other hand, the lessee gets the object which can be used even without being the owner or bearing the pressure of owning it.

When it comes to real estate, the prime purpose is to generate rental income from the tenants. Thus, only two parties get involved in this mode of execution, and any reimbursement for the inceptive application of funds into the real estate is covered up in the leasing rate as the strategy of the entire business setup.

• There is a constant debate about when to lease space/equipment and when to own the entire thing. The main factor which plays an important role in leasing is the time and time value of money. In simple words, we need to consider how long we will use the leased property.
• To minimize the residual/sunk cost when the demand for certain equipment is only meant for a short-term basis, leasing is considered the ideal decision. These can be operational requirements needed for expansion or growth coupled with temporary market conditions. At this point, leasing is an idle scenario because it reduces the burden of owning the equipment as a whole and thus ends up with a huge sunk cost.
• When the requirement or demand for certain equipment is considered a long-term purpose, owning or owing is the best decision. Also, in the case of real estate, the value appreciates, which can add value to the initial investment made.
• Also, when a company does not want to focus on non-core business issues like equipment and property maintenance, leasing can be an option as it removes the burden of owning the same and maintaining it.

The lease rate is very important to understand and estimate the overall payment, which needs to be made for the lease, or else the lessor can easily add a few extra amounts, and the lessee will not even come to know about it. A small extra amount added every month unknowingly can be a big number at the end of the lease period. Thus the lease rate helps us to understand the overall cost of leasing.

This article has been a guide to what is the Lease Rate. Here we discuss the example of the lease rate calculation and two leasing practices – car lease and space lease. You can learn more about accounting and financing from the following articles –

• Accounting for Capital Lease
• Meaning of Operating Lease
• Meaning of Finance Lease