Lease Rate Factor

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21 Aug, 2024

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The lease rate factor is the regular payment that one needs to make when an asset is taken under the lease agreement and is usually expressed as a percentage of the total price of the equipment that has been leased. Alternatively, it can be defined as the single rate factor, which, when multiplied by the cost of the leased equipment, will give the regular payment that one has to make for taking the lease.

For the sake of lease rate factor calculation, suppose an equipment cost $10,000 has a lease rate factor of .0260, which means a monthly payment of (10,000 *.0260) = $260. It means that the lessee must pay $260 for leasing the equipment in consideration of the required number of periods, which is set in the lease agreement.

What is Lease Rate Factor?

Lease Rate Factor Explained

The lease rate factor is the cost of leasing assets such as equipment, vehicles, etc. It represents the monthly lease payment for every thousand dollars of the asset’s value. This is an important determinant in lease rate factor calculator and helps in comparing different leasing options.

It is often expressed in the form of decimal or percentage and is used in conjunction with the capitalized cost, the value of the leased asset. This is used to calculate the monthly lease payment using the formula.

The setting of the rate depends on a variety of factors, such as the type of asset being leased, the creditworthiness of the lessee, and the duration of the lease can play a crucial role. Therefore, it is natural that individuals or businesses with a better credit history will secure the lease at a much lower rate in comparison to others with comparatively poor credit history.

However, the importance of comparing different leasing options based on their factors is extremely important as even the smallest of changes in monthly payments can lead to incurring significant costs in the long run.

Understanding these terms also equips the lessee to negotiate better terms and eliminates the possibility of being outsmarted by the other party in the agreement. Therefore, the lessee takes advantage of the clarity to negotiate better terms and helps them strategize and make budgetary allocations accordingly.

Types

There are two types of lease rate calculation, generally explained as car/equipment lease and space lease rate factor. 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 they can use 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 application of funds into the real estate is covered up in the leasing rate as the strategy of the entire business setup.

Formula

Let us understand the formula that shall act as a basis of our understanding of the lease rate factor calculator and its intricacies through the discussion below.

Monthly Lease Payment = Lease Rate Factor x Capitalized Cost

Here,

Lease Rate Factor = monthly payment per thousand dollars of the asset’s value.

Capitalization Cost = The value of the leased asset.

How To Calculate?

Let us understand how to calculate using the formula or get to know how a lease rate factor calculator functions through the points below.

The first and foremost thing considered is the equipment value and the depreciation rate before we calculate the lease rate factor. The calculation of the equipment value also has a methodology associated with it. Suppose we are leasing equipment whose retail price if we purchase new is $70,000 and has a useful life of 10 years. That means after applying depreciation over ten years, the residual value stands to be $10,000. Then the equipment value for leasing stands to be $70,000- $10,000 = $60,000.
Now coming to the calculation of depreciation part, here we have seen the equipment value on the grounds of leasing stands to be $60,000, and suppose the lease term has been set to 5 years. Thus, the depreciation part of the lease payment to be made monthly will stand at $60,000/60 = $1,000.
Coming to this calculation, let us, for example, consider the annual rate of interest to be 5% per annum. It is calculated by dividing the interest rate by the months considered for leasing. So here it will be (0.05/60) = 0.008.
So finally, to arrive at the monthly amount to be paid for the lease, we need first to calculate the interest payment, which is calculated as follows: ($70,000+$10,000) *0.008 = $640. The total payment must be made in the depreciation part too, and thus it makes $1,000+$640 = $1,640.

Examples

Let us understand the practical application of the lease rate factor calculation through the examples below.

Example #1

Let us take an example of a piece of machinery used to produce toys that have been leased for five years with a lease rate factor of 0.008. It means considering the annual interest rate in the market as 5%; the factor has been calculated by dividing the interest rate by the number of years the lease is concerned. i.e. 0.05/60 = 0.008. For calculating the interest payment, the market value of the equipment plus the residual value is added and multiplied by the lease factor.

Example #2

Increasing interest rates are driving a necessary surge in helicopter lease rates, with Russell Christopher, MD of Thora Capital, highlighting the pivotal role of interest rates in determining the 2023 business outlook. To keep pace, a 20 basis points increase in lease rate factors is deemed essential.

Thora Capital, with a strong pipeline, anticipates doubling its portfolio in the year 2024. Mike Platt, Vice Chairman of LCI, emphasizes that while demand for helicopters persists, the real challenge lies in elevated funding costs. A 1% rise in rates could necessitate an additional $8,000 monthly in rent for a typical AW139 helicopter.

Lease Rate Factor Conversion to Interest Rate

Considering both interest rate and the lease factor is very important when we want to check which is costing us less, i.e., whether going into a lease agreement is beneficial to buying equipment where interest payment on loans comes into the picture. A very important number that comes into this comparison is 2400, multiplied by the lease rate factor to arrive at the interest rate. An example of this can suppose we have a lease rate factor of 0.003, as mentioned above; when we want to convert it to the interest rate, we multiply the factor by 2400, i.e., 0.003*2400 = 7.2%. Thus, the annual interest rate comes to be 7.2% when the leasing factor is used in 0.003. To cross verify this calculation, we can again do a reverse calculation, i.e., 7.2/2400 = 0.003

Why Are They Used?

Now that we know so much about lease rate factor calculators and the core concept, let us also touch upon why exactly are they used through the points below.

There is constant debate about when to lease space/equipment and 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 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 at the end.
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 and maintaining the same.

Lease Rate Factor vs. Interest Rate

Lease factors can, at times, make very costly loans look cheaper. The lease rate factor has a money factor instead of an interest rate, whereas an interest rate factor has a percentage rate of interest calculated annually. When we want to convert the money factor or lease rate factor to interest rate, we need to multiply the same with 2400. In the loan agreement where interest rate comes into the picture, the asset owner must bear both the charges of the loan and interest and the asset's residual value. Here, the asset user does not have to hold the asset with them till it reaches its residual value; thus, cost savings can be brought in.

Conclusion

It 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. It helps us to understand the overall cost of leasing. The interest rate may change depending on the market scenarios, but once agreed, the lease rate factor remains fixed for the rest of the lease term.