Lease, rent, or buy: an improving economy is driving a strong construction equipment market
Published in: Masonry Construction
Date: 3/1/2005
By: Worthington, Ted
Business is beginning to look up for the construction market after a couple of rough years. Contractors are starting to feel more confident about the future, and as evidence of this fact, they are opening their purse strings to acquire construction equipment. This very important business conclusion is based on a survey of over 1300 interviews with manufacturers, dealers, and customers sponsored by the Equipment Leasing Association (ELA).
Owners have increased their outlays for construction equipment, with capital expenditures improving to $22.1 billion in 2003, after posting lower numbers in 2001 and 2002. The upward trend is expected to continue through 2004, when construction equipment expenditures are forecast to surpass the recent high in 2000 of $23.2 billion. And 2005 could be even better. (The “Construction Equipment Capital Expenditures” bar chart on the next page plots this purchasing information for a seven-year period.)
Outright purchasing of equipment is reserved for those flush with cash, such as large corporations or the government, and that portion of the market doesn’t appear to have changed, according to the survey.
Typical contractors don’t often have that sort of large cash reserves available, so their best options traditionally have been leasing or renting. As an alternative to buying, these two approaches allow contractors to get into equipment they otherwise wouldn’t be able to afford, and use that equipment to make more money. Basically, leasing is a long-term mechanism, whereas renting is for a short-term need.
The survey found that customers seem to have less desire to own construction equipment today. In light of this change in thinking, contractors need to review the concepts of leasing versus renting to find out what works best for them.
Consider the possibilities
In the past, renting or leasing was sometimes seen as a precursor to buying; in other words, an opportunity to test out equipment with no long-term strings or large costs attached. A six-month rental frequently would be converted to a purchase, if only to avoid losing the equity invested up to that point. However, during the recent economic downturn, many customers chose to return the equipment to its owner because of the uncertainty of future business, said the study.
While choosing between leasing and renting may not seem important, it could mean the difference between landing the bid or not. Consider this simplistic example to compare the options and the possible financial ramifications of each.
If three contractors are competing for a project, the company who owns its equipment only has to consider the interest paid on financing the purchase when costing the job.
The leasee, who may or may not have started with a down payment, has monthly payments to consider for his estimate. But these payments are considered a tax-deductible overhead expenses and there is no depreciation.
The renter only has a fee to pay, though this amount is typically higher than the leaser or buyer would pay. However, the renter only pays for what he uses, and doesn’t have the equipment sitting idle, not making any money.
How each contractor amortizes the costs over this job and possible future projects could make a difference in determining who gets the bid. But this example only touches the surface of a complex puzzle that gets to the heart of the business. The decision to lease or rent has implications about the company’s credit line, net asset value, and performance bonding.
Financing options
To complicate matters, there are a great many types of financing plans offering a wide range of options to entice contractors, with terms averaging from three to five years. The ELA suggests that industry specific knowledge, which allows quick turnaround and acceptable credit ratios, is vital in establishing successful leasing arrangements.
First, there are different parties from whom you can lease equipment. Some major manufacturers like Caterpillar and John Deere have financing arms that allow contractors to lease directly. About 20% of the market is financed from these types of sources.
Banks also offer leasing opportunities. However, they can fade in and out of the construction equipment market depending on the strength of the economy. Some banks steer clear of construction equipment because of the perceived risk, but about 60% of leasing financing comes from banks and bank-affiliated companies. (The other 20% comes from third-party sources such as CIT, CitiCapital, and GE Commercial Finance.)
Leasing options
There are many different leasing options to suit almost any need. Capital leases are among the more common and are accounted for as a purchase, while operating leases are generally used for a shorter term and not considered a purchase. Residuals-based leases, which have grown in popularity, offer the leaser the opportunity to purchase the equipment at the conclusion of the lease. Other varieties are available, including those without insurance and maintenance,
Financing companies offer a number of options to encourage customers, including below market rates, 0% interest for the first year, and flexible repayment schedules. Because construction is a seasonal business in many parts of the U.S., payment flexibility, such as stepped or skipped payment options, can be particularly attractive.
Conclusions
Leasing still remains the dominant means for getting contractors into new equipment. For the construction market, as much as 45% to 55% of the equipment is lease financed, according to the study. The general economy, government spending, rental company demand, housing starts, and interest rates are major factors affecting the leasing market. Annual growth for the this market is expected to be 8% to 10% for 2004 and 2005. (The “Construction Equipment Leasing” bat chart below plots the annual activity in this area for a seven-year period.
The study also shows that smaller-scale transactions between $25,000 and $250.000 are responsible for the spending improvements. In fact, 72% of the leasing transactions are for these ticket dealings.
The rental side of the business also expects a positive growth in 2004. About 50% of many dealers’ equipment movement comes from this part of their operation. The survey indicated that more than 60% of dealer volume is expected to result from rent to sales business in 2004. Most major manufacturers and several independent firms such as United Rentals, Rental Service Corp., and National Equipment Services operate in this market.
Deciding whether to lease or rent comes down to personal taste or what the contractor feels most comfortable doing from a financial perspective, but it is a decision that should not be made quickly or without thorough evaluation of the many possibilities.
Construction Equipment Capital Expenditures
1999 $22.9
2000 $23.2
2001 $20.3
2002 $21.0
2003 $22.1
2004 $22.1
2004 (E) $23.5
2205 (E) $25.0
Source: U.S. Department of Congress
Note: Table made from bar graph.
Construction Equipment Leasing
1999 $12.0
2000 $11.5
2001 $11.0
2002 $10.5
2003 $11.4
2004 (E) $12.5
2005 (E) $13.5
Source: Equipment Leasing Association and R.S.
Carmichael & Co. estimates
Note: Table made from bar graph. COPYRIGHT 2005 Hanley-Wood, Inc.