BY DON KAFKA, CEO
TOOLWATCH

In the construction industry, the question whether to buy or lease equipment is often a thorny one. The answer: It depends.

Many factors enter into the buy/lease equation. To list just a few, company size and reach, the overall economy, corporate financial goals and objectives, projected equipment utilization, maintenance and repair costs, interest rates, depreciation, taxes, and even geography can tilt a decision to one option over another.

Take geography as one simple test: In areas with severe winters, many types of equipment remain idle for months at a time, making leasing a smarter decision for a local or regional operation. But if that same company has national reach, buying the equipment and transporting it to the company’s more temperate operations during winter may make sense, even with the added transportation expense.

Equipment ownership carries a number of benefits, because recurring expenses such as depreciation, sales and ownership taxes, loan interest, and depreciation yield hefty tax savings. Equipment is treated as an asset on the balance sheet, contributing to a healthy bottom line.

But owned assets depreciate over time, and their repair and maintenance costs increase as they near the end of their useful lives. In addition, buying equipment ties up a great deal of capital that might strain cash flow over the life of the loan and keep the company from making nimble financial decisions during the loan term.

Another consideration in the buy-or-lease discussion is whether technology or construction practice is likely to advance during the financing term to the point a piece of equipment will have to be replaced with a newer model before the end of its useful life. Anticipated obsolescence, then, is an important nugget of information to add to the buy/lease calculus. And when the equipment "ages out," what will be the costs of removing it from inventory and replacing it with a more advanced model?

Regulatory impact on equipment purchase should be taken into account, as well. As concern for the environment increases, stricter regulations governing the EPA emissions standards for "nonroad engines" are likely to be promulgated, and those regulations will affect a lot of construction machinery. When that happens, the affected equipment will have to be modified to meet the tougher standards — or be replaced, perhaps before it has been fully paid for. But if equipment is leased, regulatory compliance falls to the leasing company, not the construction company lessee.

Owned equipment must be maintained and repaired, and manufacturers may specify rigorous maintenance schedules that must be complied with to keep a warranty in force. Leased equipment is typically maintained by the leasing company, freeing the lessee from the cost of performing warranteed maintenance and repair (the lessee is usually responsible for repairs that aren’t covered by the warranty). However, if leased equipment breaks down, dealer servicing may be delayed if the unit is in a remote or hard-to-reach site.

Leasing construction equipment isn’t really very different from leasing a car, just on a larger scale. A leasing company owns the equipment and then leases it to construction operators, which pay a down payment and a monthly fee, plus interest (usually higher than that on a purchase loan), throughout the lease term. At the end of the term, the equipment is returned to the owner or may be bought outright by the lessee. Understanding the vagaries of the construction industry, some leasing companies offer flexible terms, including allowing deferred payments during slow seasons. Leasing is considered an operating expense, which is deductible from income taxes. And like leasing a car, leasing construction equipment enables construction companies to take advantage of newer technology as it becomes available.

Now, a brief word about renting construction equipment, although renting isn’t the main focus of this article. For companies that use a particular item only rarely, short-term rental is definitely the most cost-effective option, despite the generally higher cost of renting over the long term. However, rental equipment is generally top of the line and well-maintained, greatly reducing the likelihood of breakdowns in the field. If a breakdown does occur, the rental company will repair the equipment at no additional cost or replace it with a new one.

Renting is also a good way to test-drive equipment a company is considering acquiring or upgrading to. Such short-term use gives a company a chance to try out new features and determine whether a brand or model is a good fit for its overall needs. If the rented equipment fills the bill, rental companies may offer rent-purchase options at better terms if ultimate ownership is the renter’s up-front objective.

A number of equipment manufacturers and fleet owners offer both purchase and lease options to their customers, along with helpful decision-assisting tools to help guide the process. Many other online calculators allow users to plug in their desired financing or leasing terms (in months), sales taxes, depreciable asset life, state and federal tax rates, interest rate, and other factors. Useful calculators can be found at Lease-vs-Buy.com (lease-vs-buy comparisons), Calculator Plus.com (equipment lease calculator), and TCalc.com (lease interest rate calculator); and various equipment manufacturers and lending institutions also provide online calculators.

Whatever the equipment needed, for whatever purpose, the buy or lease (or rent) determination is above all a business decision that should be informed by the knowledge and expertise of a company’s financial, operating, engineering, and business teams, along with professional outside advisors like accountants and tax counselors. In the end, the equipment acquisition decision may well be all three, depending on the various items of equipment needed.

Finally, remember the construction industry rule of thumb: If a piece of equipment isn’t in use at least 60 to 70 percent of the time, it’s siphoning off money that could be used more profitably elsewhere. That may be the most succinct way to frame the buy-or-lease (or rent) debate.