Lease vs buy: the options

Railway Age, April, 1989 by Gerald D. Birmingham

Lease vs buy: The options

"There is no best way to add equipment...Each situation is different and there are several solutions to get you the equipment you need for an acceptable price and term."

Leasing is not a new device for financing equipment. It actually is an evolutionary and unique product of money lending, with some historians tracing it back to the founding of the Empire of Babylonia. Formalized leasing seems to have begun shortly after World War II when it became a popular means of financing equipment over the life of "cost-plus" contracts. It was in the early 1900s that railcar leasing began between third party owners, shippers and railroads. Today, both shippers and railroads have access to rail equipment through the "use," rather than ownership, of over 500,000 railcars covered by various types of leases. * Leasing basics. While leasing is an easy to understand process, it makes sense to review the basics before talking about some of the new transactions that are taking place in the industry. The user first must determine the car types and how many cars are needed. Then the lease versus buy decision is made, taking into consideration the cost of funds available, lead times for new cars, staffing requirements, and other issues. Once the decision is made to lease, usually to avoid the major capital outlay a purchase demands, plus other considerations like accounting and maintenance associated with ownership, then the userlessee has to determine the period of time it will need the equipment and who will manage it.

Perhaps just as important as identifying your company's internal needs and comparing the various types of leases available, it is critical to evaluate and compare the leasing firms providing equipment. Today there are six sizeable leasing companies, each with a tendency to specialize in certain types of cars such as covered hoppers, tank cars or boxcars.

Meet the people and view their systems. Talk with some of their major customers, including a company similar in size to yours. While competitive rates are important, evaluate how attentive they are to your needs and concerns. In periods of tight car supply, as we are experiencing now, it's wise to lease from more than one firm. The competition and different fleet sizes can work to your advantage. However, always be sure the company you do business with is of sufficient size and depth, and that it can provide the value added services to meet your needs. * Match the lease to your needs. When shippers and railroads purchase cars it's generally for long-term, clearly defined needs. These owned cars become their "core" fleet and are considered recession-proof. Over and above that they will lease to meet surge factors, or because of a short term increase in demand. When negotiating the lease term, the lessee should negotiate for flexibility in the lease term to cover down cycles or new equipment opportunities or other changes in the supply side of the market.

When determining what type of lease to enter into, whether it be full service, net, etc., many factors should be considered. One is whether or not the shipper wants to pay for the railcars' maintenance. If the shipper determines that there will be low maintenance costs, because perhaps the leased equipment is new, it may be a good situation for a net lease, where the shipper is responsible for maintenance costs, and in return gets a lower lease rate from the owner. The rate is generally lower as the owner does not have to include the cost of maintenance in the lease rate. The trick here is knowing or predicting maintenance costs. Maintenance is a function of actual wear and tear on the car, plus the unknown of what AAR (Association of American Railroads) maintenance might be. AAR is a category of maintenance that includes any work the railroad that has the equipment on it deems necessary to keep the car in safe operating condition. The railroad determines the maintenance necessary, and the lessee has no say about it; he just gets the bill. Needless to say, it's a tough cost to plan for.

That's generally why 60% to 70% of all leased cars are on full service leases. This lease arrangement calls for the owner to pay for all maintenance, scheduled and AAR. Full service leases give the lessee full use of the car, but the owner covers all maintenance, tax and insurance costs. In this type of lease, the lessee receives one montly invoice from the lessor, and then approximately approximately three months later will begin to receive offsetting mileage credits from the lessor for loaded miles traveled on a railroad. These credits have been paid to the owner by the using railroads.

Another lease type is the "split-lease" which has been used for years by the LP gas and ammonia companies and allows the shipper to overcome cyclical markets. The ammonia shipper with equipment idle half the year would "split" the lease with an LPG shipper who would utilize the equipment in the winter months, thus allowing each to operate the equipment for six months per year.