"Open End Vehicle Lease Agreement"
OPEN- VS. FLEET MANAGEMENT CLOSED-END LEASING: ? C WHICH IS RIGHT FOR YOU Choosing between the two types of commercial leases involves understanding your fleet driving patterns, your internal fleet management capabilities and your appetite for risk. BY CHRIS BROWN COMMERCIAL LEASES ARE DIVIDED I The lessee can select the deprecia- volved over the lease period. Rate factors into two types: the open-end TRAC lease tion factor, used to amortize the capital- are calculated using the average out- and the closed-end lease. Each has a dif- ized cost (with some limitations). Differ- standing balance over the full lease term, ferent set of rules and parameters. Each ent factors can be used for different as opposed to the “step down” method works better for different fleet situations. vehicles based on specifications and in TRAC leasing. Very simply, in an open-end lease the usage. I Lessor sells used car at lease-end for lessee assumes the depreciation risk but I The lessee assumes the depreciation market value. Lessee/employee may pur- has more flexible terms. In a closed-end risk. The capitalized cost (original pur- chase at a price set by lessor. lease, the lessor assumes the depreciation chase price) is reduced monthly by a pre- I The lessor is responsible for gain or risk but the terms are more restrictive. determined amount (depreciation fac- loss on resale, although provisions for a We asked lessors at three fleet leasing tor) for as long as the vehicles remain in percentage of gains or losses between les- and management companies to dig a lit- service. see and lessor may sometimes also be tle deeper into both to help you deter- I When the vehicle is taken out of available. mine the lease that works best for your service, the sales proceeds are applied to I The lessor establishes depreciation situation. All four write both types of the book value (capitalized cost minus factor. leases, and have no vested interest in accumulated depreciation) with any re- I The lessor can influence choice of one over the other. sulting gain passed on to the lessee. If make, model and equipment to enhance The first step is to understand the def- the selling price is less than the book residual value for the client, though the initions of both types of leases. value, the lessee must pay the difference, lesee has final say. OPEN-END TRAC ( TERMINAL RENTAL although provisions for a percentage I A closed-end lease is rate-sensitive ADJUSTMENT CLAUSE ) LEASE sharing of gains or losses between lessee by make, model and lease term, with and lessor may sometimes be available. prime consideration being the vehicle’s CLOSED-END LEASE ( aka NET, I This type of lease is also known as residual market value. ILLUSTRATION BY TARIQ KAMAL NO RISK OR WALK-AWAY LEASE) a finance lease, which as the name im- I A closed-end lease traditionally has plies, permits the lessee to determine the preset mileage restrictions over lease vehicle’s service life after a short mini- I There is a fixed rate and term, usu- term (usually 12,000 to 15,000 miles an- mum term, usually 12 months. After this ally 12 to 48 months. The lease agree- nually). The lessee is responsible for ex- period, the lease may be terminated at ment will only show the monthly rental cess mileage charges that can vary from any time without penalty. amount, and not the rate factors in- $.10 -$.15 per mile or on a graduated 14 BUSINESS FLEET MAGAZINE NOVEMBER /DECEMBER 2007 WWW.BUSINESSFLEET.COM WWW.BUSINESSFLEET.COM NOVEMBER/DECEMBER 2007 BUSINESS FLEET MAGAZINE 15 FLEET MANAGEMENT scale, i.e., $.05 for first 200 miles, $.15 for all additional mileage. Anticipated higher mileage may be “purchased” at Fleets that are subjected to rough usage and incur high mileage are better suited for open-end leases. 2 Know Your Appetite for Risk On an open-end lease, the lessee is re- lease inception with cost added to “The greater the percentage of the ve- sponsible for the vehicles’ residual value. monthly payment, or a graduated al- hicle’s life that is going to be consumed Are you comfortable with exposure at lowance may be available. Some lessors by the fleet, the greater the likelihood lease end when a vehicle’s worth drops will write closed-end leases with no it’ll be an open-end lease,” says Jack unexpectedly? mileage restrictions. Leary, president of Motorlease. “Con- Generally the open-end leased vehi- I The lessee is responsible for exces- suming 50 to 60 percent of a vehicle’s cle will be depreciated properly to reflect sive wear and tear as well as early termi- life, the client would probably be on a its end-of-term value, says Jack Man- nation penalties. closed-end lease. Consuming 95 percent ning, president of American Leasing. Yet NARROWING YOUR DECISION of vehicle’s life, the client is better on an sometimes extenuating circumstances open-end lease.” throw those values off and a company Those terms and conditions are a lot On the open-end lease, the lessee will can unexpectedly lose a lot of money. to digest, but you can narrow your deci- use up, and pay off, a great percentage The aftermath of 9/11 is a case in 1 sion by filtering your own fleet profile of those vehicles’ useful lives, so their point—travel came to a standstill and through three “big picture” parameters. residual values at end of term are less of rental cars flooded the used car market, a factor. The lessee will often pay off Understand Your Fleet Usage driving values down considerably. Fleets these vehicles down to a dollar and leave and Driving Patterns with open-end leases took a steep hit on them on the fleet management compa- de-fleeted vehicles, says Robert Singer, Defining how you use your fleet is the ny’s books, who will continue to handle vice president of Merchants Leasing. first step t lease type. the vehicle’s taxes, licensing and man- In a less dramatic scenario, large SUVs Do your sedans stay relatively damage agement reporting. recently have experienced a more pre- free, or do your trucks and vans get Fleets with passenger vehicles that cipitous drop in value than expected be- banged up on the job? Do you drive set run predictable yearly mileages, such as cause of high gas prices, Singer says. routes, and a set number of miles per sales reps, are better candidates for This is not much of an issue for fleets year? Do you put a lot of miles on your closed-end leases. Wear and tear is more that run their vehicles into the ground. fleet vehicles? Is turning over your fleet predictable, and the lessor can more de- But the risk is greater for those open-end every three years important to you, or do finitively match the pre-set mileage cap leases with substantial life, and thus you plan to run them until they “drop?” to the driving pattern. residual value, left in de-fleeted vehicles. 1999–2006: OPEN-END VS. CLOSED-END LEASING 1999 Open- 43.7% 84.6% Open- 2006 End End 56.7% 72.7% Closed- 56.3% 15.4% Closed- End Fewer End than 200 401-999 43.3% 27.3% Vehicles Vehicles 201-400 1,000 or Vehicles More 87.5% Open- 71.9% Open- Vehicles End End 84.2% 93.9% Closed- 28.1% 12.5% Closed- (Corporate/Business Fleet End End Respondents Only) Fleet 15.8% 6.1% Size by Number of Vehicles This survey, conducted by Business Fleet’s sister publication, Automotive Fleet, does not break down fleets under 200 vehicles. However, the majority of small fleets in Business Fleet’s domain (under 50 vehicles) use closed-end leases. 16 BUSINESS FLEET MAGAZINE NOVEMBER /DECEMBER 2007 WWW.BUSINESSFLEET.COM FLEET MANAGEMENT On the closed-end lease, this is the versely, if a fleet blows the cap out of the percentage runs higher, “We need to sit worry of the lessor, not the client. “In water, the lessor may not stick the client down and have a conversation on their the closed-end situation the client for $.15 on every mile, but a reasonable expectation of usage,” he says. is right every time,” says Leary. “If we amount that reflects the vehicle’s drop When repairs are warranted, the leas- 3 happen to be wrong it doesn’t affect in value because of high mileage. ing company should provide the client their payment.” Some lessors pool mileage for the entire with the photos of the damage and the fleet. Factoring the aggregate mileage actual repair invoice if requested. How involved do you want to be across the fleet will help to smooth out any The client has the right to repair the with fleet management? spikes or dips incurred by single vehicles. vehicle, though the fleet management Larger companies pay dedicated fleet Ultimately, if drivers are continually company can secure wholesale pricing managers to run the fleet as efficiently over the mileage cap lessor will rewrite and thus generally repair for cheaper, 4 as possible. They use a leasing company the lease to reflect the current condi- Leary says. to put vehicles into service at the lowest tions, Singer says. However, on an open-end lease the lessee does not get away any easier, Know your business’s cash-flow, rate possible, and retain much of the Singer says, as the damaged unit will budgeting and accounting needs fleet management duties in house. Open-end leasing gives the fleet man- simply return less at resale. THE BOTTOM LINE ager to arrange purchase agreements Companies on open-end leases that with manufacturers, set a depreciation want a greater short-term cash flow can rate that reflects the company’s financial adjust their monthly reserve for deprecia- Unlike many retail transactions, the needs and cycle the fleet to take advan- tion. This flexibility can be a valuable ac- reputable fleet lessor is not in the busi- tage of favorable buying and selling con- counting tool, though the fleet knows full ness of steering you to one type of lease ditions. well a balloon payment will come down over the other, because both lease types However, because you’re reading this the line if the reserve is set too low. are viable for most situations. Yes, magazine, you’re in charge of a small The open-end lease bill the lessor is looking to preserve fleet among a host of other concerns. breaks down the monthly his profit margin, but the “Long term, a well-executed open-end lease and a driving force is to keep the client satisfied and thus well-executed closed-end lease are not going to preserve the business. differ greatly in total cost,” Leary says. “If you’re going to nickel and dime a guy, it’s going to be a short-term re- You’ve got a business to run, and fleet is depreciation, management lationship,” Singer says. “If not your priority. fee, interest and taxes. Monthly you’re fair and equitable, things “I generally recommend to my cus- payment amounts vary, usually stepping have a way of working out. I’m doing tomers that because running a fleet is down year-over-year as the asset is amor- everything within my power to add not their core business, don’t take the tized. At end of term, the final account- value to the relationship.” residual risk,” says Singer. ing will show a loss or gain, recondition- Fleet management companies are The closed-end lease is part of the big ing and transportation charges and a constantly analyzing the fleet to wring picture for outsourced fleet management. disposition fee. greater efficiency out of the present situ- Under this philosophy it’s the lessor’s job The closed-end lease statement makes ation, Leary says. A little flexibility goes to estimate the vehicle’s value at lease life easier on the accountant: All taxes a long way. end, so better leave it to the experts. and fees are bundled into one fixed “If the sales guy covering Chicago With this burden, the fleet manage- monthly payment. Budgeting is simpler, moves to the suburbs, he’ll be driving ment company chooses optimal reserves as the fixed term determines the cost of more. We’ll write a new contract. What for depreciation and has a greater say in the lease upfront. The car is returned to good is it to hold the client’s feet to the fleet selection. the lessor, and the lessee walks away, fire?” says Leary. “We’re supposed to go The closed-end lessee is also subject- provided the mileage is within limits to the client with this information, not ed to mileage restrictions, which some- and there is no vehicle damage. the other way around.” times feels like a “heads I win, tails you Some fleets budget for excess wear Ultimately, your fleet costs should lose” situation, says Leary. The fleet is pe- and tear, others do not. come out equal with either lease. nalized for exceeding the mileage cap, Smaller companies are more apt to re- “Long term, a well-executed open- but doesn’t get a check back for driving serve for wear and tear, where larger end lease and a well-executed closed-end under the cap. Lessors have ways to rem- companies generally pay those losses as lease are not going to differ greatly in edy this. they occur. total cost,” Leary says. “However you If a fleet falls considerably under the Leary estimates that a Motorlease shake this, the client is going to pay for cap some lessors will make a “goodwill client should be paying for damages on the part of the vehicle’s life that they adjustment” and credit the client. Con- less than 10 percent of the fleet. If the consume.” BF 18 BUSINESS FLEET MAGAZINE NOVEMBER /DECEMBER 2007 WWW.BUSINESSFLEET.COM