In Praise of Fair Market Value Leases in Materials Handling

by Tibor Horvath September/October 2007
To properly price a Fair Market Value lease for materials handling equipment, a lessor needs to be one part detective, one part numbers-cruncher, and one part customer advocate. The effort involved can benefit all parties to this type of lease and in today’s environment, it’s more important than ever to offer such beneficial solutions.

For many materials handling equipment customers, a Fair Market Value (FMV) lease is a viable alternative to capitalized lease structures. This “pay-as-you-go” approach can benefit the customer through lower monthly payments, the possibility of off-balance-sheet treatment for reporting purposes, expensing the payment instead of depreciation, using pre-tax dollars to acquire assets, replacing the equipment at the optimum economic lifecycle and avoiding technological obsolescence.

The ability to offer FMV leases is almost a necessity if a lessor is to be competitive in the materials handling industry. But to successfully offer this option, lessors must take into account a host of factors — not the least of which is what’s best for the customer.

Customers who are in the market for new materials handling equipment justifiably want the highest quality for the lowest price. But while a low lease payment initially may appear attractive to the customer, it may not be in their best interest. Unless the lessor takes into account reasonable residual risk and numerous industry-specific variables, the payment may be low, but the residual may turn out to be prohibitively high for the customer. The result? A surprised and unhappy customer — and, perhaps, the permanent loss of their business.

All equipment dealers know it is essential to accurately evaluate a customer’s needs to determine the right equipment for a specific application. But what some lessors may not realize is that using the dealer’s evaluation to determine an appropriate wholesale residual value for equipment is of equal or greater importance.

Key Considerations
A lessor should consider the following when writing an FMV lease for materials handling equipment:

Residual Position
The lessor must correctly identify and analyze the configuration of the equipment, as well as its application, usage environment and estimated annual hours.

For example, a forklift that has a quad mast, runs high annual hours, and operates in and out of a cold-storage environment, will command a much lower residual position than one that has a-three-stage mast, runs low hours and operates in a dry warehouse environment. If a forklift is to be used for an application that thorough investigation reveals is in a characteristically dusty environment, this usage should be considered “normal,” resulting in an appropriately higher residual.

What about a forklift designated to be used in a foundry? Although this is generally considered to be a “severe” application, a proper plant survey might reveal that the application is actually located in the foundry’s loading dock, far from areas of extreme heat and abrasive dust — again, resulting in a correctly higher residual.

A lessor also should consider competitive residual positions and overall desired return. Too high a residual position will help win the deal, but may result in a lower-than-desired yield upon sale of the equipment. Too low a residual may result in a boost in yield upon lease termination and resale of the equipment, but given the competitive marketplace, it will likely keep the lessor from being awarded the lease.

The asset management team’s role here is key. The goal of the team is to find the middle ground — that is, taking residual positions, which bring in the deals, while at the same time generating some residual upside and increased yield to the lessor at lease maturity.

Often, the lessor realizes increased yield as a result of the lessee continuing to rent the equipment — typically on a month-to-month basis — after the lease has matured. This has the added benefit of allowing the lessor to write-down the residual position while taking additional rental income.

Pricing
Tax benefits available to the lessor allow for lower pricing to lessees while the lessor realizes its internal rate of return. As owner of the equipment, the lessor takes the depreciation write-off, thus reducing taxable income. Depending on the time of year, FMV rates are typically 50 basis points to 1% or more lower than money-over-money rates. Lessors with no tax-lease appetite (AMT tax players) do not benefit from the extra depreciation, however they can sell these depreciation benefits to lessors who can use the benefits.

Lease Documentation
Usage surveys — including return provisions and penalties for excess hours and abuse — signed by the customer and made a part of the lease, are an important part of the documentation package. Inexperienced lessors have suffered significant losses because their documentation did not adequately address return provisions and penalties.

End-of-Term Notification of Intent
Provisions incorporated into the lease requiring notification prior to lease maturity enable a lessor to prepare for upcoming equipment returns. Most successful lessors include a 60- to 90-day requirement for the lessee to indicate their intent to return, purchase or continue to rent the equipment. After receiving this information, asset managers can then focus on turning the returned assets as the lease comes to maturity.

Dealer Partnerships
Independent lessors are not typically in the retail equipment business. Lessors must build an acceptable outlet for equipment returned at end-of-term. Dealer and wholesaler relationships, along with program agreements, which include remarketing assistance, are critical to the development of a successful FMV program.

Looking Out for Dealers & Lessees
Setting wholesale residual values that are aggressive yet realistic for all parties requires not only a skill set that comes from industry experience and knowledge, but also a desire to be a true advocate for dealers and their customers. As we’ve all heard time and time again, it costs less to retain an existing customer than it does to attract a new one. Partnering with a dealer is one of the best ways to ensure customer retention.

For example, local dealers have a keen interest in maintaining leased equipment in good condition. Off-lease equipment — forklifts in particular — are an important source of used products that can be resold or put into short-term rental fleets. Lessors can educate dealers on how offering fleet management and maintenance programs creates a beneficial domino effect for all parties:

  • The customer benefits from the minimized downtime (maintenance costs) and maximized uptime (productivity) that are a byproduct of good equipment maintenance.
  • The dealer benefits from income earned from leased equipment covered under their fleet management and maintenance contracts. Well-maintained off-lease equipment also gives dealers a source of high-quality used stock.
  • Because good fleet management typically results in higher-quality equipment at the end of lease, the lessor is more willing to take a higher residual. This keeps the customer’s lease payments low and results in fewer hassles when they return the off-lease equipment.

If a dealer works with several lease providers, the lessor can help the dealer educate their customers on evaluating those providers based on factors including industry and FMV lease experience, reputation and track record, an effective equipment-remarketing program, and a consultative versus a “hard sell” approach.

Leasing companies, which are competing for new relationships, should be prepared to supply references from companies whose fleets they finance. Lessors with a reputation for smooth return of equipment coming off lease and good working relationships with local dealers will be the best at minimizing overall costs associated with leasing forklifts.

The Bottom Line
Satisfied customers who feel they are getting a good deal and being treated fairly will generate repeat business with a dealer. And equipment dealers who recognize their lease provider “has their back” — and the backs of their customers — will become repeat customers themselves.

A commitment by all lessors to develop the procedures and resources to properly evaluate the residuals used in FMV leases will certainly benefit our industry. Our customers will have the assurance that they will be offered a payment commensurate with the application of the equipment. Moreover, lessors will have confidence they will be able to remarket their lease-end assets, attain a reasonable margin, and develop a strong presence in the marketplace.

In our industry’s current environment, it is more important than ever to cultivate trust and offer solutions that benefit everyone. That can only be done through long-term business relationships with dealers. Cultivating enduring partnerships has been the cornerstone of De Lage Landen’s success, and we believe it can help all lease providers enhance their reputations and that of our industry.


Tibor Horvath is vice president, sales, Materials Handling & Construction for De Lage Landen Financial Services, a global provider of asset finance and vendor finance programs. He has 34 years of experience in the equipment finance industry, 22 of which have been focused in the materials handling sector.

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