We’ve had some clients who used to be of the mindset of running vehicles into the ground but now that they understand how open-end leasing can work to their advantage, they have changed how they operate their fleet. For example, an open-end lease structure allows you to keep trucks for a set period of time vs. running them into the ground over 15 years and hundreds of thousands of miles. At the end the lease, you have three options:
- Buy the vehicles
- Extend the lease
- Trade in the vehicles toward a new leased vehicle
Turning Vehicles More Often is Advantageous
Uptime – Newer vehicles need fewer repairs. Fewer repairs mean your fleet vehicles spend more time on the road doing revenue-generating work vs. sitting in a repair garage costing you money.
Brand Image – Your branded vehicles are rolling billboards. What does a worn out 15-year-old vehicle say about your brand? Leasing allows you to have newer and more reliable company vehicles, making positive first impressions and attracting new customers.
Employee Retention/Acquisition – If you are like many companies, you struggle to find and keep quality employees. If your competition provides newer and more reliable vehicles to their employees, their employees are happier, more engaged, and more productive. You deserve the edge.
Vehicle Fitment – A lot can change in 15 years. There are many new technology and safety features available on vehicles today vs. 15 years ago. Engines drop from 8 to 4 cylinders, have hybrid and electric powertrains and dozens of important safety features.
So Exactly How Do Open-End Leases Work?
Leasing allows business owners to pay for the portion of the vehicles they use. This naturally reduces payment compared to financing a vehicle where the intent is to build equity.
Three choices exist at lease-end: buy, extend, or return.
Business leases (another term for open-end leases) have no mileage charges or damage charges. The lessee bears the risk for the value of the vehicle at the end of the lease and has the benefit of the equity built up during the lease. Closed-end leases, by contrast, are typically consumer leases and include mileage and damage charges. The lessor bears risk for the value of the vehicle at the end of the lease and the lessee has no claim to equity. Mileage and damage charges are often much greater than the actual loss in value to the vehicle.
Knowing which levers to pull is the key to structuring open-end leases that are best for your company.
- Approximately how much will the vehicle be driven each year?
- Approximately how are the vehicles used and what condition will they be in at the end of the lease?
- Setting the right depreciation rate (residual) reduces the risk at the end of the lease.
All of these factors are used to determine the estimated value of the vehicle at the end of the lease. This is what is called the residual value. This value drives how much the vehicle depreciates each year, which in turn determines your monthly payment and your cash flow. The right answer to what your residual value should be all depends on your company goals and objectives.
- Are you trying to increase your cash flow now?
- Or do you want to minimize risk at the end of the lease?
- Do you want to build equity in the vehicles over time and increase you tax deduction throughout the lease?
- Is there a chance you will end the lease early?
The logic seems straightforward: set a low rate and your monthly payments will stay low. Set a high depreciation rate, and consequently, your monthly payments will increase.
Things are not always as they seem.
If you over-depreciate your vehicles throughout the lease, your monthly payments increase and you potentially build equity in the vehicles over time. The equity at the end of the lease could be used as a down payment on a new vehicle. If you under-depreciate the vehicles, your monthly payments are lower but you will have to pay for the deficit at the end of the lease in lump sum.
Mileage and usage will impact the value of the vehicle at the end of the lease. If you put on significantly more miles than you originally planned, the vehicles’ value at the end of the lease will be lower and you may owe money at the end of the lease. To avoid surprises, it is important to be realistic when you estimate the number of annual miles and conservative with the residual value. Certain industries put a lot of wear and tear on a vehicle. No problem! Just make sure this is accounted for when you set your monthly payment and residual value.
When the lease ends (either at the end of the lease term or in the middle of the lease) the vehicle is sold and the difference between the net sale price and the residual value set at the beginning of the lease (or current payoff) is the responsibility of the lessee. If the net selling price is greater than the residual value, the excess is paid to the lessee. If it is lower, then the lessee is responsible for the deficit.
Professional fleet management firms are experts at setting residual values. They watch for trends in the used vehicle market and can help you set reasonable lease-end values that meet your business objectives.
If you no longer want to run your vehicles into the ground and are looking for cash flow savings, want to optimize the cost of your fleet, and a little uncertainty at the end of the lease doesn’t bother you, an open-end lease is exactly what you are looking for.