How Does Lease-Purchase
Financing Differ From True Leasing?
To a governmental lessee, the
difference between lease-purchase financing and true leasing is the nature
of the interest acquired in the asset. In the lease-purchase, the lessee
acquires ownership of the asset. In a true lease, the lessee acquires only
the right to use the asset for a period of time - it does not acquire
ownership of the asset. The lease term of a true lease is usually much
shorter than the asset’s useful life, while the lease term of a
lease-purchase often approximates its useful life. The difference in term
of lengths can be explained by what happens at the end of the term. With a
true lease, the municipality typically relinquishes the asset but may
purchase it at a price which reflects its residual or market value. With a
lease-purchase, the municipality retains the asset without paying more
than a nominal price in relation to the value of the asset, usually $1.00.
Additionally, due to the ownership structure, lease-interest paid by the
municipality to an investor is not taxed by the Federal and in some cases
state government. In a true lease, rentals usually reflect interest at a
taxable or commercial interest rate.
In some cases, true leasing
may be the most cost-effective form of financing for an equipment project.
An example of this instance may be if a city needs temporary space, such
as a relocatable building for one year while city hall is being rehabbed.
After the one year the city has the option to give back the building to
the vendor, purchase it at the residual value or refinance it under a
lease purchase agreement. True leasing may also be cost effective for
technology purchases whereby the equipment becomes obsolete in a short
period of time. The USLease program will determine whether true leasing
makes sense on a case by case basis and make recommendations. USLease
staff will evaluate each project and provide the alternatives available.
Lease-Purchase Financing Differ From Bond Financing?
A lease-purchase financing is
an exercise of a governmental entity’s authority to acquire or dispose
of property. The issuance of bonds is an exercise of the authority to
incur debt. Unlike a bond issue, a lease purchase financing is not
considered to be debt for state law purposes, and no voter approvals are
necessary to authorize the transaction. The underlying security for the
two types of obligations is also different. With bond financing, the
borrower commits a designated revenue source, such as property taxes or
user charges, and obligates itself to raise revenues to the extent
necessary to pay debt service. There is no such obligation supporting a
lease-purchase agreement. The governmental entity covenants only to budget
and appropriate lease payments from available revenues each year.
The financing mechanism for
USLease is also different in structure than a traditional bond financing.
Typically, funding for projects financed by bonds is obtained through the
issuance of bonds in the public marketplace, also known as a public
offering or underwriting. In this case, the debt issued by the public
agency is sold to many investors with each investor receiving a
proportionate interest in the principal and interest payments. Due to the
cost associated with a public offering, including legal, trustee, printing
costs, bond financing makes sense for larger, long term projects.
Equipment financings, which tend to have shorter financing terms,
generally are not financed through bonds unless larger projects are
Funding as part of the USLease
program is received through the private placement market. The private
placement market provides municipal lessees with access to funding from
large, sophisticated investors. Investors include institutions, banks and
high net worth individuals. USLease bids each equipment project on behalf
of the public agency to find the most cost-effective financing. Once the
lowest bidder (funding source) is identified, USLease handles
documentation and funding on behalf of the local agency. USLease documents
have been pre-approved by multiple funding sources in the marketplace as
well as numerous cities, counties, and special districts.
For more information about
USLease and other financial programs offered through USCM, call Lilla
Hammond or Justin O’Brien at 1-888-828-8763/ e-mail: firstname.lastname@example.org
or Tracy McWilliams with USLease at 1-800-635-3993, extension14. For
instant financing quotes, visit www.zipquote.com
(Editor’s note: This is the
second of three articles about lease purchase financing.)