Leases are classified into different types based on the variation in the elements of a lease. Very popularly heard leases are – financial and operating lease. Apart from these, there are the sale and leaseback and direct lease, single investor lease and leveraged lease, and domestic and international lease.
A lease is a very important financing option for an entrepreneur with no or inadequate money for financing the initial investment required in plant and machinery. In a lease, the lessor finances the asset or equipment and the lessee use it in exchange for fixed lease rentals. In other words, lease financing is an arrangement where the lessee who requires the equipment or machinery gets the finance from the lessor for the agreed rental payments. Such a kind of lease is called a finance lease. There are many such arrangements and hence, there are many types of lease. Let us have a look at the different kinds of the lease.
A certain variation in the elements of lease classifies lease into different types. Such elements are as follows:
- The degree of ownership risk and rewards transferred to the lessee.
- No. of parties involved
- Location of the lessor, lessee, and the equipment supplier
- The lessor and the lessee
Here, risk means the chance of technological obsolescence and reward refers to the cash flow generated by the use of the equipment and the residual value of the equipment.
Types of Leases
On the basis of the above dimensions, leases are classified into two parts
- Leases for Business
- Leases for home (house)
Leases For Business
Finance Lease and Operating Lease
A finance lease, also known as Full Payout Lease, is a type of lease wherein the lessor transfers substantially all the risks and rewards related to the asset to the lessee. Generally, the ownership is transferred to the lessee at the end of the economic life of the asset. The lease term is spread over the major part of the asset life. Here, a lessor is only a financier. An example of a finance lease is big industrial equipment.
On the contrary, in an operating lease, risk and rewards are not transferred completely to the lessee. The term of a lease is very small compared to the finance lease. The lessor depends on many different lessees for recovering his cost. Ownership along with its risks and rewards lies with the lessor. Here, a lessor is not only acting as a financier but he also provides additional services required in the course of using the asset or equipment. An example of an operating lease is a music system leased on rent with the respective technicians.
Sale And Lease Back and Direct Lease
In the arrangement of sale and leaseback, the lessee sells his asset or equipment to the lessor (financier) with an advanced agreement of leasing back to the lessee for a fixed lease rental per period. It is exercised by the entrepreneur when he wants to free his money, invest in the equipment or asset, to utilize it at the whatsoever place for any reason.
On the other hand, a direct lease is a simple lease where the asset is either owned by the lessor or he acquires it. In the former case, the lessor and equipment suppliers are one and the same person and this case is called ‘bipartite lease’. In a bipartite lease, there are two parties. Whereas, in the latter case, there are three different parties viz. equipment supplier, lessor, and lessee. And it is called a tripartite lease. Here, the equipment supplier and lessor are two different parties.
Single Investor Lease and Leveraged Lease
In a single investor lease, there are two parties – lessor and lessee. The lessor arranges the money to finance the asset or equipment by way of equity or debt. The lender is entitled to recover money from the lessor only and not from the lessee in case of default by a lessor. Lessee is entitled to pay the lease rentals only to the lessor.
Leveraged lease, on the other hand, has three parties – lessor, lessee, and the financier or lender. Equity is arranged by the lessor and debt is financed by the lender or financier. Here, there is a direct connection of the lender with the lessee and in a case of default by the lessor. The lender is also entitled to receive money from the lessee. Such transactions are generally routed through a trustee.
Domestic and International Lease
When all the parties to the lease agreement reside in the same country, it is called a domestic lease.
The International lease is of two types – Import Lease and Cross-Border Lease. When the lessor and lessee reside in the same country and the equipment supplier stays in a different country, the lease arrangement is called import lease. When the lessor and lessee are residing in two different countries and no matter where the equipment supplier stays, the lease is called a cross-border lease.
Combination Lease offers features of both financing or capital lease and Operating Lease. This is a customization form of leasing. One of the simple examples of a combination lease is a capital lease that carries a clause for cancellation.
Leases For Home
A sublease is a rental agreement where the original lessee(tenant) rents out the premises to another person called the sub-tenant or sub-lessee. The new tenant gets few rights as the sub-lessee. The original tenant (lessee) can only give those rights to the new tenant (sub-lessee) which he has got from the original landlord (lessor). He cannot pass on more rights of use on the property. The flow of rent is from the sub-lessee to the lessee and the lessor/owner. The risk of rent is always mainly borne by the lessee. In case the sub-lessee is unable to make full or timely payment to the original lessee, the lessor is still entitled to his timely rents and the risk is borne by the lessee.
Modified Gross lease
In it, some of the building or property expenses are borne by the tenant. while the remaining is borne by the landlord with no single party responsible for all the operating costs. As an instance we can consider this: In a modified gross lease, the tenant may pay CAM costs. while the landlord may take up taxes and insurance.
A Gross lease is the simplest form of a lease. In this format, the lessee agrees to pay the lessor a flat fee at a regular interval for instance monthly and the lessor takes care of any and every expense associated with the property. The rate charged does not change. It is a rent agreement in which the cost of keeping up the rented asset, including its protection and charges, is borne by the lessor. Gross lease rental is usually higher than the net lease rental as the lessor would have factored in different types of expenses in the rentals that are being charged.
Triple Net Lease
A triple net asset is the most commonly used type of lease for commercial and even some residential estates. Here the tenant will pay for everything from rent, property taxes, insurances, and common area maintenance and repair expenses (also known as CAMS – Common Area Maintenance Items). Hiring regular staff and maintenance help can also be part of this – e.g receptionist, lobby attendant, etc.