Now Leasing?

There are more things, and ways, to lease than ever—but also an ever-lengthening list of what to watch out for, too.

by Don E. Vance, CCM (editor@clubandresortbusiness.com)
March 2007
 

With cash streams increasingly stressed by renovations, discounted initiations and other realities of modern-day management, managers and department heads are continuing to explore new ways to tap into the value of leasing arrangements. And this search is no longer limited to what has traditionally been leased at club and resort properties (i.e., golf cars and course maintenance equipment). It’s now also being extended to a wide variety of new areas, including (but not limited to) indoor and outdoor furniture, kitchen equipment, computers and point-of-sale equipment, phone systems and other office machines, and fixtures and equipment for fitness centers, pools and spas.

No matter what you may now be thinking of leasing, advantages and disadvantages need to be studied carefully before any agreement is signed. Yes, leasing is a good way to free up cash flow, if you can negotiate a lease with the right interest rate. And yes, leasing improves your ability to stay up with the latest technology by making it easier to exchange existing items for new ones. But will you really use—and benefit from—the upgraded features, or can the existing equipment continue to serve you well, long after it’s been paid for?

In many private club settings, the biggest driving force behind leasing is debt. Industry statistics show that 50 percent of clubs have some level of debt service, and the percentage is growing with the recent boom in capital improvement projects. As it becomes more difficult to service this debt, leasing is sometimes viewed as a way to minimize other expenses and not add more liabilities to the club’s financial statement. This can certainly be a prudent strategy as long as it’s not done out of short-term desperation, or doesn’t lead to the use of inferior equipment that causes negative quality and service trends in the club.

Putting it to the Tests
In the end, the decision to lease should always pass the same tests as a decision to buy: Will it lower our cost of doing business and help to increase net income? Will it represent the best use of our cash and/or our available credit?

The first test is a relatively simple process of comparing expenses and revenues before and after equipment is acquired. The second involves an assessment of cash flow and the time-value of money, to determine payback periods or internal rates of return on investment. The numbers yielded by this test should be compared to standards that have been established as company policy—and no matter how sweet a lease deal may look, it shouldn’t be made if paybacks and ROIs don’t meet those standards.

Beyond these basic tests, here are some other good practices to follow, and things to watch for, when considering leasing as an option:

• Decide if an operating or capital lease is best for a particular need. An operating lease is basically a rental agreement that provides you with off-balance sheet financing. A capital lease is set up basically as an installment sale. Which one is right for a particular situation depends on how much you want to eventually own what’s being financed, and how much additional use you might be able to get out of it.

• Leasing is often especially attractive for start-up properties that don’t yet have a credit history. But be aware that your interest costs will usually be higher—so there may be some things you’ll want to bite the bullet for and still try to buy.

• Carefully study the optimum timing for leasing terms. At one club I managed, we leased our golf cars and found that turning them over every three years was still the best way to go, even if it meant larger monthly payments compared to longer agreements. This was because three-year terms let us take the best advantage of the golf cars’ trade-in value; holding them another year would reduce that value far below any benefit to be gained through lower payments.

In addition, we saw that holding on to the cars would lead to significantly increased repair and maintenance costs. (And remember, even if you can get some or all of those costs covered in a lease, there’s also the cost of downtime on service, and the risks posed to customer satisfaction.)

• Watch for penalties for terminating your lease before the end of the lease period. Typically, capital leases are longer-term and do not have much flexibility to cancel without huge penalties, while operating or service leases are shorter-term and fairly easy to cancel, at little or no cost.

• Have your accountants review all lease agreement terms prior to committing, to make sure they’re sound from a tax standpoint and not disguised as installment purchases or full of other hidden traps. Keep in mind that usually, the big print “giveth” and the small print “taketh away.” I actually saw a clause recently in a lease that stated, “Lessee hereby waives any right to trial by jury in any proceeding arising out of this lease.”

• Remember that interest rates and terms for leases are negotiable. When we were in the market for a new photocopier at one club, we opted for leasing as the way to best keep up with the latest technology. The initial lease, though, came in at 16 percent interest, which was of course way out of line. Through a couple of weeks of negotiations, we were able to cut the rate in half.

• Watch out for automatic renewal terms; they could obligate you to a longer lease than you expect. And carefully check the language pertaining to standard return conditions, and the penalties for returned equipment that does not meet those standards. Return-related charges can often make a lease cost more than a purchase.

• Make sure the lease specifies responsibility for property taxes, insurance costs and maintenance costs. A lease where the lessee is obligated to pay these costs, in addition to the direct lease payment, is commonly called a “triple-net” lease.

Go With the Flow
In my opinion, clubs or resorts with strong cash flow positions should probably lean more to purchasing rather than leasing, except for equipment where technology is changing rapidly.

The key in all cases is to fully understand how your financial statement will be affected. Capital leases that do not show up as an expense can be particularly helpful for departments that may be losing money, such as food and beverage. But don’t fool yourself: An operating expense is an operating expense, no matter how you post it.

In competitive markets, there should be little difference between the final costs of leasing and buying. The interest rates should determine your decision. If your cost/benefit review shows that the cost of the lease is cheaper than owning the asset, that’s your best signal for signing on.