Garry Bartecki Buy-Lease-Rent Financing status: You better sit down for this
At this time in our economic lives this topic has a lot of pros and cons to consider before deciding what dealers need to do, what customers want to do and how dealers need to assist customers meet their goals using proper financial options.
When we consider the three variables involved (buy-rent-lease)…. the pandemic equipment pricing for both new and used equipment…..interest rates along with new bank loan agreements and covenants……the inability of customers to handle the monthly nut now required if a unit is purchased or part of a long-term rental program.
And then there is the collateral risk associated with lease residuals as well as book values four or five years out where the book value or residual will not even be close to reasonable once the new and used markets get back to a “normal” status where new unit pricing has decreased and there is adequate supply of used units available causing used sales to return to a “normal” as some percentage of recent new unit cost.
Let’s face it folks, someone must pay for these crazy new and used costs and still make a buck doing it. Check out the auto industry to see how this is working out for them. There are dealers taking new and used cars to auction to try to get rid of them, and they are not hitting the reserves to make a deal. Banks are doing the same thing with repos.
What I saw today watching CNBC is that CarMax is doing better because the glut of used cars for sale is causing pricing to soften to the point where they are improving their bottom line. The commentator also noted that more car customers are keeping their rides longer and buying used cars because they cannot afford a new one. If this same scenario repeats itself for other types of financial assets, the players will wind up in the same situation be that an OEM, Dealer, Customer or Bank.
And if you think this situation is going away any time soon, think again. The supply and demand situation may continue to lower the cost to build new units, but it may be accompanied by a recession as well as continued high interest rates. In other words, this scenario of tighter money with less financing availability will take years to play out a delay out causing the value of used units (including rental units) to decrease to where you are upside down on the residual and/or book value which converts to taking losses on units purchased at pandemic rates.
Is there money available for purchasing or leasing a unit. Yes, there is, but at a cost customers may not want to deal with. Interest rates could be somewhere between 8-13% depending on the FICO score, years in business and the ability to establish that you are running a profitable business.
To give you some perspective on this issue I found in the June 17th issue of John Mauldin’s THOUGHTS FROM THE FRONT LINE, specifically a comment by Peter Boockvar which is as follows:
“The credit crunch is here, and this will take not quarters, but years to play out if the cost of capital remains high. Understand too that many small and medium businesses have to pay an interest rate on a loan that is above 10% if they can even get one. Things in the private economy worked ok at 3-4% interest rates, not so much at 10% as were on a whole new economic playing field that I don’t think is being fully appreciated.”
To which John Mauldin added. “Read that quote two or three times. An entire generation of investors and business leaders has never known a capital-constrained economy. Can they adjust? Probably, but not easily or instantly.”
Let’s assume that I am one of those younger folks going through this type of economy for the first time. I have a company to run and need to have my material handling equipment operating properly to keep my efficiency levels where they need to be generating a proper Gross Profit that converts to budgeted profit and cash flow. Keeping that GP % means keeping costs where they are at because I don’t have the ability to pass on cost increases to my customers. Let’s further assume that I stay up to date on economic matters and thus expect higher costs for materials, services and especially equipment, which are big ticket items.
What will my thought process be under these circumstances?
- Do I need new units?
- Can I find a used unit if I need it?
- Do I have anything to trade-in at these aggressive values?
- What will it cost to finance a new or used unit? Can I afford it?
- Wonder what it would cost to refurb the units I have?
- Maybe I should lease them?
But if I am leasing new units won’t the lease cost also rise due to the cost of the units?
I wonder if I can get the OEM or Dealer to buy down the interest rate.
Would an RPO work for me in this situation?
Can I gain enough newfound efficiency to cover the higher cost of the units?
I do not want to get stuck with a residual value or book value I can’t recover. How do I avoid this?
Can I just do a rent-to-rent deal for the months in the year when I need more units?
How will a purchase impact my loan covenants? For that matter how will a lease impact my loan covenants?
Being that I have worked primarily in two equipment industries …. material handling and construction equipment, I am comfortable calculating what a rental rate should be to cover the cost with a “standard” level of usage over a five-year period, and what to expect the residual value to be assuming proper maintenance has been incurred. Having this knowledge would also cover budgeting for the purchase of new or used units, or budgeting for an operating lease where the lessee covers the maintenance cost.
So, what do I do under these circumstances ……drum roll please!
First choice is to DO NOTHING. Step up the maintenance on what I have and get through the next couple of years. I see what is happening in the auto industry and expect it to carry over to all categories of equipment.
Take advantage of the high used prices. See what I have available to trade-in and find used units that are newer and in better shape than what I have. Hopefully, this type of deal puts me in a more comfortable position in terms of debt service.
Have my dealer go out and search for good used units.
Review an RPO transaction if you can get monthly rental payment to where it is not excessive in terms of what the residual should be if you turn it in and not buy it.
Get on the allocation list for something 24 months out, with the ability to back out if need be.
I guess if I had to, I could sell the business and let the next guy/gal deal with these decisions.
In conclusion, there is money available to buy or lease. It will be more costly in terms of interest rate and other costs. Rates will be in 8-12% depending on your history and credit rating. The bank will be concerned about the collateral value and require a valuation to support OLV each year. If it gets to the point where the OLV is lower than what you owe on the note, expect a request to step up the payments to get OLV back in line with balance owed.
Dealers should push OEMs to bring down the cost of new units since we know the supply shortages etc. are reversing. I also would ask them to buy down the interest rates or arrange equipment financing at the lower end of the interest rate spectrum.
Let’s hope the Fed can get inflation down to where they want it to be, which will in turn allow interest rates to be reduced, which will reduce the cost of acquiring new and used units.
About the Columnist:
Garry Bartecki is a CPA MBA with GB Financial Services LLC and a Wholesaler columnist since August 1993. E-mail [email protected] to contact Garry.
