What is a Direct Lease?

Ken Black

A direct lease is a financing arrangement by which the lessor buys the property and rents it directly to the lessee. In such cases, the owner of the property truly never intends to ever directly use it for its intended purpose. Rather, it is simply a mechanism for investing and making future profits.

In a direct leasing arrangement, the lessor buys a property and rents it directly to the lessee, also known as the tenant.
In a direct leasing arrangement, the lessor buys a property and rents it directly to the lessee, also known as the tenant.

A direct lease can be used when two criteria are satisfied. The first condition that must be met is that collection of minimum lease payments is assured. The second factor is that there can exist no major uncertainties regarding the amount of unreimbursable costs that may be incurred. In other words, both sides need to be aware of all costs associated with the lease up front.

Further, a direct lease differs from a traditional lease in that the lessor is not a manufacturer or dealer, but rather a third-party owner who buys the property. This may be a bank or some other type of investment firm. Any lease that does not involve a third-party owner cannot be considered to be direct.

In some ways, direct leasing can be very attractive to a company needing to perform a job. This is especially true for companies in heavy manufacturing and construction. In these cases, equipment may not be very cheap. Instead of using it every so often and paying for it even when it sits idle, it may make sense to only use it when it is needed through a direct lease.

It is for this reason that heavy machinery may be good candidates for this type of lease. Very few general contractors, for example own their own cranes when working on taller building projects. Rather, they specifically rent a crane from an owner who can provide one they need. Due to the fact the crane owner is usually not a manufacturer or dealer, it can be considered a direct lease.

Direct leases offer a number of advantages. For example, one thing companies must constantly deal with is the depreciating value of equipment: because the company does not directly own a piece of equipment, this is not a concern. Also this type of lease requires a smaller initial cash outlay than does an outright purchase. This frees up valuable capital for other projects.

Further, while a direct lease is a business expense, it does not count against the company's debt. Due to the fact that the company did not go into debt to use the equipment, it may be more attractive to investors. At the very least, a lower debt load will help lead to more favorable bond ratings. Thus, in some ways this type of lease is a way to incur debt without that debt actually counting against the company in other ways.

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