FINANCIAL MANAGEMENT/ Lease-purchase agreements offer flexibility
Financial officers must budget millions of dollars for capital equipment each year, but they rarely have enough funding to buy what they need. Faced with equipment shortages and the prospect of borrowing funds or selling bonds, cities are choosing to participate in municipal lease-purchase financing.
In a municipal lease-purchase transaction, a municipality (lessee) acquires equipment using funds provided by a lender (lessor) and agrees to repay the funds over a set period of time.
The ability to spread the cost of new equipment over an extended period of time is the primary benefit of lease-purchase financing. In addition, because lessors do not have to pay federal and, in most cases, state income taxes on municipal leasing income, rates are typically 30 to 35 percent less than commercial borrowing rates.
While leasing rates are typically slightly higher than bond rates, leases usually have minimal up-front costs. By eliminating underwriting fees, legal fees and other expenses, leasing often can provide a lower net cost than issuing bonds.
Lease-purchase financing is available to any governmental entity including, but not limited to, towns, cities, townships, counties and states. Special rules exist to include other government agencies, such as volunteer fire departments.
Many municipalities obtain lease-purchase financing by requesting that equipment suppliers include it in their equipment bids. Others have found it advantageous to advertise for leasing bids separately from the equipment purchase.
Most lessors that work with municipal borrowers will require that the equipment qualify as “essential use” equipment – e.g., fire trucks, ambulances, snow plows, garbage trucks and school buses. Other types of equipment, such as playground furniture, water slides and golf carts, may not qualify as essential use, depending on the guidelines used by each lessor.
Municipal leases are structured as installment purchase contracts. The lessee makes payments over a period of time and may “purchase” the equipment for a nominal fee, usually $1, at the end of the period. The lessee maintains title to the equipment throughout the term and builds equity with each payment. Typical lease terms range from three to 10 years and should be matched to the useful life of the asset.
Payments can be made monthly, quarterly, semi-annually or annually to fit the cash flow needs of the municipality or those of the specific department. A municipality paying for equipment through its general fund may prefer to have annual or semi-annual payments that are due after property tax receipts are received. If the payments come in whole or in part from user fees, such as trash collection, the municipality may prefer monthly or quarterly payments.
With a lease purchase, it is possible to acquire equipment in the current year even though the municipality has no funds designated in its budget. The lessor can agree to have payments begin in the next fiscal year, possibly as much as one year away.
To meet statutory restrictions on long-term debt, municipal leases typically include non-appropriations language that allows the municipality to terminate the lease at the end of any fiscal year if it does not have the funds to pay for the equipment. Because of that language, leases actually are a series of annual obligations and generally are not considered long-term debt.
Lease-purchase financing has become a valuable tool for many communities as they struggle to provide a high level of serv-ice within budgetary constraints. Departments benefit from obtaining much needed new equipment, and taxpayers benefit from spreading the cost over time at very low rates.