Leasing

A lease or tenancy is a contract that tranfers the right to possess specific property. In law, there are two types of property:

• Historically, land is the more important because, under normal circumstances, it holds the highest value in economically developed societies. Ownership of land is an aspect of the system of real property, realty or immovables.
• All other property is considered personal property, personalty or movables and this property is either tangible or intangible, i.e. it is either physical property that can be touched like a computer, or it is an enforceable right like a patent.

There are three separate levels of rights or interests affecting both forms of property. In descending order of importance they are:

• ownership,
• possession, and
• control.

The legal documents that transfer these rights are respectively: conveyance, lease/tenancy, and bailment/pledge for trangible personalty.

Conceptual background

If a person is not accountable to anyone else for the use of property, that person is considered the owner. So, under normal circumstances, owners cannot steal their own property, nor can they be held responsible for the destruction of their own property. This does not deny the power of the state to regulate the rights and duties of an owner and to impose liabilities should others be endangered by any use to which the property is put. But, in general terms, owners have considerable freedom of action under all legal systems, both national and international.

By definition, an owner will have the rights of both possession and control over the property, but is able to allow others access to those rights:

• real property — the transfer of possession and control is through a lease or tenancy agreement. For this purpose, the owner is called (the lessor) and the other person is called (the lessee) and the rights to possess and control the land are exchanged for some consideration (usually a monthly rent). A lease may be for a specified period of time (the "term") or it can be contingent, i.e. it lasts until some specified event occurs, or it is at will, i.e. it lasts only as long as the parties wish it and can be terminated without penalty. Because ownership is retained by the lessor, he or she always has the better right to enforce all the contractual terms and conditions affecting the use of the land, Normally, the contract will be express (i.e. set out in full and, hopefully, plain language), but where a contract is silent or ambiguous, terms can be implied by a court where this would make commercial sense of the transaction between the parties. One important right that may or may not be allowed the lessee, is the ability to create a sublease, i.e. to transfer control to a third party. Hence, the builder of an office block may create a lease of the whole in favour of a management company that then finds tenants for the individual units and gives them control.
• tangible personal property — an owner can allow another the use of a car or a computer either for a fixed period of time or at will. This can be a simple leasing transaction, or it can be a more complicated transaction that is intended to allow the user the right to buy at some future time.
  • In the former, P pays O a rental for the use of the car during the agreed period. Normally, only P will be allowed to use the vehicle and, in such a case, P has possession and control. But, P could be an employer who allows C the use of the car to visit clients, and thereby gives C control.
  • In the latter, O could allow P to hire or lease the car for a specified period of time. If all the payments are made, P will then be allowed to buy the car at a low or nominal price. It is relatively unusual for the owner to offer these forms of hire purchase/lease purchase schemes. More usually, a finance company is introduced as a third party into the transaction. Hence, O sells ownership of the car to F, and F then leases or hires the car to P. It is standard for the contractal terms to prohibit P from parting with possession or control of the car to another. These transactions are complicated because it is not always clear to what extent any representations as to quality and reliability given by O to P during the initial negotiations will be enforceable against F who will be the party actually contracting with P.

An owner of tangible movables may only transfer control. This may be for short-term storage or delivery purposes (e.g. depositing valuable property in a bank vault or using a carrier to transport goods to a specific destination) or it may be a form of mortgage. A banker holding property is a bailee. A pawnshop holds a pledge over the goods depositied until the money lent is repaid.

Closed-end leases

Aside from straight property rental, the most common form of lease is known as a "closed-end lease". Closed-end leases are so called because they run for a fixed term, and the lessor and lessee agree in the lease contract what the residual value of the property being leased will be. In most cases (particularly in retail motor vehicle leases), the lessee has an option to purchase the property for the agreed residual value at the end of the lease term. Closed-end leases are not used for property which increases in value.

In most cases, when a closed-end lease is entered, the lessor does not already own the property being leased. Rather, the lessor agrees to purchase the property for a certain amount (the "capitalized cost") from a third party, such as a car dealer. The lessee will often be required to offer money up front as an offset against the capitalized cost (this is called the "capitalized cost reduction" although it is sometimes erroneously referred to as a "down payment"). The difference between the (adjusted) capitalized cost and the residual value is the depreciation component of the lease cost. In addition to depreciation, the lessee must also pay the lessor's cost of financing the purchase of the vehicle, which is referred to as "rent"; the rent also includes the lessor's profit.

The total lease cost can either be paid in a single lump sum, or amortized over the term of the lease with periodic (usually monthly) payments.

Closed-end leases generally provide that the lessee is responsible for insuring the property, for maintaining it in accordance with the lessor's requirements, and for paying any taxes or license fees which may be assessed on the lessor as owner of record. Motor vehicle leases generally include a provision for determining the amount of "excess wear and tear" (or "wear and use") at the end of the lease term, for which the lessee is responsible upon returning the vehicle.

Closed-end leases have become very popular for automobile buyers in the United States since the mid-1980s. Shield laws in most states allow lessors to avoid legal responsibility for the actions of their lessees, which has made it practical for automakers to offer leases direct to consumers without fear of "deep pockets" liability for injuries resulting from an accident. In those states which assess a use tax on vehicles, lessees need only pay tax on the amount of their lease payment, not on the entire value of their vehicle at the time of purchase. Finally, and most significantly, because lessees pay only for depreciation and financing, and not the entire retail cost of the vehicle, payments can be significantly lower than in loan-based financing. This allows consumers to significantly shorten their purchase cycle, increasing new-vehicle sales, which gives the automakers reason to emphasize leasing programs in their marketing.

Closed-end leases are not always the best choice for consumers. The finance companies which offer consumer car leases frequently require lessees to hold more-costly insurance policies than would otherwise be necessary. Automakers often view leasing as a sales tool, and artificially inflate the lease-end residual value; this can make exercising the purchase option at the end of a lease more expensive than simply financing the vehicle over the longer term in the first instance. Finally, because of the increased financial risks undertaken by the lessor, higher credit quality is generally required to enter into a lease than to purchase a vehicle.

Real estate leases

Most adult consumers have, at some point in their lives, been party to a real estate lease. Many businesses, also, choose to lease rather than own property. The two most common forms are rental, which can apply to both residential and commercial property, and net leasing, which is used only by businesses. Unlike with other forms of property, there is no depreciation component to leasing real estate. The term of real estate lease agreements varies widely, and can be as short as a week, as long as 999 years, or even perpetual.

Property rental

A lease for the rental of property requires four elements: parties, property, rent and term. The parties are the lessor and the lessee. The property is the subject of the lease for which the right of possession will be conveyed. The rent is the amount of money due to the lessor. The term is the time period that the lessee will have the right to possess the property.

The above elements are very important because without them a lease is not created. Without the above listed elements, all that is executed is a contract. This has drastic consequences. With a lease comes implied obligations for the lessor such as the implied warranty of habitability. With a contract, the only obligations that are implied are those under standard contract law which don't import lessee safegaurds. Implied obligations are important to a lessee to ensure that he does not get the short end of the stick if there is a subsequent dispute about the property.

See also Tenancy agreement, also known as "rental agreement," for more details.

Net leasing

Other forms of leasehold estate

Benefits of commercial leasing

For businesses, leasing property may have significant financial benefits:

• Leasing is less capital-intensive than purchasing, so a business which has constraints on its capital can grow more rapidly by leasing property than it could if it had to purchase the property outright.
• Capital assets may fluctuate in value; leasing shifts these potential risks (and rewards) to the lessor.
• Leasing may provide more flexibility to a business which expects to grow or move in the relatively short term, by not renewing leases at the end of their terms; it may be more difficult to dispose of property that is no longer needed if it must be sold or salvaged.
• Depreciation of capital assets has different tax and financial reporting treatment from ordinary business expenses. Lease payments are considered expenses, which can be recognized as soon as they are paid.

There are some significant drawbacks:

• If circumstances dictate that a business must change its operations significantly, it may be expensive or otherwise very difficult to terminate a lease before the end of the term. In some cases a business may be able to sub-lease unneeded property, although this may not recoup the costs on the original lease, and frequently requires the consent of the original lessor.
• Property which the business owns outright can be sold if need be.
• If the business is successful, lessors may demand higher payments when leases (particularly real estate leases) come up for renewal. If the value of the business is tied to the use of that particular piece of property, the lessor has a significant advantage over the lessee in negotiations.