In any lease agreement, involving either a commercial property or even a residential property in Australia, there is usually the person that is leased the property. The individual is the one known as the lessee, who usually rents the property from the owner to use it.
A lessee in that arrangement will usually encounter some advantages and disadvantages when utilizing a particular property.
Advantages of leasing to a lessee
A lessee will most likely benefit from a lease in the following ways.
100% financing/ Initial Cash Outlay is avoided
Through a lease agreement, an investor can be able to finance huge commercial property investments. It enables a businessperson or company to acquire the property without making any immediate down payment. Under such a lease financing, a lessee will avail 100% finance to acquire the asset. The hurdle that a lessee can face is whereby a firm wants payment in advance the first lease rent.
Easy and cheaper source of finance
For those who need long-term and intermediate financing, leasing is one of the best sources. Since the property is not transferred to the lessee but remains with the lessor, it will not be mortgaged.
It is cheaper than a loan as the initial finance raising cost is much lesser. Finally, leasing doesn’t involve stringent formalities like loan financing.
The structure of the rental payments can be tax advantageous to the lessee. For tax purposes, rentals are usually deductible from the taxable income. The rental amount can be lowered to minimize the liability to tax of the lessor. The lessor will then pass that benefit to the lessee inform of reduced lease payments.
A lease agreement to finance a commercial property doesn’t involve such cumbersome and lengthy procedures and formalities like an institutional loan financing. As a result, its documentation is simple and leasing companies take less amount of time to process a lease proposal. This will enable the lessee to minimize delays in the use of the property.
Obsolescence risk is shifted
In the modern dynamic world, the lessee will bear the whole obsolescence risk in the circumstance where an asset is purchased. However, the risk can be shifted over to the lessor when the lessee chooses to lease a property instead of purchasing it. The lessee can even further request the lessor to upgrade the real estate property to be more useful.
Flexibility and convenience in the structuring of leases
The lease rentals are actually structured in such a way that they are able to accommodate the lessee’s cash flow position. Depending on the rental payment capacity, the lessee will usually pay lease rentals with the funds that business operations will generate. However, you might find that repayments of institutional finance to be cumbersome regarding the fact that an investment will usually not generate adequate income to settle the rentals.
The maintenance and administrative cost is less
The lessee can organize for the lessor to cater for maintenance of the property through specialized services under the gross lease arrangement. The same provision can be extended also to the lessor under an operating lease agreement.
Even though the lessor could charge high rentals to cater for the maintenance and service costs, the lessor’s specialized services will eventually reduce the overall service and administrative costs that a lessee will bear.
Disadvantages of leasing to the lessee
Apart from the above advantages, the lessee is also bound to face several drawbacks.
Entails High costs
Lease rentals are usually higher in the long-term compared to purchasing a given real estate property. The reason for this is that lessor has to cater for both the income margin and the obsolescence risk cost in such kinds of rentals. For that matter, you will find that the lease financing is regarded by many as a higher cost finance.
Ownership incentives are lost
Owning a property, whether for commercial or residential purposes, usually comes with certain benefits. Such incentives of owning a particular property are things like investment allowance and depreciation. But when it comes to a lease arrangement, the lessee will not be entitled to enjoy such kinds of advantages.
Moratorium period loss
The lease rentals do not account for the incubation period when the investment is just starting out. For that reason, you might see that it takes a longer time for the investment to eventually pay off. As opposed to the leases, term loans allow for a moratorium period that a borrower can comfortably make the loan repayments. However, a lease agreement usually lacks a moratorium allowance.
The salvage value of the property is lost
Most of the properties whether residential or commercial, usually have their useful period within which they can serve their purpose well. But, after its useful life has expired, what is left of the property is its salvage value. Therefore, when the lease of a property expires, the lessee is not in a position to realize its salvage value as the individual has no ownership rights to the asset. Rather, the full salvage value of the property will usually revert to the lessor.
Risk of deprivation of asset use
In case the leasing company winds up or its financial position deteriorates, the lessee will risk the chances of being deprived the use of the property. This can really interfere with the operations that the lessee is currently undertaking. Deprivation can be very detrimental when the user of the property is at a critical point of operation.
No changes to the property or alteration are permitted
In a lease agreement the lessee is not the owner of the property but usually uses it to undertake certain activities. For this matter, the lessee is not in a position to make any significant changes to the property occupied. However, for an investor who purchases a property, the buyer can choose to increase its utility through altering or modifying the property whenever there is an opportunity to alter.
Penalties are levied when the lease is terminated
In a lease agreement between the tenant and the landlord, there are usually certain conditions that are fundamental to that agreement. One of them is that the tenant will have to use the property for the entire period that is stated in the lease. However, in the event that the lessee chooses to terminate the lease before its expiry period, the lessee will have to suffer certain penalties.
After going through the advantages and disadvantages that a lessee encounters when entering into a lease agreement and using a particular property, you now know what you are bound to face. In that way, you will be in a better position to overcome most of its disadvantages.