Types of Lease

Leases are classified into different types based on the variation in the elements
of a lease. Very popularly heard leases are financial and operating lease. Apart
from these, there are sale and lease back and direct lease, single investor lease
and leveraged lease, and domestic and international lease. Lease is a very
important financing option for an entrepreneur with no or inadequate money for
financing the initial investment required in plant and machinery. In lease, the
lessor finances the asset or equipment and the lessee uses it in exchange of fixed
lease rentals. In other words, lease financing is an arrangement where the lessee
who requires the equipment or machinery gets the finance from the lessor for
the agreed rental payments. Such kind of lease is called finance lease. There are
many such arrangements and hence there are many types of lease. Let us have a
look at the different kinds of lease.
Certain variation in the elements of lease classifies lease into different types.
Such elements are as follows
The degree of ownership risk and rewards transferred to the lessee.
No. of parties involved
Location of lessor, lessee and the equipment supplier
The lessor and the lessee
Here, risk means the chance of technological obsolescence and reward
refers to the cash flow generated from the use of equipment and the
residual value of the equipment.
Types of Lease:
On the basis of above dimensions, leases are classified into following:
Finance Lease and Operating Lease: Finance lease, also known as Full
Payout Lease, is a type of lease wherein the lessor transfers substantially
all the risks and rewards related to the asset to the lessee. Generally, the
ownership is transferred to the lessee at the end of the economic life of
the asset. Lease term is spread over the major part of the asset life. Here,
lessor is only a financier. Example of a finance lease is big industrial
equipment.
On the contrary, in operating lease, risk and rewards are not
transferred completely to the lessee. The term of lease is very small
compared to finance lease. The lessor depends on many different lessees
for recovering his cost. Ownership along with its risks and rewards lies
with the lessor. Here, lessor is not only acting as a financier but he also
provides additional services required in the course of using the asset or
equipment. Example of an operating lease is music system leased on rent
with the respective technicians.
Sale And Lease Back and Direct Lease:
Arrangement in which one party sells a property to a buyer and the buyer
immediately leases the property back to the seller. This arrangement allows
the initial buyer to make full use of the asset while not having capital tied up
in the asset. Leasebacks sometimes provide tax benefits. also called
leaseback.

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In the arrangement of sale and lease back, the lessee sells his asset or
equipment to the lessor (financier) with an advanced agreement of leasing
back to the lessee for a fixed lease rental per period. It is exercised by the
entrepreneur when he wants to free his money, invested in the equipment or
asset, to utilize it at whatsoever place for any reason.
On the other hand, direct lease is a simple lease where the asset is
either owned by the lessor or he acquires it. In the former case, the lessor
and equipment supplier are one and the same person and this case is
called bipartite lease. In bipartite lease, there are two parties. Whereas,
in the latter case, there are three different parties viz. equipment supplier,
lessor, and lessee and it is called tripartite lease. Here, equipment supplier
and lessor are two different parties.
Single Investor Lease and Leveraged Lease: In single investor lease,
there are two parties - lessor and lessee. The lessor arranges the money to
finance the asset or equipment by way of equity or debt. The lender is
entitled to recover money from the lessor only and not from the lessee in
case of default by lessor. Lessee is entitled to pay the lease rentals only to
the lessor.
Leveraged lease, on the other hand, has three parties lessor, lessee and
the financier or lender. Equity is arranged by the lessor and debt is
financed by the lender or financier. Here, there is a direct connection of
the lender with the lessee and in case of default by the lessor; the lender is
also entitled to receive money from lessee. Such transactions are
generally routed through a trustee.
A leveraged lease or leased lender is a lease in which the lessor puts up some of the
money required to purchase the asset and borrows the rest from a lender. The lender is
given a senior secured interest on the asset and an assignment of the lease and lease
payments. The lessee makes payments to the lessor, who makes payments to the
lender.
The term may also refer to a lease agreement wherein the lessor, by borrowing funds
from a lending institution, finances the purchase of the asset being leased.
The lessor pays the lending institution back by way of the lease payments received from
the lessee. Under the loan agreement, the lender has rights to the asset and the lease
payments if the lessor defaults.
In this type of lease, the lessor provides an equity portion (often 20% to 50%) of the
equipment cost and lenders provide the balance on a nonrecourse debt basis. The lessor
receives the tax benefits of ownership.

Domestic and International Lease: When all the parties of the lease
agreement reside in the same country, it is called domestic lease.
International lease are of two types Import Lease and Cross Border
Lease. When lessor and lessee reside in same country and equipment
supplier stays in different country, the lease arrangement is called import
lease. When the lessor and lessee are residing in two different countries
and no matter where the equipment supplier stays, the lease is called
cross border lease.