November 2007, Business Fleet - Feature
Open vs Closed End Leasing: Which Is Right For You?
By Chris Brown
2. Know Your Appetite for Risk
On an open-end lease, the lessee is responsible for the vehicles' residual value. Are you comfortable with exposure at lease end when a vehicle's worth drops unexpectedly?
Generally the open-end leased vehicle will be depreciated properly to reflect its end-of-term value, says Jack Manning, president of American Leasing. Yet sometimes extenuating circumstances throw those values off and a company can unexpectedly lose a lot of money.
The aftermath of 9/11 is a case in point-travel came to a standstill and rental cars flooded the used car market, driving values down considerably. Fleets with open-end leases took a steep hit on de-fleeted vehicles, says Robert Singer, vice president of Merchants Leasing.
In a less dramatic scenario, large SUVs recently have experienced a more precipitous drop in value than expected because of high gas prices, Singer says. This is not much of an issue for fleets that run their vehicles into the ground. But the risk is greater for those open-end leases with substantial life, and thus residual value, left in de-fleeted vehicles.
On the closed-end lease, this is the worry of the lessor, not the client. "In the closed-end situation the client is right every time," says Leary. "If we happen to be wrong it doesn't affect their payment."
3. How involved do you want to be with fleet management?
Larger companies pay dedicated fleet managers to run the fleet as efficiently as possible. They use a leasing company to put vehicles into service at the lowest rate possible, and retain much of the fleet management duties in house.
Open-end leasing gives the fleet manager to arrange purchase agreements with manufacturers, set a depreciation rate that reflects the company's financial needs and cycle the fleet to take advantage of favorable buying and selling conditions.
However, because you're reading this magazine, you're in charge of a small fleet among a host of other concerns. You've got a business to run, and fleet is not your priority.
"I generally recommend to my customers that because running a fleet is not their core business, don't take the residual risk," says Singer.
The closed-end lease is part of the big picture for outsourced fleet management. Under this philosophy it's the lessor's job to estimate the vehicle's value at lease end, so better leave it to the experts. With this burden, the fleet management company chooses optimal reserves for depreciation and has a greater say in fleet selection.
The closed-end lessee is also subjected to mileage restrictions, which sometimes feels like a "heads I win, tails you lose" situation, says Leary. The fleet is penalized for exceeding the mileage cap, but doesn't get a check back for driving under the cap. Lessors have ways to remedy this.
If a fleet falls considerably under the cap some lessors will make a "goodwill adjustment" and credit the client. Conversely, if a fleet blows the cap out of the water, the lessor may not stick the client for $.15 on every mile, but a reasonable amount that reflects the vehicle's drop in value because of high mileage.
Some lessors pool mileage for the entire fleet. Factoring the aggregate mileage across the fleet will help to smooth out any spikes or dips incurred by single vehicles. Ultimately, if drivers are continually over the mileage cap lessor will rewrite the lease to reflect the current conditions, Singer says.