By Jim Patrico
Progressive Farmer Senior Editor
A few years ago, about 80% of the John Deere combines with "Olsen Custom Farms" stenciled on the side arrived at the Minnesota farm with purchase agreements. Now, half of the new machines come with lease agreements. That change is a sign of the times.
As weak commodity prices eat into farms' cash-flow, and low used-equipment prices make return on purchase investment less certain, leasing has become more popular.
Manufacturers saw the trend coming and have geared up to help customers ride it. "Our leasing activities are extremely busy right now, and we have made adjustments to handle the higher volume," said Mike Moeller, product marketing manager for John Deere Financial. "We haven't seen this much [leasing activity] since the late 1990s, early 2000s."
MOST CLASSES
The appetite for leases extends over most machinery categories and sizes. From Class 9 combines to utility tractors, leases are hot.
Brothers Travis and Chad Olsen, of Hendricks, Minnesota, have long used leasing farm equipment as a risk-management tool. They view it as a way to fix most equipment costs and to reduce risk. "If you want to budget a certain number of dollars for equipment, leasing will let you do that and not worry about it," Travis said.
Of course, in most risk/reward scenarios, when you minimize risk, you also minimize potential rewards. That's one downside to leasing. "In years where there is a strong used-equipment market, you will lose out on equity [by leasing instead of owning]," Olsen said,
STRIKE A BALANCE
The brothers always keep a balance between owned and leased equipment in their fleet. If economic conditions change, they don't want to be all in on any one strategy. Typically, the Olsens' balance in years past was 80/20 owned versus leased equipment. The current slump in the used-equipment market convinced the Olsens to lean more toward leasing. They don't see as much potential upside to ownership if equity leaks quickly from the combines and tractors they operate. So, leases look more attractive.
Since the Olsens run about 85 combines and 24 tractors to trek the annual custom-harvest trail from Texas to Manitoba, their equipment decisions have huge implications.
Sound Rationale. Weakness of commodity prices is a key reason for the current shift to leasing. With fewer revenues coming in, farmers have fewer dollars on hand to purchase equipment. Since lease payments are generally lower than installment payments, leasing can improve cash-flow.
"It's not fair to describe North American farmers as 'cash-strapped,' because their balance sheets are still pretty good," said Alistair McLelland, vice president of marketing, AGCO North America. "But their cash-flow and profitability are under pressure. And in that environment, leasing can be an attractive option. It provides low cost of ownership, cash-flow benefits and is off the balance sheet so it doesn't adversely affect lines of credit they might want to use for other purposes."
Effect on credit lines can be crucial when dealing with bankers about operating loans, said Bill Hermann, Mitchell, S.D. He and his sons Ryan, Steve and Tim farm 10,000 acres in the eastern part of the state. "You have a better chance of getting operating money when you have less debt on your balance sheet," Hermann said.
He and his sons lease one Case IH Quadtrac, four 4WD John Deere tractors, four John Deere combines, some smaller farm equipment and a pickup truck or two.
Hermann likes the certainty of leasing. "You know about your fixed costs when trying to get your cost per acre down," he said.
A typical lease for him is three years. He said that length of time gives him flexibility. His family rents a lot of acres, and leasing equipment lets them shed or add equipment quickly if they lose or gain land.
Staying current with technology is another reason some farmers lease equipment. It's a less-expensive way to be on the cutting edge even before buying. At lease maturity, the producer then has the option to buy the equipment. "This risk-management strategy works well in a depressed market," Moeller said.
PAYING UNCLE SAM
Tax considerations also have persuaded some farmers to lease rather than own. In recent years, a $500,000 cap write-off provided by Section 179 of the IRS code and bonus depreciation made ownership hugely attractive. When the future of those provisions became uncertain, some machinery buyers became machinery lessees. They can deduct lease payments at business costs.
(At this writing, the U.S. House has passed a bill making the $500,000 cap for Section 179 permanent. The Senate version calls for a two-year extension. Observers predict some form of the write-off will be law soon.)
If Section 179 and bonus depreciation were to be reinstated, "It would not drastically reduce leasing, but it might slow it," Deere's Moeller said. "Customers might look more toward installments. However, the potential for lower commodity prices and high input costs could continue to make leasing look like a better choice."
Lease customers like the fact they can customize a lease agreement, Moeller said: "If a customer [working through a dealer] wants a 47-month lease rather than a 48-month lease, for instance, we can give that to him."
Row-crop growers might prefer a yearly payment to coincide with selling crops. Dairymen might prefer monthly payments because they get monthly milk checks. Quarterly, semiannual or skip-payment schedules are all possibilities.
NEGOTIATIONS WORK
In the current climate of reduced machinery sales, manufacturers and dealers view leasing as a key path to moving equipment. They are more open to negotiation. "We have tried to encourage [leasing] by increasing the attractiveness of our leasing offers," AGCO's McLelland said.
Negotiations do not necessarily end at lease signing. Leases are generally structured with a specified term (years) and a specified number of hours of use. If, after the first year, a farmer finds he is using more hours than he estimated, he can approach the dealer to expand the number of hours ... for a price, of course.
REASONS NOT TO LEASE
Staying within the number of hours is important, because there can be sizable charges for exceeding allotted hours. There also can be painful penalties if the equipment does not come back to the dealer in good shape.
While lease payments are often lower than installments in an ownership agreement, leases are not always the low-cost alternative over time. An astute shopper might buy a low-hour used tractor or combine at a great price these days. A large owner might get a volume discount on a new piece of equipment. In these and other situations, ownership might well be more cost-effective than leasing.
"You have to be careful that your lease payments are not higher than your ownership costs. Don't lock yourself into being a high-cost producer," said Michael Langemeier, associate director at Purdue's Center for Commercial Agriculture.
Pride of ownership also plays a role. "A lot of people have the attitude, 'I want to own it,'" Hermann said.
"My sons are like that."
But in today's machinery environment, where equipment loses its value quickly, leasing can look like the better option, Hermann said. "My boys are smiling at me for a change. We are not taking the risk; the dealer is."
TYPES OF LEASES
Lease terms vary from one year (rare) to five years, with a three-year lease being the most common.
Most leases offer a "walk away" option. At the end of the term, the lessee can renew the contract or buy the equipment for a predetermined or negotiated price. If neither of those options is appealing, he can walk away. This type of lease offers the most flexibility.
Here are two other types of leases with less cost but also less flexibility:
-- PRO Lease (Purchase or Renew Only). PRO leases can have a guaranteed purchase price, which might work to the farmer's advantage if used-equipment prices rise during the lease period. But if equipment goes down in value, a PRO lease would cost the farmer the lost opportunity to buy the same equipment for less.
The renewal option can be a plus. For example, if a farmer had rented some land for three years with a fourth-year option, he might exercise the renewal option of the equipment if he keeps the land.
-- PUT Lease (Purchase Upon Termination). A farmer can trade or buy the equipment at the end of the lease, but he cannot walk away. He is at the mercy of the market.
IS IT A LEASE?
Just because the top of the paper says "Lease Agreement" doesn't mean it really is a lease agreement, said Andy Biebl, who writes the Taxlink column for DTN/The Progressive Farmer. Biebl is a tax principal specializing in agriculture for the accounting firm CliftonLarsonAllen LLP.
A lease has to be "more than a disguised finance [purchase] agreement" to pass IRS tests, Biebl said.
Chapter 4 of IRS Publication 225 (see www.irs.gov/publications/p225/index.html) lists seven criteria that can determine if an agreement is a lease or a conditional sales agreement. Since leases and sales agreements have different tax implications, it's a good idea to show a tax accountant any lease agreement you sign or intend to sign.
There might not be huge tax implications if you mislabel an equipment transaction as a lease when it's really a purchase agreement. But you and your tax accountant should know up front what it is before tax time.
"If the lease label gets you the best financing and fits your cash-flow, do it," Biebl said. "We [tax accountants] can look at it and decide if it is really something you should be depreciating. If it is, that's not a big deal because we have a lot of choices about how that depreciation occurs."
Still, it's always better to know than to guess.
(AG)
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