Five Major Types of Lease Agreements

A lease agreement is a contract between a lessee (borrower) and a lessor (owner) for the use of a building, property or other asset. It allows the lessee to use the asset for a specified rent and period of time. A lease agreement formalizes the duration of the lease, identifies the assets under lease, includes the names of the two parties and specifies the payment method (periodic or lump sum).

Operating leases, also called service leases, are agreements between two parties in which one provides rent to the other for using an asset. In an operating lease, the borrower uses an asset for only a fixed portion of the assets life. The owner of the asset is responsible for all maintenance costs and other operating costs associated with the leased asset.

Capital leases, also called finance leases, are those in which the borrower has full control over the use of the asset(s) during its lease period, is responsible for all maintenance and other associated costs and is directly affected by its associated advantages and disadvantages.

A sale and leaseback arrangement is a type of lease in which one party purchases property, equipment or land from another party and immediately leases it to the selling party under specific terms. The seller could be an individual investor, a limited partnership, an industrial firm, a leasing company, a commercial bank or an insurance company. A sale and leaseback arrangement is a type of capital lease, with the only difference being that a buyer purchases a used asset instead of a brand new one (as is common in capital leases).

Read More: Simple Lease Rental Agreement

Combination leases combine aspects of both capital and operating leases. An example of a combination lease is a capital lease that incorporates a cancellation clause, typically associated with an operating lease.

A synthetic lease is a type of operating lease that is recorded in such a way so it does not show as a liability on a company balance sheet. It is instead recorded on the income statement as an expense. This allows the borrower to use the asset without being burdened by tax. Synthetic leases offer numerous advantages in comparison to other types of leases. There are various financing sources available, including bank debt, private placement and commercial paper on a fixed or floating-rate bases. Borrowers use synthetic leases to finance equipment for hospitals, corporate headquarters, movie theaters, retail branches and data centers. <br /><br />According to Eugene F. Brigham and Philip R. Daves in the book “Intermediate Financial Management,” synthetic leases became popular in the 1990s, when well-known companies such as Tyco and Enron first used them.