Many lessees enter into lease transactions that they believe are competitive based on faulty rate assumptions. Most lease rate calculations don’t take interim rent into consideration. Interim rent is the trap door that allows lessors to receive increases in lease pricing. It is unpredictable and the amount can be arbitrary. By understanding how interim rent can impact your lease, you can close this trap door and enjoy the lease pricing you thought you negotiated.
What is Interim Rent?
Interim rent, also known as stub rent, is the rent that a lessor charges a lessee from the time the lessee accepts the leased equipment until the official lease start date. Most leases start on the first day of the month following equipment acceptance. In a lease with monthly payments, interim rent is calculated as follows: multiply the number of days in the interim period by the monthly payment amount and divide the product by 30. In the extreme case, interim rent can add almost a full periodic payment to the lease. In these cases it lifts the effective lease rate dramatically.
The impact of interim rent in the extreme case can be seen in the following example: assume you accept a 36-month lease for equipment that cost $100,000. Also assume that the monthly payment is $3,113 per month, paid on the first of each month. Assume that the lease allows you to acquire ownership of the equipment for $1 at lease end. Therefore, your effective lease rate is 8%.
Now assume that the interim lease period is 29 days. For simplicity sake, we will round the period to a full month and add it to the lease. The new effective rate for 37 payments of $3,113 is 9.7%. The new rate is more than 20% higher than the rate originally quoted by the lessor. This higher rate represents a trap door in your lease that produces more cost for you and a higher return for the lessor.
The Purpose of Interim Rent
Many lessors justify interim rent as compensation for obligating themselves to pay equipment vendors on behalf of lessees in connection with lease transactions. As further justification, these lessors point out that lessees have use of the equipment during the interim period.
Problems with Interim Rent
There are two flaws in the reasoning offered by these lessors. First, interim rent is exorbitant since it is based upon the periodic lease payment instead of the lessee’s borrowing rate. Since each lease payment has a return-of-capital component, the periodic payment is not an appropriate standard to use for interim rent calculations. A calculation based on the lessee’s borrowing rate is probably a fairer measure.
The second flaw in this reasoning is that lessors often have not paid for the equipment during the interim period. They may not have incurred any additional cost during this period. The net result is that lessees incur significant increases in their effective lease rates while lessors are able to sneak extra yield through a trap door in the lease. Interim rent can turn a competitive lease into a relatively high rate transaction.
Savvy lessees look for ways to limit or eliminate interim rent. They try to ensure that they receive the lease deal for which they bargained. Here are five strategies to blunt the impact of interim rent:
1. Eliminate interim rent. Try to negotiate a lease that excludes interim rent. One way to eliminate interim rent is to have the interim period count as a partial payment period. Another partial payment period can be added at the end of the lease, such that the two periods constitute one full payment period.
2. Pay interest instead of interim rent. Instead of paying interim rent based upon the periodic payment, base the interim payment upon the implicit transaction rate or your borrowing rate. This method will eliminate the return-of-capital component that plagues most interim rent calculations.
3. Limit or fix the amount of interim rent. If you cannot eliminate interim rent, you can try to negotiate a limit on it. You can offer the lessor a fixed interim period, regardless of the equipment acceptance date.
4. Manage equipment deliveries. Another strategy is to coordinate with the equipment vendor to schedule equipment delivery and acceptance towards the end of the month. End-of-the-month acceptances would ensure a reduction in interim rent since the interim periods would be short.
5. Sale-leaseback at month end. As a last strategy, if allowed by the lessor, you could schedule a sale-leaseback of newly acquired equipment at month end. This strategy would also guarantee a short interim period.
It is important to understand the impact of interim rent on your lease. Rather than assume that you will receive the lease rate quoted, review the lease carefully. If your lease includes interim rent, plan to negotiate this feature. Use one of the strategies above to reduce this potentially costly aspect of your lease. Even if you cannot eliminate the interim-rent trap door, you may be able to seal it.