The buck stretches here

Without a leasing contract, Graham County, Ariz., would have a difficult time replacing its old phone system. But by spreading the payments over five years, the county can afford an Internet-based system with networking capabilities and several low-maintenance features.

This year, Union City, Calif., took a similar path, leasing a phone system as well as several fire trucks. Through leasing contracts, countless other municipal, county and state governments have managed to stretch their revenue to pay for equipment and other acquisitions.

State and local governments are leasing many common items — including school buses, police cars, construction equipment, copiers, computers and laptops — all without large down payments that could inhibit other departments’ operations. Less commonly leased items have included online security systems for paying parking tickets, a paint job on bleachers in a municipal stadium, an energy-conserving heating and air conditioning system, office furniture, golf carts and exercise equipment for a school workout room.

A business decision

“Leasing is a financing transaction. It can be for any tangible item the state, city or county needs,” says Dennis Brown, vice president of state government relations for the Arlington, Va.-based Equipment Leasing Association. “Unfortunately, it’s the belief of many elected officials that they can only serve the public good if the public owns the item. But they need to rethink this. It’s not that you own it. It’s that you use it and it works.”

The rapidly changing world of electronics makes the strongest case for standard leasing contracts. Because laptop computers are considered obsolete after three years, owning them at the end of a 36-month contract offers little advantage. In many cases, ownership of such items in conventional terms also involves a hefty down payment. Leasing, however, allows a government entity to pay only the lease payment and skip large initial cash outlays, leaving money for other expenditures or investments.

“Business has always seen leasing as a way to match the revenue stream with expenses,” says Denise Beauchamp, senior vice president of government leasing for Popular Leasing USA in Green Cove Springs, Fla. “With tightening of budgets, governments are starting to look for better and more creative ways to manage their revenue streams.”

For many large purchases, governments must hold voter referendums or sell bonds. With leasing agreements, governments can avoid those measures and work expenses into annual appropriations.

Contracts can be cancelled

Government officials have advantages over commercial customers when negotiating lease contracts. Unlike commercial accounts, local officials can include a “non-appropriations clause,” which allows the government to cancel the agreement and return the leased item if funding is not appropriated for the succeeding year. However, to include the non-appropriations clause, the government must pledge intent to own the equipment at the end of the agreement, making it a lease-to-own contract.

That can be a good decision for items with a long life span. “It depends upon the nature of the equipment and if you are able to get any further benefits once the lease term is up,” says Will Fuentes, financial analyst for Union City, Calif. “A fire truck is good for 20 years. Generally, we do a lease-purchase agreement where we can buy the truck or car for $1 or $10 once our [10-year] lease term is up.”

The non-appropriations clause of lease-to-own contracts also places much of the risk on the lender or leasing company. But, most prudent lenders manage to limit their exposure by financing only “essential-use” items, Beauchamp says. “Historically, there’s been little risk for the lenders unless they go outside of the box of essential use.”

While companies can get burned on leasing non-essential items — such as exercise equipment, office furniture and golf carts — “essential use” is interpreted broadly. That is partly because leasing and lending companies want government leasing contracts, the income from which does not require payment of federal taxes, Brown says. Still, he warns that governments should be prudent and committed to their appropriations. “A government can non-appropriate, but this can mess up a credit rating as well as a bond rating and make it more difficult to obtain loans and leasing agreements in the future,” he says.

Many states, like California, now pool their purchasing power through master leasing contracts that offer low interest rates and economies of scale to cities and counties. Since 1996, leasing contracts have saved California more than $50 million, says Pat Mullen, the state’s finance marketplace manager.

Mullen also helped to create the GS $mart program that allows local governments, like San Francisco, with bond ratings lower than the state average, to use the high state average bond ratings. The program, however, does not penalize communities with the best bond ratings.

Leasing myths still persist

Mullen and other government finance officers know the advantages of leasing to best use revenues, but unfortunately, they say many elected officials are not aware of its benefits. “Where education is needed is with elected officials,” Beauchamp says. “The finance professionals understand, but they sometimes run into problems with their boards. A vocal board member’s experience might only be with a car lease, which was not a good experience, so they just tend to discount it without really understanding what it is.”

Brown agrees and says one of the biggest barriers to leasing is the term limits of legislators. “You educate one person who understands how it works and the advantages, and then he or she is no longer in office,” he says. “You have to convince the next person all over again.”

Even so, plenty of local governments are leasing. Okeechobee, Fla., acquires 24 new police-equipped Ford Crown Victorias each year through a lease-to-own contract, recouping the cost of the cars at the end of the year by selling them to other local law enforcement agencies. “We have no maintenance budget, but the cars all have the one-year warranties, so the only thing we need are oil changes and maybe tires at the end of the year,” says Okeechobee Police Maj. Robert Peterson. “It works out. At the end of the term, we sell them for almost what we paid for them.”

But in selling vehicles to expectant buyers, Peterson says the needs of the second owners should be considered. His cars are outfitted with light bars, sirens, cages and consoles that are compatible with those used by other departments. “All the other departments have to do is put their new stripes on them,” he says.

The cars, which patrol a 5-square-mile area, have relatively low mileage at the end of one year — 10,000 to 12,000 miles. Also, Okeechobee police officers are discouraged from abusing the vehicles so they will remain in good condition for the sale.

Selling equipment at the end of a leasing contract is becoming fairly common. Mullen helped to develop a “salvage rider” used in some of the state’s lease-to-own contracts, which extends salvage rights to a third party at the end of a typical 36-month contract. That works well for auto fleets, which typically incur high maintenance costs at the end of three years, he says. “We were finding that maintenance costs for the older cars were higher than finance charges for new vehicles. So, we decided to address this.”

Still, leasing can be a useful financing method for items that will be used long after the contract ends. Graham County, Ariz., recently purchased an Internet-based phone system that connects several county operations previously not included in its old phone network, such as its highway department, fairgrounds, animal shelter and sheriff substation. Graham County’s new phone system will be paid for in five years, and the county intends to keep it indefinitely, expanding and maintaining it by purchasing upgrades. “We decided to put the money into the new phones through a lease setup to keep the cost the same as what it had been historically,” says Clef Flake, the county’s chief financial officer.

“It was the first leasing contract that we’ve had in a long time that I’m aware of,” he says, adding that it opened his mind to the possibility of creative leasing to finance other projects as well. A new copper mine is expected to draw 1,000 construction workers and eventually 400 to 600 employees to Graham County. Access to the mine will require county infrastructure improvements, and Flake says he may consider leasing to pay for the improvements.

As Brown of the Equipment Leasing Association says, “With leasing, it’s whatever you want.”

Susan DeGrane is a Chicago-based freelance writer.

10 questions to ask before signing a lease

1. How will the item be used?
2. Does the leasing representative understand the government’s needs and how the transaction helps the organization operate?
3. What is the total lease payment and what other costs will be incurred before the lease ends?
4. What happens if the government wants to change the lease or end the lease early?
5. How is the government responsible if the equipment is damaged or destroyed?
6. What are the government’s obligations for the equipment (such as insurance, taxes and maintenance) during the lease?
7. Can the equipment be upgraded or more equipment added under the lease?
8. What are the options at the end of the lease?
9. What procedures must the government follow to return the equipment?
10. Are there any extra costs at the end of the lease?
    — Equipment Leasing Association, Arlington, Va.