Interest rates and equipment prices: the case for leasing farm equipment

Interest rates are a bottleneck for farm equipment buyers and sellers. Since 2017, interest rates have increased by 213%. On March 16, 2017, the Federal Reserve Prime Interest Rate was 4.00%. The last rate hike by the Federal Reserve was July 27, 2023, to 8.50%. During the same period, new equipment saw a 60% increase compared to used equipment prices. As payment structures look for relief, leasing is becoming more popular. 

I interviewed Greg Roberg, vice president of sales for AgDirect, a Farm Credit Services of America subsidiary, in Moving Iron podcast #435. Roberg and I discussed leasing activity and the increase in quoting and written leases. 

“We’ve been talking about cash flow, and at some point, with commodity prices the way they are, we're probably going to see more producers say, if I can afford the payment, it [leasing] makes sense with my cash flow,” Roberg says.

Leasing volume is typically about 7% to 8% of total volume, according to Roberg. In March, it was around 11%.  

Cash flow considerations

Farmers are familiar with cash flow when budgeting year-over-year and month-over-month expenses vs. available cash. Although there has been upward movement in the grain markets over the past few weeks, the breakeven points are still tight or out of reach, leaving producers looking to upgrade, scratching their heads regarding available options. 

Leasing is an option to explore because of cash flow and balance sheet implications. You will need to consult with your accountant before heading the path of leasing to see if the purchase method suits your operation. Also, be aware of your state’s property tax laws concerning leasing. 

Leasing structures

Most lending institutions operate with one or all of the following leasing structures:

• Capital lease: A $1 buyout lease is a type of capital lease, which means you own the equipment or property throughout the life of the lease (and afterward). The leased equipment will show up on your balance sheet as an asset.
• Purchase upon termination (PUT): This lease has low monthly payments throughout the course of the agreement, but requires the lessee to purchase the equipment at the conclusion of the lease contract with a pre-determined balloon payment. The balloon payment can range from 10% to 20% of the original invoice amount.
• Fixed price purchase option (FPPO): The right, but not the obligation, to buy a leased item at the end of a lease term at a price determined from the onset of the lease agreement. A fixed price purchase option’s purchase price is established when the lease terms are set. The lease agreement should also describe when the option can be exercised. This agreement usually sets the timing to occur at the end of the scheduled lease term. These agreements have much lower residual rates then other lease agreements.
• Purchase or renew only (PRO): At lease termination, you can either purchase the equipment at a fixed amount stated up front or renew your lease. While an FPPO will give you a better tax deduction, a PRO lease will lower payments to improve cash flow.
  

Benefits of leasing vs. buying

Leasing can have incredible benefits to an operation's cash flow. Sometimes, a lease can be  half the payment of a traditional retail note option. Another advantage of a lease is how the asset is presented on the operation’s balance sheet. Does the entire amount of the equipment or only the payment show as a liability? Depending on the growth goals of the operation, a lease could benefit debt-to-asset ratios, leaving space for expansion efforts. 

The equipment cost in today’s market will require creativity when it comes to financing. New and used equipment prices of $400,000 to $1,200,000 are now commonplace. With equipment interest rates at 6.5% or more, leasing should have a place in the discussion. 

Here is an example of what a $400,000, five-year lease would look like with a 60% residual compared to a seven-year retail note. The residual rate is not from any residual schedule for any lending institution. I am only using the residual rate as an example.  

What’s your equipment goal?

Leasing has pros and cons. When looking at a lease, several questions should be asked: What are your equipment goals? What is your equity position in your equipment? 

If you want to build equity or maintain a strong equity position, there are better options than leasing. A lease rarely works out to have equity at the end of the lease. Normally, they are at zero or slightly negative equity. I strongly advise against rolling any equity into a lease. It might lower your payment, but the equity will be gone at the end of the lease.

If the goal is to operate your equipment as cheaply as possible within a defined amount of time and within a stated amount of hours and without concern about building equity, then leasing is a great option. As shown above, leasing will allow for a lower cost per hour, but some stipulations must be followed. 

For more on used equipment, listen to my episodes on the Successful Farming podcast on the last Monday of each month. Aaron Fintel and I explore market conditions and factors driving used equipment. Please tune in to the Moving Iron podcast, where I track the economic drivers of the farm equipment business, and check out movingironllc.com for everything related to Moving Iron.