Options for Equipment
There are alternatives to paying cash for collection equipment. We help you sort out the choices.
No doubt about it, the times are a-changin’. Actually, they’ve changed. Credit is tight and tax revenue is down, but the trash keeps piling up, equipment ages and new technology beckons. What to do?
There have long been alternatives to the old cash-on-the barrelhead routine for buying or replacing collection equipment, and with the economy in the shape’s it’s in, now’s as good a time as any to dip into this varied bag of tricks. Leases, when properly managed can get you the truck you need and with a little creative thinking may also help reduce maintenance and personnel costs. What the industry calls lease financing is a particularly sound alternative to traditional loans and municipal bond issues, and renting, often thought of as an expensive-court-of-last-resort, can fill in gaps and give managers valuable time to catch their breath.
To be effective, however, you will have to do some clear thinking, marry short-term objectives with long-term goals and balance operational and financial considerations.
Renting is without doubt the quickest way to get a piece of equipment in your yard without being tied down to a long-term commitment. The bad news is you’ll pay about twice what it would cost to lease or finance for this convenience. Options include local and regional outlets such as RDK Truck Sales in Tampa, FL, chains like Big Truck Rentals Inc., and sometimes equipment distributors. According to David Orf, senior vice president at Rush Refuse Crane and Towing Systems, the company will soon be rolling out a “full-feature rental program” that offers a variety of rental options. Heil Environmental thinks the refuse rental market is so underserved that it’s entered into an agreement with Big Trucks to be its sole equipment supplier. One idea is to fill the gap when it comes to seasonal collection and one-time events like storm clean up.
An important factor in renting is the age of the equipment. Big Truck Rentals’ trucks are typically 18 months old or less, which puts them under warranty so there’s no hassle if something goes wrong. Prices are typically based on a normal one-shift route or 50 hours a week, with anything beyond that spelled out. Insurance and routine maintenance are the renter’s responsibility. Rental payments are deductible as an expense and terms are usually month to month, although some companies offer longer rent-purchase agreements with an option to buy and rent-to-own, where a portion of the rental fee is applied to a predetermined, discounted purchase price.
The City of Denver opted for this kind of rent-purchase option when it needed a truck to service a pilot compost collection project. “We didn’t have the capital for a new truck,” says Charlotte Pitt, operations manager for the City and County of Denver Solid Waste Management Division, “and we saw renting as an opportunity to try out some different trucks, which was helpful because Denver has some unique service perimeters.” Denver went ahead and purchased the first truck it rented from a local supplier and will likely buy the Big Truck automatic sideloader it’s currently renting.
Renting helped make it possible for E.L. Harvey & Sons Inc. in Westborough, MA, to diversify into residential collection and snag eight municipal contracts in three years. “These contracts have a quick turnaround, and we didn’t have the inventory,” says B.J. Harvey, vice president of operations. “Renting allowed us to get the vehicles we needed to get the contracts up and running and gave us time to do some due diligence in a town so we could buy the right equipment.” Harvey says the company’s rentals have usually been short term, 3–6 months. “A couple of extra months and a couple of extra thousand dollars to get the right trucks for a long-term contract is money well spent.”
With three trucks down, one to a fire, the other two with engine failures, David Holman, divisional fleet maintenance manager at IESI in Crowley, LA, filled in the gap with three automated sideloaders from the local Big Truck Rentals affiliate. “The trucks were brand new, and the few problems we had were taken care of immediately under warranty.” Holman figures renting the automated trucks was $2,000 month more than it would have been for a rearloader with labor but was considerably less expensive than losing his customer base. He recommends anyone renting should check the rental agreement carefully for who’s responsible for what, who to call if you run into problems and procedures for addressing malfunctions.
When it comes to leasing, more thought is called for. An operating lease will get you the equipment you need in exchange for a fixed monthly payment, but while you get to expense the payments, the lessor claims depreciation. The term of the lease is usually significantly less than the expected life of the equipment, and the sales tax is rolled into the monthly payment. A capital lease functions more like financing. The lease represents the true cost of the equipment plus interest, you immediately get some of the benefits of ownership, e.g., depreciation, and you can log the equipment on your balance sheet as a capital asset.
Although more binding than renting, leasing is cheaper, and in the past closed-ended leases put no obligations on the lessee to purchase equipment (also called a true lease or walk-away lease). However, according to Kevin Steier, regional sales manager at TCF Financial in Louisville, KY, anyone interested in an operating lease these days will likely find themselves looking at a fair market lease that requires monthly payments for an agreed-upon term (typically 60 months, no less than 24) and a balloon payment at the end. Options for handling the difference between the residual and the fair market value of the equipment include refinancing, selling the equipment yourself, or having the bank or finance operation sell it for you. With tight staffs and heavy work loads, letting the leasing organization dispose of the equipment may seem the easiest route, but be aware the standard is no longer fair market value that determines the price of the buyout but what similar equipment is going for at auction. This can bring the value of an $80,000 truck down to $60,000 to $65,000, and you’re on the hook for the difference. And unlike renting, if for some reason your plans change or you come up short on the monthly payments, the truck you leased could be repossessed.
“When it comes to leasing, maintenance is the name of the game,” says Steier. And so is the term of the lease: “Obviously the value of the equipment is going to higher at the end of 36 months than five years.”
Another thing to be aware of is that credit standards for a lease, whether operational or capital, will typically be the same as for a loan. According to Robert Marino, senior vice president and general manager at Webster Capital Finance in Blue Bell, PA, new OCC regulations established after the bank collapse and bailouts have caused lenders to narrow down on collateral and cash flow, which means it’s not as easy as it once was for a smaller hauling company to get deals done based on future income on contracts. Gone too are application-only type deals, where you could get a $250,000 truck on an application and a handshake. If you’re looking to lease, says Marino, be prepared with financial statements, company and personal income tax returns and an internally prepared, “very well put together profit and loss statement.” And have a minimum personal FICA score of 700.
Because the leasing company gets the tax benefits of depreciation and leaves you with the end-of-lease buyout, leasing has sometimes gotten a bad rap. Not so, says, Scott Anderson, senior vice president at Rush Truck Financing, Leasing and Insurance. “Especially for cash-strapped municipalities, a sound operating lease can have particular value. If you’re trying to minimize repair and maintenance costs, you could consider a shorter-term lease that keeps the equipment under warranty and mileage down, which can help reduce your costs in maintenance equipment and personal.”
“Leasing is a guaranteed way for me to keep my equipment updated,” says Bobby Smith, sanitation supervisor at Muncie Sanitation District, Muncie, ID. “If you can get seven years out of an automated piece of equipment, you’re doing pretty good. But it can get to the point where maintaining an old piece of equipment can cost you more money than a lease payment.”
Smith is talking about lease financing, effectively a no-cash way to buy a piece of new equipment. “If you’re looking to turn over the equipment in a couple of years to keep up the residual value, an operating lease may be the way to go,” says Steier. “But if want to hang onto it and depreciate the cost, a capital or finance lease could well be better.” Right now, Steier says, he’d opt for ownership, in part because Rule 179 of the tax code allows a company to take the full amount of depreciation on a piece of equipment up to $500,000 in the first year.
“At first blush, a lease looks cheaper than financing,” says Steier. But in the long run it will cost you more. Right now, the monthly payment on an operating lease for a $150,000 piece of equipment would be approximately $2,391. On a lease finance it will be $2,832. So it looks like you’re saving yourself roughly $500 a month. But if you want to keep the leased equipment, there’s the 20% residual you have to worry about at the end. This $30,000 ups the total payment on a $150,000 truck to $173,460 versus $169,920 if you lease financed.”
Matt Polcyn, proprietor of the Mr. Rooter of North Central Ohio franchise in Millersburg, OH, has gone both routes and doesn’t mince words that a lease finance agreement is superior for a small company like his that aims to expand. “I had one bad experience leasing with the residual at the end. I had to either raise the money or refinance or give the equipment back just when I got used to using it. People need to look down the road. You don’t want to be in a position where you need this piece of equipment to make money and they’re taking it away from you. At my stage of business, when you’re starting as a company, you want to make as much as you can and pay as little taxes as you can. Which means I want to be getting the full benefit of Rule 179. So think, size, long term goals and where you’re at as a company.”
Also says Polcyn, be aware of where you’re required to deliver the equipment at the end of the ease—he got stuck with shipping charges to California—and be very careful who you finance with. Equipment manufacturers like Rush Refuse and McNeilus offer a wide variety of financing options. Marino recommends using a direct lender, ideally one who knows the industry and is affiliated with a reputable bank in your area. Broker deals may look good at first blush, but as Steier says, a broker is going to be hard put to beat a bank-affiliated finance company on rates.
|Photo: Rush Refuse Systems
Steiner also agrees with Polcyn’s small company logic. “If you’re a larger company, one with, say, 12 trucks, leasing makes sense because you’ll be going in and out of trucks every five years. Even a fair market lease will hold at least 60% to 75% of its value, which means you could sell the truck yourself with no problem. But under the current law, an operator with maybe three or four trucks who wants to hold onto his equipment and purchases through a lease finance agreement can write the whole truck off the first year and make his bottom line look excellent.”
Niki Varlas at VHP Enterprises Inc. in Tarpon Springs, FL, says the company wouldn’t be in business without lease financing. The company does structural steel painting for the federal Department of Transportation, removing old lead-based paint from bridges and applying a new acrylic coating. Some of the equipment can run up to $450,000 a unit. “We get paid by the state,” says Varlas,” so it can take a couple of months. Meanwhile, we have to put the money up front to get the job done. So lease financing allows us to keep our cash for overhead and payroll and the costs of mobilization. And as a company we have to have a certain amount of equipment and economic stability to be bonded, and this also helps with that.”
Municipal Finance Leases
Municipalities that want to lease and also hold onto their equipment have the option of tax exempt municipal lease financing. A municipal lease is different from what’s available to private haulers in that there’s typically a $1 buy-out at the end and the lease is required by law to have what’s called non-appropriations language, which means if a municipality fails to appropriate money to pay for the lease in a given fiscal year, it can turn the equipment back and walk away with no obligation.
“The reason banks are willing to agree to this,” says TCF Vice President Dave Penoff, who specializes in municipal leases, “is because equipment financed this way is what’s called ‘essential use equipment,’ which means the municipality has to have it to be able to provide essential services.” Not to mention that even with the large number of municipal leases entered into annually, the non-appropriations clause is very infrequently exercised. A third advantage of a municipal lease is that the bank or third-party financer doesn’t have to pay state or federal income tax on the money it makes on a lease, and this translates into significantly lower interest rates. Although leasing rates are typically slightly higher than bonds, it’s important to remember that leases have no underwriting fees, no legal fees and no bond issuance expenses. Municipalities are also not called on to provide extensive financial documents because their finances are matter of public record and municipal leases feature flexible payment schedules depending on the lessee’s need. Best of all, they free up a municipality’s cash for other community programs.
Penoff says he often finds municipalities have budgeted some capital equipment money but not enough to buy a new truck. The solution? Use the cash to reduce the lease payment and finance the rest. He’s also financed situations where a municipality has leased equipment and then brought in a contractor to operate it and municipalities financing carts while it contracted for collection so residents don’t have to change if the contract isn’t renewed and a new hauler comes in.
The average municipal lease runs five years but can be arranged to fit the municipality’s expectations for holding the equipment or its schedule for paying it off—maybe you’re going into an automation project and expect to run those trucks for seven years, or maybe you’ve got a $50,000 annual appropriation in your budget and want to pay off a $150,000 truck in three years. And because the money for a new lease is seldom budgeted, Penoff can facilitate your purchase by putting the first payment into arrears so it’s not due until a year from delivery.
“In Muncie we bought our equipment outright for years,” say Bobby Smith. “But industry here has fallen off—we’ve probably lost 20,000 jobs in the last two years—and with it tax revenue.” Smith saw it coming, and instead of farming out collection to an independent contractor and losing control 13 years ago, he talked his three-member board into automated collection. He bought the equipment through Best Equipment Co. Inc. in Indianapolis, which specializes in helping communities automate, and Best Equipment President Mike Dahlmann introduced him to municipal finance leasing.
“Because most of our equipment results in cost reduction and productivity gain,” says Dahlmann, “the sooner a municipality implements a program, the sooner they start realizing the savings. A finance lease means they can begin the new system immediately rather than waiting until the following year to put it in the budget.”
Before Muncie automated, Smith had a fulltime staff of 63, a $2.5 million payroll, and annual worker comp claims of $385,000. As of last year, the staff was down to 32, the budget was at $1.2 million and worker comp claims had dropped to $12,000. Muncie’s system has been so successful that Smith and two partners started a consulting company, Refuse Solutions, to help other municipalities automate. First automate, then lease, says Smith. “We cut down from 11 three-man trucks a day to eight one-man trucks.”
Dahlmann thinks another benefit of the municipal lease option is the opportunity to take advantage of technology. “When you have a five-year lease and turn the truck over more frequently than you might otherwise, you can take advantage of advances that may have occurred in that product that make it perform better or run cheaper.” Use the same logic to other equipment like a pickup truck and many of the same efficiencies apply.
But Penoff cautions there can be a downside to this kind of thinking. “Manufacturers are pushing short-term operating leases as a way to get the customer in the cycle of buying new equipment more often than they may have in the past. It may make sense for some contractors based on usage, but a short-term lease is not the best answer for everyone. One thing you have to get comfortable with is the idea that you will never fully pay for the truck and you’ll always have a truck payment.
“For municipalities the benefits of a short-term operating lease are even tougher to support because much municipally owned equipment is used for fewer hours or miles than a private contractor. There may be some higher maintenance equipment such as street sweepers where it may make sense, but it’s not the answer for everyone.”
So the long and short of rent/lease/finance is to have an accurate idea of your short-term needs versus your long-term organizational goals. Make sure you’re up to speed on the tax codes and accounting reporting practices and that everyone in your organization is on the same page. Then go out and find the best deal you can, using your distributor, the equipment manufacturer, or one of the finance companies that knows the solid waste industry and its equipment.
Penelope Grenoble writes on issues concerning waste operations, equipment, and technology.