Market Know-how: To Borrow Cranes

Wet Crediting

"Leasing in the broad sense unites all kinds of operations for the provision of renting objects, and in a narrow sense it means renting out an object property by the owner to a tenant for productive use and with the condition of preserving the property rights of the object until the termination of the leasing contract, explains Alexander Osipov, adviser of the general director at Peresvet-Invest. It is a credit in which the traditional monetary loan is replaced with a kind of property hiring. Usually the leasing provider in coordination with the leasing customer buys the object at full cost from the manufacturer or the supplier of the equipment and after its transfer to the tenant receives leasing payments for its use."

Leasing transactions can be carried out in various forms, the main ones being financial and operative leasing, the expert continues. With financial leasing the period of rent is comparable to the duration of the operational period of the equipment, and on its termination the property is then available for sale at residual cost to the tenant. With operative leasing, after a rather short term of rent the property is returned to the leasing provider, which then searches for a new tenant. There are also differences between "wet" leasing (the leasing provider is obliged to bear the charges of technical servicing of the equipment) and "pure" leasing (the leasing customer caries out preventative and operating repairs).

With leasing, Osipov emphasizes, there are several advantages. First, it reduces the risk for the credit institute (leasing providers keep the property rights to the premises so additional mortgaging and financial guarantees are not required, and the necessity to control the target use of the loan disappears). Secondly, it facilitates access for leasing customers to new equipment, while at the same time gives them the opportunity to decrease their tax base. Thirdly, an increase in manufacturing and sales promotes the growth of the total product.

In the majority of economically developed countries in view of the given effects, legislative acts are developed that stimulate leasing. And Russia takes similar measures. In particular, according to governmental order of the Russian Federation dated 27.06.1996 752 (edited in 6.06.2002) "On state support of the development of leasing activity in the Russian Federation" in purchasing new equipment the leasing provider uses a tax discount for investments and accelerated amortization that enables it to reduce the size of payments of "customers". However, unlike the majority of developed countries where the encouragement of leasing is a form of stimulation of demand for machine-building production of domestic production, in Russia a large volume of transactions are due to imported equipment as it surpasses Russian in a number of major characteristics, the expert notes.

Boris Kurtsman, the general director of Globus-Leasing, unequivocally calls Russian legislation benevolent in relation to this tool: "The Russian law on leasing is the best in Europe, and the Tax code is also quite good. Problems arise because laws are not always equally treated by fiscal bodies and leasing companies."

The interests of businessmen in the Federation council, State Duma and the Ministry of Finance are defended by the Russian Association of Leasing Companies (Rosleasing). Its chairman Elena Skrynnik thinks that in the last few years sufficient legal experience on various aspects of leasing activity has been gained for the new edition of the law, which corresponds to the present time.

Leasing on a big road

In countries of Western Europe, North America and Southeast Asia leasing is vigorously developing in the construction industry and sphere of commercial real estate. In a number of countries, for example Portugal, leasing also covers residential real estate. This is confirmed by Arkady Gerasenko, general director of ING Lease (Russia): "In many western countries leasing of real estate is especial popular. The provision of leasing with real estate better protects the creditor in terms of the loan-to-value ratio (loan-to-value (LTV) is the ratio between the outstanding share of credit and the market cost of the asset). The presence of real estate in a leasing portfolio also introduces an element of long-term stability as returns are predicted on longer time periods. And finally, in some countries (for example, in Italy) additional privileges, including tax privileges, are applied to leasing transactions, which makes this kind of financing even more interesting for leasing customers in comparison with usual bank credit. Of course, we are talking about liquid real estate: office buildings, retail areas, warehouses. And specialized industrial assets or, for example, car showrooms are not very popular – to re-rent this property to someone else is not very convenient."

As writes magazine California Builder and Engineer, in the American construction industry leasing is now highly demanded, and is also contributed by the recession in the economy. Thanks to leasing construction companies can be engaged in long-term projects, keeping within strict budgetary frameworks. That is important, because construction equipment can cost from $15,000 to $100,000 and more. According to results from last year the leasing of building equipment in the US has increased by almost 2 per cent. Leasing allows construction organizations to quickly change equipment depending on the premises and the complexities of work, and also to order more modern equipment. For leasing customers such a scheme is also convenient because in this case there is amortization which allows for a reduction in the tax burden and will allow the customer to buy the equipment at a lower cost price. With leasing it is possible to get anything: bulldozers, cranes, concrete mixers.

Leasing contracts in construction usually last for 2-5 years in the US. The customer of the property, according to a leasing contract, pays the leasing provider a contractual monthly payment. To purchase the construction equipment the leasing company takes credit from a bank.

In the last few years banks or affiliated structures are becoming more engaged in leasing. In the US leasing customers are responsible for the safety of the equipment which it, as a rule, should insure with its own funds. A construction company itself can choose the seller/manufacturer of this or that equipment, negotiate on a price, and then contact a leasing company for its support. The leasing company, in turn, buys the chosen equipment and leases it to the construction company. In the future the construction company has three options: extend the contract, return the equipment, or buy it at the real/residual cost.

Magazine Business Week says how Steve Hogan, executive director of NPPHA, an organization controlled by the state, which is in engaged in the construction of a tolled highway in the state of Colorado and had a debt of $416 million in 2005, found a way out. The company had problems with new loans, however at the beginning of 2007 Hogan received an interesting offer from bankers, offering to help him with the condition that he would rent out the highway under a leasing contract to private investors. After Hogan said yes, he started to receive letters from private investment firms from all around the world that were interested in the project, which guarantees huge money in the future. Leasing in this case suited all parties. Motorists no longer sit in traffic jams and have an excellent highway, and the bankers, construction companies, and investors start receiving their percent, profits and payments.

In recent years private investors have shown interest in airports, bridges, garages, car parks, water pipes and other objects and systems of public infrastructure and municipal services. At the same time, investment in public infrastructure has its own features, writes Business Week. Unlike investments in traditional premises which pay off in a maximum of 5-10 years, here the recoupment times can be tens of years, although the risks are insignificant. Therefore contractual periods of leasing of public premises/systems can reach 75-99 years.

It is worth saying that less well off Americans, including motorists, are not happy about the transfer of social systems (for example, roads) to private companies which have propensity to overestimate rates.

Rapid expansion

In Russia the market of leasing services is annually doubling in growth. In 2005, for example its volume was $8 billion, while in 2006 it was already $14 billion. And last year, according to the data of Expert РА, the leasing market increased by 2.6 times and reached $39 billion.

According to Osipov's estimations, in view of the high level of deterioration of equipment in Russia leasing has big potential. The development of this sphere is promoted by the growth of the real sector of the economy and, as a consequence, sharp need for the updating of fixed capital. Double the number of enterprises use this financial tool, which is shown in the increase in the share of leasing in the total amount of investments from 8 per cent in 2006 to 16 per cent in 2007. And also the share of leasing in the volume of gross national product from 1.5 per cent in 2006 to 3.1 per cent in 2007.

Among the features of Russian leasing the expert pays attention to the fact that development of leasing in the country has mainly been through banks creating leasing affiliates. However the degree of this growth is absolutely insufficient, as it does not allow many industrial fields to survive the crisis.

Of the most significant events of the last year Osipov names the active regional expansion of leasing companies, and the strengthening of competition and concentration of key players. The process of expansion to the regions, according to his forecasts, will proceed and in 2008 large universal companies will most actively try to grasp the market by using their resources, experience, effective technologies of work and high degree of automation of business.

The first signs

Leasing in the sphere of commercial real estate is also growing. However here its share, according to Expert РА is still only 1.5 per cent of the total volume of leasing. In the future, approves Alexei Buzhbetsky, the head of the advertising and promotion department at leasing company Uralsib, the volume of the leasing of commercial real estate premises will grow at accelerated rates and in 2008 will exceed $1.3 billion. The real volume of the market, according to his estimations, will grow even more, but leasing companies for various reasons hold back some transactions. The share of regional transactions will increase in the structure of demand as will the segment of small and medium sized businesses.

Experts explain such growth by the huge demand for real estate premises, the high cost of rent and the increase in demand from small and medium sized businesses. The subject of leasing in this case is office buildings/premises, warehouse constructions, shopping and entertainment centers, shops and so forth.

At the same time, Gerasenko notes that it is only possible to talk about leasing in Russian real estate and its characteristics only in theory. "The market is too small and transactions can be counted on your hands, for example, our company needed three years to close a project on the financial leasing of real estate for the sum of several tens of millions of dollars. And in the given segment this was perhaps, the largest market transaction. Perhaps, the small quantity of real estate leasing transactions in Russia is also one of its characteristics."

"In developed countries, leasing of real estate makes up 15-20 per cent of the total volume of leasing, and in Russia it is approximately 2 per cent. The fact is that long money here is necessary. This is problem number one. Western banks have long money, but they wouldn’t risk large sums with the existing problems of the compensation of VAT. This is problem number two. A number of questions also exist in other areas of taxation and civil legislation, which create additional risks for leasing providers when investing significant funds. I think that the key message for the development of the market of financing of real estate through the mechanism of leasing in Russia is stabilization of the tax regime in this area, and first of all ordering the administration of VAT. Investors are interested, it just needs to be used in the right way," he says.

Mikhail Viktorov, general director of the Russian Union of Constructors, cannot remember many examples of leasing in the sphere of real estate. At the same time he notes that in the commercial real estate segment there is a tendency for the growth of leasing transactions when, for example, an office is not bought outright or rented usually, bough is obtained on a hiring basis with the subsequent right to buy it later. It is clear that in this case rental payments are higher than average market rental rates due to all the leasing components. And the Advisory Council on defining the reliability of construction enterprises (part of the Russian Union of Constructors) confirms this: such an approach nevertheless is favourable, especially in conditions of a rise in the prices of real estate and a deficit of premises in a number of commercial real estate sectors. The Russian Union of Constructors’ statistics say that this scheme makes up about 10 per cent of transactions. Mainly it is still only the destiny of large regions, such as Moscow and St. Petersburg, Viktorov emphasizes.

Valentin Karnaruk, senior manager at Globus-leasing, names among the obstacles to leasing in the sphere of real estate the deficit of suitable premises for these purposes. Sellers of liquid real estate (including land) dictate their own conditions, and competition frequently arises between buyers. And the buyers using legal ways of payment seem not to be in the best position. The problem is in the discrepancy of the actual price of the majority of real estate premises with the market price.

The benefit of leasing of real estate, in the expert’s opinion, is that the premises is transferred to the leasing customer after full payment to the leasing company. This means that enterprises have the opportunity to save on property and income tax. Besides, VAT paid in the structure of leasing payments, is returned to the enterprise.

"When talking about the appeal of leasing in the sphere of real estate, it is necessary to underline some key aspects of its use. first leasing is a financial tool for the purchase of commercial real estate premises: retail, warehouses, office premises. The minimum requirements for a leasing customer are: no deposit, minimal initial payment and the long period of leasing makes leasing accessible and attractive to both large companies and small and medium sized businesses,” Buzhbetsky emphasizes. "Besides this leasing is an additional way of externally attracting financial resources and increasing funds without increasing debt. It is important to note that at the stage of construction leasing is not used, however the most advanced leasing companies can offer clients combined financial solutions with banks: at the stage of construction the leasing company will provide a bank loan or act as a co-investor, and in the future will buy the completed premises and then transfer it to the company through leasing."

Yuri Aidarov, deputy chief of the department for leasing equipment at Expo-Leasing, lists the advantages in his opinion: "Firstly they provide the opportunity to purchase real estate premises without a large lump sum payment. Leasing also allows the use of the property without risk of a prescheduled termination of the contract. That is to say, it is not necessary to be afraid about a change of proprietor, its refusal to prolong a contract, an increase in rent payments or eviction. The size of leasing payments is slightly higher than rental payments, but at the end of the contract the tenant becomes the proprietor of the building. Leasing does not burden the balance of the enterprise as the property stays on the balance of the leasing company, and does not reduce its credit appeal. The use of the mechanism of accelerated amortization with a high coefficient is possible and result of which is that the tenant receives a practically completely amortized property that possesses a high market price. Besides this leasing stipulates a more loyal approach to the client in comparison with usual crediting. In this case, there is no need for a deposit as the subject of the leasing is enough provision.”

Among factors which limit the development of leasing of real estate both in Moscow, and the regions, Buzhbetsky names the prevalence of demand over supply, a lack of experience and qualified experts in this area, and also questions of legislative nature and taxation. "During work we have come across, in particular, with the fact that several individuals act as the seller of a premises, or the previous proprietor had not legally executed re-planning, or the rights to the land plot on which the premises is located have also not been registered properly," says Buzhbetsky.

Not pure enough

According to Osipov, the leasing of construction equipment is in 3rd to 4th place in the rating of fields, conceding to the leasing of transport equipment (cars, planes, railway and sea and river boats), agricultural machinery and telecommunications.

Leasing in construction from the point of view of buying equipment rather widespread, says Viktorov. For a period of seven years the analysts of the Advisory Council on defining the reliability of construction enterprises carried out research on construction companies according to the results of which they found that 60-70 per cent of large and medium sized Russian firms use leasing schemes to buy machinery and equipment.

For constructors, as well as representatives of other sectors of the economy, leasing is very useful by way of the opportunity of accelerated amortization of rented equipment. And for example because the construction of a usual typical apartment building takes about 2.5 years, and the contract of leasing is also approximately for this period - in this time the leasing provider has time to write off the equipment from its balance, and the construction firm (leasing customer), obtains it at a minimum price. Accordingly, the construction company pays an insignificant tax on the bought equipment. Naturally, the expert explains, the period of the leasing contract depends on many circumstances, including the possibilities and structure of the construction company, its business plan, etc.

Aidarov names the hidden disadvantages of leasing as the incomplete legal history of the real estate premises, the unwillingness of sellers to conclude transactions for the full price, the use of the scheme of buying a company together with a building, which is unacceptable for leasing, and also the use of offshore schemes.

In his opinion, a problem is also the impossibility of transferring a building to leasing at the stage of construction, before commissioning. He thinks that to make further steps in the development of leasing it is necessary to bring uniform standards to the legislative base, to stop the price of real estate premises from being underestimated, and to stop the practice of VAT returns being unreturned by tax specialists.

Talking about the main problems of leasing, Viktorov, in turn, pays attention to the instability of the market which is closely connected with two factors: rise in prices and increase in bank interest rates. In European countries a change in price of 1-2 per cent in a year is considered significant, in Russia this figure is 10-20 per cent a year. In addition interest rates for loans has recently begun to grow. Therefore, as much as ever, the factor of stability and predictability is important, the expert emphasizes.