Lease vs Rent

Difference Between Lease vs Rent

A lease is a legal contract binding two parties obligatory to each other under the terms and conditions mentioned in the contract. The contract is made to rent an asset which may include things like machinery, a building, or a piece of land. Similar to a lease, Rent is a legal contract binding two parties with respect to the usage of an asset for less than a year.

Let us study much more about lease and rent in detail:

Many a time we need something which is either desired or needed, for instance, a bigger house to live in or a car to make our daily commute easy. Business entities may require big machinery and large pieces of land to set up their factories. But sometimes individuals and companies may not have an adequate supply of capital to fund the purchase of these assets. When direct purchasing of a particular asset is not possible, many individuals and companies opt for the option of leasing or renting.

What does it mean to “lease out” something?

A lease is a legal contract between two parties with terms and conditions. The contract addresses the two opposite parties as “lessor” and “lessee”. The owner of the asset is referred to as lessor while the user of that asset is referred to as a lessee.

Let’s take a simple example to make this concrete.

Suppose a student has moved to a new town for their college graduation and is looking for a house to live in. Due to financial constraints, the student can’t buy an entire house and hence decides to look for the place available for monthly usage in return for payments made for it. The owner of the house (lessor) and the student (lessee) will get into a legal contract, called a lease agreement. The agreement will entail all the details and guidelines pertaining to the maintenance of the property by the lessee.

Characteristics of a lease agreement:

• One of the defining characteristics of a lease agreement is that the onus of maintenance lies with the lessee. Clear guidelines are mentioned in the contract in terms of allowed use of the asset and the lessee is bound by those.
• Typically, the duration of the lease agreement starts from 1 year and can last to as long as 20 years, though there is no clear upper bound on the duration.

There are two main categories of a lease agreement, namely:

1. Operating Leases
2. Capital Leases

The classification of a lease into an operating or capital lease is based on the accounting treatment. Following are conditions under which a lease agreement is treated as a capital lease:

1. If the value of payments made on the lease agreement makes up for most of the fair market value of an asset.
2. Duration of the lease agreement and the effective useful life of the asset being leased out are almost the same
3. At the expiration of the agreement, there is an option to purchase the asset.

Additionally, capital lease constraints the recording of the asset as a “fixed asset” on the financial statements. The obligation is listed as a liability on the financial statements.

There are no such requirements or constraints for operating leases. The lease payments can simply be recorded as expenses for accounting purposes.

What does it mean to “rent” something?

Similar to a lease, renting is a contract binding two parties obligatory to each other as per the terms mentioned within. Let us continue with the above example of a student and try to understand it.

Let’s assume that after getting into a lease agreement for the house, he needed a powerful desktop with specific requirements to do assignments. Instead of having the desktop for a long duration, he needs it only for 3 weeks. To meet this requirement, he will opt to rent it out from someone for a smaller duration. This is the process of “renting”. He will get into a “rent agreement” with the supplier of the desktop for the required duration.

Characteristics of a rent agreement:

• The defining characteristic of a rental agreement is that the user of the asset is not responsible for the maintenance of it. It is the responsibility of the person who rents it to ensure it is in usable condition.
• Rental agreements are better suited for assets that are to be used only on a temporary basis. In our case, the student needs the desktop only for a few weeks. So he would prefer renting it out rather than going to a lease agreement, which is for a longer duration.
• Renting duration typically covers a shorter time period, usually a maximum of 1 year. Like lease agreement, rent agreement also has the option to extend the contract after the term ends.

In general, rent agreements are usually far more relaxed with respect to terms and conditions

For accounting purposes, rental costs are always recorded as an expense on the income statement of the companies.

Head to Head Comparison Between Lease vs Rent (Infographics)

Below is the top 6 Difference between Lease vs Rent

Key Differences between Lease vs Rent:

let us discuss some of the major Differences Between Lease vs Rent:

• The lease agreement is taken for when the business is falling short of the capital needed to buy the asset which is crucial for running a business while renting is done when an asset is needed for the specific task and is not critical for running a business.
• The duration of a lease agreement has usually lasted many years while rent agreements are generally made for less than a year.
• There are two types of lease agreements namely operating lease and capital lease, depending on the accounting treatment.
• Leasing is generally done for assets/ equipment which is crucial to running a business. Renting is done for land, properties or other assets on a need-of-use basis.
• The maintenance of the asset is to be done by the lessee in a lease agreement. In renting an asset, the responsibility of maintaining it does not lie with its user.
• Lease agreements have clear and defined terms and conditions of use to which both lesser and lessee are bound by. Rent agreements are comparatively relaxed with respect to terms and conditions of usage.
• Lease agreement comes with the option of owning the asset at the end of the tenure of the contract. No such option of purchase is given in a rental agreement.

Lease vs Rent Comparison Table

Below is the comparison Table Between Lease vs Rent

Conclusion

While the above example explains the difference between lease vs rents out an asset, in real life the decision to rent or lease includes careful consideration of many factors and constraints

When the asset required is an important part of a business, it is always better to get into a lease agreement. For instance, a company that is into the manufacturing of hardware should lease out its machinery rather than taking them on rent. The other subtle factor is the guarantee and other specified conditions which come with lease agreement as it may prove crucial for business operations later on.

Renting is a better option when the asset is needed for a small period of time or when the business is not sure about the future use of that particular asset. Although renting costs may come out to be more in the short run, the overall expenses might be less in the long run where there is a risk of technological change and thus making the asset obsolete.

Recommended Articles

This has been a guide to the top difference between Lease vs Rent. Here we also discuss the Lease vs Rent key differences with infographics, and a comparison table. You may also have a look at the following articles to learn more

1. Long-term vs Short-term Capital Gains
2. Terminal value dcf
3. Buying vs Leasing
4. Bonds vs Stocks comparison