What are rental payments?
Rent is the equivalent of monthly rent, which is formally dictated by a contract between two parties, granting a participant the legal right to use the real estate, manufacturing equipment, computers, software or other fixed assets of the other person for a specified period.
The length of time rental payments will be made may vary from month to month, as is generally the case with business software as a service (SaaS) models, or may extend. over extremely long periods. time, such as 100 years or more, which is often the case in land rental scenarios.
A rental payment amount is determined by a multitude of different considerations, such as the value of an asset, local residual values in a given neighborhood, discount rates and a tenant’s credit rating.
Key points to remember
- Most people associate rental payments with monthly apartment rental fees; however, leases can also apply to all other assets, provided that individuals come to a contractual meeting of minds.
- Individuals can enter into rental contracts for land, cars, computer hardware, software or other fixed assets.
- The deadlines for rental contracts can be short. as in month-to-month, or long-term agreements, as is often the case in land rental scenarios, which may have contracts for a term of a century or more.
Understanding rental payments
Rental payments can be made by individuals as well as by companies. Individuals have traditionally used leases to finance cars, but they can also use them to obtain computer equipment, plots of land and other physical assets.
Lease payments from a business are used in calculating the fixed expense coverage ratio, which helps investors determine if a business is able to cover its fixed expenses, such as leases and interest. The fixed expense coverage ratio is essentially an amplified version of the ratio multiplied by the interest earned, or multiplied by the interest coverage ratio. It is highly adaptable for practical use, with almost all fixed costs, since these fixed costs are so similar to rental payments.
Common types of leases
The most common types of leases are:
- Operating leases
- Finance leases (also known as capital leases)
- Sale-leaseback agreements
- Mixed leases (those that marry two or more of the above models)
The most important feature of an operating lease is that it allows for both financing and maintenance, in which rental payments include an element for financing costs as well as maintenance elements. Operating leases require lessors to regularly maintain the rental equipment in question. For example, it is not uncommon for aircraft owners to lease their engines.
In many cases, owners do not have the technical knowledge to maintain the parts for themselves, as the components are highly specialized. In such cases, it is the owners’ responsibility to include maintenance costs directly in the rental payments.
Finance leases differ from operating leases in that they do not include maintenance costs in rental payments. New types of leases, which often offer more personalized service levels and rental payment structures, include synthetic leases and leases related to mileage, hours or usage levels. For example, General Electric often leases expensive locomotive components with mileage-related lease payments. In theory, a tenant pays only what he needs.
For consumers looking to rent an automobile (instead of buying one), be aware that some dealerships impose mileage minimums to protect the resale value of the vehicle.