The complexities of equipment acquisition seem to be growing by the day based on unrest in the world, employee shortages, and supply chain issues. Adding to that is the growing reality of inflation, which will likely be with us for the foreseeable future. What does that mean for all of us? Over the next few years, we’re going to pay continually higher prices for just about everything. The impact of that reality on a business is this: the lowest price for any needed assets is right now. As the price of everything rises, the purchasing power of tomorrow’s dollars will continually diminish.
Think about interest rates too. Right now, they are still historically low, but the Federal Reserve is considering multiple increases over the next year to combat inflation. While this counterbalancing approach has proven effective in the past, it also tends to have a slow burn impact – over the course of months and likely even years, especially since current inflation is heavily influenced by the pandemic. When you add inflation, pending rate increases, and supply chain and labor pool issues together, it’s likely going to be a long-term challenge for us all. One strong takeaway that I see is this: Since prices are going steadily and even sharply up for a while, now is the time to buy. Furthermore, this is also the best time to take advantage of low interest rates before they begin to steadily increase.
A report issued by the Equipment Leasing & Finance Foundation in June 2018 has interesting relevance to the realities of today’s economy – perhaps even more relevance than it did four years ago when it was published. The report points out that “For over a decade, the economy has sat in a realm of consistently low inflation, low interest rates, low market volatility, and modest to moderate economic growth. Understandably, many equipment finance professionals have grown accustomed to this status quo....”
Certainly, many lessors and lessees have been lulled into a belief that these metrics are less important than they used to be, but as reality sets in on rising inflation and interest rates, those content with the status quo may well be in for a rude awakening. To some, inflation and interest rates may seem like broad macroeconomic indicators that have little relevance to equipment leasing. In reality though, the highest rate of inflation in four decades coupled with rates set to rise, will have a real and lasting impact on daily decisions made by U.S. businesses in all economic sectors for many years to come.
This quadruple threat of labor shortages, supply chain issues, inflation, and interest rates will certainly set the stage for a bumpy road ahead if consumers are not just informed but ready and willing to utilize important tools like leasing to their advantage. For businesses looking to invest in new equipment, how does leasing help navigate through such tricky economic waters?
In the inflationary economy we are now in, future rents for equipment acquired through a lease based on today’s price will be paid in inflated dollars. A lease provider (lessor) can access capital funds on a customer’s behalf that shield it from inflationary trends, thus passing this protection onto the customer in the form of fixed-rate lease payments.
With the current lower, fixed-rate payments available, equipment leasing enables deferred cash outlays that don’t come into play with an upfront purchase. Inflation will then lessen the cost of future lease payments since the payments will be made with “cheaper” dollars. By making monthly payments to the leasing company with ever-inflating dollars during the term of the lease, the cost of financing is actually reduced in real dollars.
CONSIDER THE FOLLOWING EXAMPLE:
If an asset acquisition cost today is $100,000, 7% inflation will increase that price up to $107,000 if only a few months go by before a purchase decision is made. What might seem like small numbers will add up quickly as the compounding of inflation can be as fast as the compounding of interest.
THREE WAYS LEASING WORKS AS A HEDGE AGAINST PRICE INFLATION:
1) BUY LOW: Buying equipment today will cost a business less than it would to buy the same equipment tomorrow. How equipment is paid for also impacts how much it will ultimately cost. In short, by utilizing financing solutions, decisions can be sped up and a lower equipment cost locked in when an order is placed by a lessor on the lessee’s behalf.
2) BUY MORE: A decision to buy more of a product now rather than incrementally over time helps a buyer address supply chain shortages and protects a larger amount of their purchasing dollars utilizing current pricing rather than future inflated pricing. Buying incrementally during high inflation exposes a buyer to greater price increases at the time of future orders. Leasing solutions become the perfect remedy to a larger purchase commitment that exceeds available cash flow or budget allocations. A fixed-rate lease empowers a purchaser to borrow in today’s dollars and pay with tomorrow’s less-valuable dollars, hedging inevitable increases in price due to inflation and stabilizing cash flow so it can be put to work on other important business priorities.
3) LOCK IN A LOW RATE: The window of time in which rates remain low while inflation continues to trend upward will not last much longer. Many economists are now expecting the Federal Reserve will likely raise interest rates 8-9 times over the next 12 months. If there was ever an ideal time to use leasing to your advantage, that time is now! A lease signed today locks in the current rate as well as today’s equipment price. Unlike lines of credit and variable rate loans, leases are typically fixed payments based on fixed interest rates. Financing solutions also offer more flexibility on term length than typically exist through other lending options. By locking in a 2-8 year term with historically low rates before they go up, you lock in a lower fixed payment than will be available next year, next quarter, or even next month.
Rising inflation and interest rates are certain to erode margins and even feasibility for new equipment purchases. If business revenue and costs rise at a similar rate, changes to margin may not be that noticeable, but if revenue goes down or stays the same while costs continue to rise, buyers will most certainly feel the impact. A reliable hedging strategy can help reduce the sting of higher-than-normal inflationary pressure and help make a business stronger than ever.