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To say we're seeing a
boom in new equipment sales is no exaggeration. A combination of
tax incentives and low interest rates have fueled a sales frenzy
across the nation. At John Deere's Construction and Forestry Company,
for example, loan volumes for equipment shot up by more than 40%
through mid-year 2004, compared with 2003. At Volvo Commercial Finance,
loan volumes for the first five months of 2004 jumped by 30%, compared
with the same period a year ago. Caterpillar says the equipment
industry's finance volume is up more than 20% this year.
Not long ago, the industry
had developed a surplus of used equipment. Sales at Ritchie Bros.
Auctioneers were climbing steadily. Dealers had excess inventory.
Prices were at new lows. Backhoes abounded, as did other machines.
"Now there's a shortage
of used equipment," says James Galecki, manager of market development
for construction and forestry equipment at John Deere Credit. "The
market demand for all equipment, new and used, is at a record high
again." a Volvo executive says Ritchie Bros. "is screaming for equipment."
Low interest rates are
a major factor behind the surge in demand. Rates edged upward in
the spring, and were expected to rise slightly at mid-year. Manufacturers
have been subsidizing, or "buying down," the interest rates on equipment
loans.
Incentive to Buy This
Year
A second, perhaps even
stronger impetus for growing equipment sales, however, has come
from the federal government—in the form of tax breaks. Thanks
to the 2003 Jobs and Growth Act, you can write off 50% of the cost
of new equipment immediately. And you can write off the 20% of the
remaining 50% of undepreciated value that you were entitled to deduct
under pre-2003 rules, says the Associated Equipment Distributors
(AED). For example, for a $100,000 machine with a six-year depreciation
life, you can depreciate $60,000 in the first year and realize a
substantial tax savings.
To qualify for the 50%
depreciation bonus, the equipment must be acquired after May 5,
2003, and before January 1, 2005. The depreciation bonus law only
applies to new equipment—not to used machines. President Bush
and Congress enacted the law to boost equipment sales, increase
manufacturing levels, create jobs, and stimulate the economy.
What's more, the 2003
stimulus law increased Section 179 business expensing levels. Under
Section 179 of the Internal Revenue Code, companies with a sufficiently
small amount of capital investment can choose to expense rather
than depreciate their equipment purchases. The 2003 tax law increased
the amount companies can expense from $25,000 to $100,000 and raised
the eligibility phase-out cap from $200,000 to $400,000, say AED
and the Association of Equipment Manufacturers (AEM).
In some cases that can
mean a tax savings of $32,000 in the year of purchase. For every
dollar your equipment purchases exceed $400,000, the allowable $100,000
is reduced by one dollar. For example, if you buy $450,000 worth
of equipment, you can only expense $50,000, say AED and AEM. And,
Section 179 rules apply to both new and used equipment.
'Killer' Deals
Up in Forest Lake, MN,
earthmoving contractor Dennis Jensen does $20 million to $25 million
of work per year. He's recently been buying new equipment for North
Pine Aggregate Inc., where he's president. "In the past year we've
bought six new articulated trucks, nine new dozers, a new loader,
five new excavators, and two new scrapers," says Jensen. "The equipment
is split about evenly between Caterpillar and John Deere, and most
of it has been financed through Cat Financial or John Deere Credit.
"In most cases we've
negotiated 0% to 2% financing—we got zero percent for three years,
generally," Jensen says. "It's a killer deal, but you have to be
in a position to make the large payments.
"For the scrapers, the
numbers were so large that we financed for three years at a low
rate, and with a balloon at 36 months," Jensen says. "At the end
of three years we have to pay them off with cash or refinance the
balance."
Just as with auto financing,
construction equipment dealers have been offering 0% financing–for
up to 48 months. "We continue to offer 0% for 24 months on a variety
of Case Construction equipment models," says Tom Milligan, construction
equipment marketing manager for Case Credit. "In addition, we can
offer more than rate. We can finance—bundled with the machine—a
Case Care maintenance program, insurance, an extended warranty,
and a GPS locator program on the same retail note."
"Zero percent loans are
a marketing tool," points out industry analyst Frank Manfredi, of
Manfredi & Associates. "There's no free lunch. Most of the cost
of the 0% loans has been written into the cost of the machines.
Someone is paying for that interest; it may be a combination of
the dealer and manufacturer. If they hadn't offered 0% percent,
their profits would have been higher."
As interest rates edge
upward, 0% interest deals "are not disappearing, but they're becoming
less frequent," says Larry Gaburri, commercial manager with Volvo
Construction Equipment. "Right now the prime is 4%, and they're
talking about a prime rate of 4.25%. So that tells people to buy
now, if they want to finance equipment." Through 2004, manufacturers
probably "will require dealers to pony up to participate in subsidizing
low-interest rate deals," Gaburri says.
Leasing Debate
At mid-year, "Deal structures
continue to be dominated by installment sale contracts over varying
terms while the bonus depreciation is available," said Pete Tegg,
US sales manager for Caterpillar Financial Services Corporation.
"Bonus depreciation is due to end in December, and at that point
we may see an increase in tax leases."
Deere's Galecki agrees.
"As a percentage of overall construction equipment sales volume,
leasing is down," he says. "Interest rates are rising, and bonus
depreciation expires this year. So will that drive up leasing? I
think it will. By gut feel, I'd say that leasing will go up by 10%
to 20% beginning in 2005."
Galecki says more contractors
might find leasing to be more attractive than buying if they considered
the savings from lower payments. "People often don't look at the
value of having that money invested in their businesses," says Galecki.
"If I can have a monthly lease payment that's $1,000 less than a
loan payment, then I've got that $1,000 earning a return that's
better than the cost of a loan! You assume that a contractor has
to make 15% or more on his money."
Contractor Jensen says
he hasn't done much leasing lately because he's not assured of work
to support the equipment for more than about a year in advance.
He explains that it can be difficult—and expensive—to break a six-
or seven-year lease in the middle of its term. "If you get into
a job and your needs change, and you want to buy out of the lease,
you'll owe quite a bit more than the machine is worth," warns Jensen.
"I would sooner finance the equipment for a shorter term, make the
big payments, and get some of the stink off of it. Leases are tough
to get out of without running the full term.
"I never know what our
workload is going to be six or seven years out," he says. "Those
long-term leases kind of scare me." The reason for the difficulty,
Jensen speculates, is that the lessor is rapidly depreciating the
machine from year one of the lease. So if the contractor wants to
buy the leased machine, the contractor must, in effect, pay the
lessor for capital gains taxes that the lessor will incur by selling
the highly depreciated machine. "The leasing company probably depreciates
the hell out of it for the first year," says Jensen.
Another difficulty is
to avoid placing a fixed price on the machine until the end of the
lease. "One of the leasing companies' favorite things to do is to
have a balloon at the end of the lease period, and nobody knows
what the pay-out number is," Jensen says. "A lot of leases have
a fair market value at the end of the lease term, and you don't
know what it is. To me, that's scary."
Lately contractors have
not done much variable-rate financing because of low fixed rates.
But as interest rates rise, Galecki contends, variable-rate financing
will become more attractive because there's a larger spread between
the variable and fixed rates.
"With variable rates,
you can start the loan at 1% below the fixed rate, and the rate
has to go up 2.5% over the life of the loan to get you back to what
a fixed rate would be," Galecki points out. "As the rates rise,
they may end up being a point higher than a fixed rate at the end,
but those higher rates apply to lower balances toward the end of
the loan. So you may be better off with a variable-rate loan, even
with a 2.5% to 3% increase in rates. But there is a level of risk
involved."
Regional Views
We talked with a few
dealers and finance people from around the country, and summarize
their input here.
North Carolina:
"The construction economy here is blowin' and goin'," says Brett
Goodman, district manager for CIT Group Equipment Finance Inc. "North
Carolina can't keep up with the demand for roads or housing. Housing
in North Carolina has been extremely strong.
"Our interest rates are
running in the fives, sixes, and sevens," Goodman says. We asked
how he competes 0% interest from manufacturers' captive finance
companies. "Some programs offer discounted prices if you pay cash,"
he says. For payment in cash, a manufacturer might drop a price
from $100,000 to $95,000—and the customer would finance the $95,000
with CIT.
Plus, Goodman says, CIT's
National Accounts Division cooperates with manufacturers and dealers
to offer subsidized financing. The manufacturer subsidizes CIT's
loan in order to get the business. In turn, the manufacturer and
the dealer save the time involved in doing the financing.
Pensacola, FL: "Sales
have been great recently—up 10% this year over last," says Joe Meeks,
a sales manager for the Case dealer here, Coastal Machinery Company.
"If a manufacturer offers 0% interest, we offer it. Rates are always
bouncing around. We expect interest rates to inch up slightly. (Fed
chairman) Allan Greenspan will do that to offset some of this inflation
that we're starting to see come about. We expect to continue doing
deals at 6 to 8% for the next 12 months."
Southfield, MI:
"What's been your best deal?" we asked Mike Wright, finance and
insurance manager for Wolverine Tractor and Equipment Company, the
Case dealer here. "For selected customers, Link-Belt offered five-year
financing at 2.5% interest," Wright says. As interest rates rise,
"Everybody will raise their rates, but I don't expect it to have
any impact on the marketplace," says Wright. "Customers base their
decisions more on price, features, and their workload.
"Construction in Michigan
finally seems to be picking up some—our road building, commercial,
and municipal customers all seem to be picking up," Wright says.
Leasing has been down over the past 12 months, but will grow in
volume as the economy improves, he says.
Los Angeles, CA:
"We're now doing deals at 7%," says Scott Dickson, district sales
manager for CIT Equipment Finance here. "You'll see some movement
again this year, but in terms of commercial lending for equipment,
we've already seen some increases this year.
"New home sales have
been strong and it looks like they'll continue to be strong," Dickson
says. "I've had a ton of requests for pre-auction approvals. I just
gave a guy a $300,000 line of credit before he went to the auction.
Equipment prices have been steadily rising.
CIT owns a volume of
repossessed equipment—and is offering "great deals" on it, Dickson
says. "For those machines, we'll do deals at 4% for 24 months. We've
got cranes, scrapers, dozers, and more."
What's in store for the
rest of the year? "If interest rates go up, dealers will be forced
to participate in the subsidies," says Volvo's Gaburri. "And if
the momentum continues in the industry, the year-over-year increase
in sales will be 25% to 30%."
"Our contractor business
has been fantastic," says Brian Foley, senior vice president at
Comerica Bank's Dallas office. A few years ago, Comerica started
a group that does complete financial loan packages for contractors
and equipment dealers. From a loan volume of $175 million in 1998,
the group's portfolio has jumped to a current value of some $450
million.
"We don't do transactions,"
says Foley. "We provide a total money package for a contractor or
an equipment dealer." Two factors explain the group's recent, rapid
growth, he says. One is the consolidation of equipment dealers,
which drives up the demand for financing. The other is the recent
upsurge in equipment sales to contractors. "Some of our companies
have had 40% growth in their revenues," says Foley.
Frequent contributor
Daniel C. Brown is the owner of TechniComm, a communications business
based in Des Plaines, IL.
GEC
- September/October 2004
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