There are many different ways to get the new equipment you need without busting your bank account.

By Elizabeth Cutright

It could be said that a construction company is only as strong as its asset base. A complex combination of reputation, employee skill, and available revenue, an asset base establishes a foundation upon which a successful construction company can be built. A strong foundation is contingent upon access to reliable and affordable heavy equipment. Reliability may make an outright purchase appear to be the right choice, but leasing or renting may amplify the clarion call of affordability. Interest rates are rising, fuel prices are increasing, and the daily operation costs continue to bite large chunks out of profit margin. In today’s volatile financial climate, the choice to lease or buy can either save you hundreds of dollars or end up costing you thousands. Manufacturers and lenders are aware of the stakes involved and willing to make deals. As a result, whether you need a new backhoe or just an extra truck for one job, there are many options available to get you the equipment you need.

Several options exist of the construction company or general contractor looking to purchase new equipment. Equipment can either be bought outright or financed, depending on the size and needs of the buyer and the project. In terms of financing, interest rates are an important aspect to consider. Taking into account today’s economic climate, Snell advises that contractors consider buying now rather than later: “Interest rates are going to be rising across the board for our customers looking for financing,” he says. “Customers should probably consider purchasing now because interest rates will continue going up.”

Bob Bernardi, vice president of sales for New Holland Construction, agrees. “If the customer needs and can cash-flow it, the sooner he can buy it the better,” he says. “He will then be in a better position by buying it in the shorter term rather than the longer term, since we are sort of in an inflationary period.”

Rick Schulte, financial manager for Doosan Infracore, reiterates the effect of rising interest rates. “The prime rate has doubled in two years from 4% in June 2004 to 8.25% as of June 2006,” he says, “and so they are going to need subsidized financing more. With manufacturers subsidizing rates, that’s going to be more appealing than maybe what they can do with their local bank with interest rates rising.”

Martin Weissburg, president and CEO of Volvo Financial Services North America, elaborates on the connection between rising interest rates and a contractor’s bottom line.

 “Rising interest rates have a direct impact on a contractor’s cash flow because an increase in interest expense is a decrease to the contractor’s bottom line,” Weissburg says. “A contractor’s decision whether or not to purchase should be tied first to having solid work lined up for the equipment to cover many years of the repayment terms. If a contractor has ample work lined up, then current interest rates should not be the deciding factor.”

Although Anthony Travis of CNH Financial acknowledges the significance of rising interest rates, he also cautions against overstating its effect on equipment purchases. “Everybody knows that rising interest rates are a factor today, but I am not sure that’s a detriment to someone going out and buying a piece of construction equipment,” he says. “If they need a piece of equipment, they are going to buy it.”

Travis explains his position by describing the current loan climate. “When you look at the programs that the manufacturers run, you’re seeing a lot less ‘0% for 36 months,’ because it’s too expensive to buy that rate down. But you’re still seeing pretty decent rates, 1.9% or 2.9% for 36 months. There’s still decent rates out there.”

Many companies also offer skip-payment programs, which allow a customer to skip monthly loan payments during the slow season while making higher monthly payments the rest of the year.

“What a skip payment entails,” explains Snell, “is the customer skipping three months of payments during the winter months when they are not as busy and then picking up during the spring to continue making payments. It helps contractors because when they’re not receiving money it’s difficult to have that cash outflow.”

Schulte agrees that skip payments are a valuable alternative to traditional financing but suspects that most buyers are unaware of the program. “They’ve been around for a long time,” he says. “I don’t know how aware contractors are of them. But finance companies have more options than I think they realize.”

Bernardi believes skip payments are important because they can help a business stay afloat by “assisting a contractor get through the winter season.”

Skip-payment loans can help a contractor get the equipment he needs, but Weissburg warns that these types of programs may not always be the best option. “Skip payments are an option for contractors with seasonal but predictable revenue,” he explains. “There is a tradeoff to having skips since the timing of these ‘payment holidays’ can increase the borrower’s interest cost. Our experience has been that most contractors want to reduce debt as early as possible and build equity in their equipment.”

In addition to skip payments, Bernardi outlines other available financing options. “We do look at items such as waiver programs where we may choose to allow somebody to buy a unit, lock in a price, and lock in a tax position, yet not have to make interest payments or maybe even principal payments for an open period to help with cash flow and to allow a contractor to plan his business,” he says.

Snell also highlights the number of different financing options available. In particular, he states that in some cases a buyer may be able to generate capital for additional equipment purchases by using equipment he already owns. “What we do sometimes is called ‘alternate collateral,’” explains Snell, “pledging a paid-for machine as additional collateral. If you have a machine you’ve already paid for, you can use the equity in that machine to put a down payment on another machine. If you have good credit, then this is a nice alternative. Instead of putting cash down, you can put another piece of equipment down.”

Chris Pagel, former senior merchandising consultant and current sales support manager for Caterpillar Financial, agrees that the alternate collateral program is a significant tool available to budget-conscious companies looking to add another machine to their fleet. “If a customer comes in and maybe he doesn’t want to tap into cash reserves, and he has a machine that’s owned free and clear, we would definitely take a look at that and perhaps use it as cross collateral for a defined period of time, and provided he pays us right and keeps a certain equity level, we’re going to release that added lien on the collateral. That’s another way we’d be open to working with a guy,” says Pagel.

Weissburg emphasizes that most financers will work with the customer to find a loan package that fits their needs. “Volvo Financial Services has several flexible loan options that are tailored to the customer’s business needs,” he says. “Renting to own is a very popular option, which allows the buyer to enter the finance arrangement in an equitable position without tying up capital in a down payment.”

Schulte also lists the variety of financing packages that can be utilized. “Finance companies have a lot of options available for the end users,” he says. “It’s important to let the finance company know their situation: when cash flow is good and when it is not, so they can work together to make a good plan so that they are able to make their payments in a timely manner.”

Bernardi emphasizes how large financing companies are able to offer a variety of financing products and packages. “We have all kinds of finance twists with equity financing, with low or no down payments. There’s a number of different tools available to support a contractor to get into a machine,” he says. “A lot depends on what he’s buying, what he already has, his credit rating and position.”

Jim Joedicke of GE Commercial Finance says GE, like many finance companies, will work with a customer to find a perfect fit. “At GE, we work with our customers to tailor financing solutions that meet their needs. In some cases, the equipment leasing option may be the best solution for equipment users who want to minimize capital investment and improve cash flow,” he says.

Pagel feels that large financing companies widen the field for the customer. “The big benefit to Cat financial is that we have well in excess of 50 territory managers out there working in locations that are right there by the dealers, and part of their function is to travel with the salesman. If there’s financing issues or questions—Should I lease? Should I buy? Maybe look at a used machine? Is this going to be more than my cash flow can handle?—I would recommend that they say to whichever salesman they’re talking to, ‘Start thinking about the finance plan,’ before they commit to a purchase.”

Pagel details the lengths to which Caterpillar will go to help customers get the equipment they need. “Maybe a guy doesn’t have 20% down, so we might set up a structure where he’s making slightly higher payments over the first six months of the contract to help him get into that machine based on the fact that he can’t necessarily write a check for the 20% down payment.”

Continues Pagel, “We might also work with the dealer to do a rental/purchase option contract where perhaps he rents the unit for a few months and builds up a little equity and a pay history, and then we would be open to coming in and taking that off our dealer’s hands and financing it for him.”

Travis reiterates the cornucopia of financing packages most large companies offer. “We have so many programs, the flexibility that’s out there to sell the equipment and get the customers into the equipment they want for reasonable prices where they can still maintain their margins is our goal,” he says.

Jeff Segall, from C.N.A. Insurance, highlights the factors that make leasing a better choice for some customers. “For a variety of reasons,” he says, “it might be better for them to not have that debt show up on that balance sheet and instead have that monthly lease payment come up on their income statement. Customers who are a little bit larger have different needs from job to job, so they typically like to lease because they know their job is going to end every six months. That type of equipment isn’t going to be necessary after the lease is over.”

Leasing a piece of equipment can result in smaller monthly payments and little or no initial money down. As a result, more and more contractors are starting to see that sometimes it makes more sense to stick to short-term equipment use. Pagel has definitely seen a rise in the popularity of leasing as an alternative to pricey equipment purchase.

“Leasing’s becoming more popular. That’s sort of the industry trend. There are quite a few contractors out there that want to own equipment. With 17 consecutive rate increases by the fed, it’s something that’s definitely got contractors watching loan rates a lot more closely.”

In response to the possibility of increased demand for leasing options, CNH Capital has introduced a new pilot program. Travis explains, “The customer’s payment for the first 12 months is competitive with a rental, and then they have the option to walk away from the machine at the end of the 12 monthly payments. If they keep it, their payment drops more than half for the next 24 months. So it’s really a 36-month lease, with a 12-month option to walk away.

“That’s something we introduced in the third quarter,” continues Travis, “in the western region, which is basically west of the Mississippi river as a pilot. So we’re going to be watching that closely to see how that works.”

“If interest rates are going up,” comments Schulte, “your payment might be more and leasing might be a better alternative.”

Weissburg believes that for some contractors, leasing construction equipment makes the most sense because of the flexibility it offers in terms of equipment use and repair, along with the smaller amount of money needed up front and the smaller monthly payments.

“Leasing frees up cash and increases asset liquidity,” says Weissburg, pointing out that nevertheless, “The viability of this alternative weighs heavily upon the intended use for the machine and the buyer’s long-term intentions. The advice of an accounting professional is important when considering this option.”

Whether or not to choose leasing over buying may ultimately depend on the types of jobs a contractor is working on. “It’s all in the commitment,” says Travis. “Not everybody with these interest rates in this environment wants to commit that long to anything. This lease matches up better with contractors’ jobs. Most jobs out there don’t go five, six years—even though we’d like them to, they don’t. A lot of them are short-term. To get that piece of equipment and have to rent it, or have the other option of a shorter-term lease that will basically let them match the job, match the commitment, they will have the option of getting more and more equipment as they go: different sizes, whatever it takes. More flexibility options.”

Ultimately, the choice to lease rather than buy depends on individual needs and concerns. “When you get to leasing, everyone is different,” elaborates Schulte. “Some people may be looking at a cash-flow aspect of it where they need a lower payment, so leasing might be the best option. You may have someone who eventually wants to own the equipment. You can have a lease to buy; you can have a lease set up to roll into new equipment every two years. It all depends on the situation with the contractor.”

“Right now the thing that I would caution people about,” says Pagel, “is that we’re in sort of a strange period in that equipment values and demand for equipment is extremely high, and as a result, you’re seeing prices that probably haven’t been seen in quite a long time, or price levels on used equipment—you’re seeing those prices really having skyrocketed—and I think customers are better served to really analyze their purchasing decision.”

Pagel advises potential equipment buyers to give a lot of thought about expenses, because “as more and more contractors get stretched on debt, it affects their bonding. There are so many contractors these days that if things tended to slow I think they could potentially be in a little bit of trouble because they’re stretched too thin. We want to be able to work with them in both the good times and the bad.”

Travis concurs. “Our customers who bond and get these jobs—the better their financial statements look, the better the credit risk, the lower their bond cost is. That can be a huge advantage out in the field, as more and more of these big companies compete and their margins get crunched. They need to look at better and better bonding and more efficient ways to do business out there,” he says, “and that’s where the leasing versus buying and everything else is getting more and more focused because they have figured out that ‘Hey, I can watch my margins and make more money if I’m business savvy or have a better focus on what I am doing as a total and complete organization.’”

“The people that watch that cash flow,” warns Pagel, “need to just make sure they don’t get saddled with way too much debt. Because it will affect them. It’ll affect their ability to get jobs in the future.”

“Everybody’s managing their balance sheet,” agrees Travis. “And for a long time history has dictated us to put a bunch of numbers on a piece of paper and go, ‘Look, this one’s better than that one. This one costs me less, this one costs me more.’”

Travis encourages a broader view. “That’s not the way it is anymore. Contractors need to manage their balance sheets for one reason, and they need to manage their taxes and what they pay. They need to manage their equipment and the disposal and acquisition of that equipment. So lease versus buy does not fall into those three arenas of why I should do what, why, when, how,” he says.

As Bernardi points out, “We all have to be aware we’re in an environment where the fed seems to be raising short-term rates, and as those rates go up, they will be reflected in all areas of the business eventually.”

Weissburg offers this final tip: “Contractors should always keep a watchful eye not only on the local economy in which they do business but also on the macroeconomic trends that can also prove useful when deciding on a future equipment purchase.”

Elizabeth Cutright writes features for Forester Communications.

GEC - November/December 2006

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