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What is a Lease?

A lease is a formal agreement between a lessor (the asset owner) and a lessee (the individual or business wanting to use the asset). Under this contract, the lessee is granted the right to use the asset for a set period, typically in exchange for regular rental payments. While leasing is commonly linked with homes, offices, and cars, many other items such as storage units, machinery, software, and even airplanes can be leased.

Lease vs. Rent

Although the terms “lease” and “rent” are often used interchangeably, they have different meanings. A lease refers to the legal agreement itself, while rent is the payment made for using the asset. Importantly, neither renting nor leasing grants ownership rights over the asset.

Understanding Residual Value

Residual value, also known as salvage value, is the estimated worth of an asset at the end of a lease. This term often comes up in auto leases. For instance, a car initially worth $30,000 might have a residual value of $16,000 after a 3-year lease. Residual values apply to any depreciating asset and generally decline over longer lease terms—except for real estate, which may appreciate over time. To estimate depreciation, you can use a Depreciation Calculator.

Leasing a Car

Leasing a vehicle offers the advantage of driving a new car under warranty without committing to long-term ownership. However, leasing often costs more than buying in the long run. Key factors to consider include the initial down payment, monthly lease payments, lease duration, and annual mileage limits. Car leases also use a “money factor” to express interest costs, which can be converted to an annual percentage rate (APR) by multiplying by 2,400.

Monthly payments are primarily based on the difference between the car’s initial value and its residual value at the end of the lease. Be prepared for additional fees, such as security deposits, and carefully review all contract terms. Some leases also offer the option to buy the car afterward. To plan your auto lease payments, try using an Auto Lease Calculator.

Renting vs. Leasing Cars

While both renting and leasing involve paying to use a car you don’t own, the timelines and purposes differ. Leasing is a longer-term commitment (usually years) and often happens through dealerships. Renting, however, is short-term—ranging from a day to a few weeks—and is typically arranged through car rental agencies.

Business Leasing

Many large corporations lease assets like equipment, vehicles, and office spaces instead of buying them. Leasing allows businesses to access necessary tools with lower upfront costs and flexibility to return, extend, or buy the equipment after the lease. This is especially beneficial for startups with limited capital. Additionally, operating lease payments are often tax-deductible, providing businesses with potential savings.

Capital vs. Operating Leases in the U.S.

Business leases are generally classified into two categories:

• Capital Leases: These are treated like asset purchases for accounting purposes. They appear on balance sheets and can be depreciated over time. Capital leases are typically used for long-term leases where the asset remains valuable over time.

• Operating Leases: Also known as service leases, these are for short-term use or assets that may quickly become outdated. The lessee doesn’t claim ownership, and rental payments are listed as operating expenses. Some operating leases offer a bargain purchase option at the end.

Leasing Real Estate

Residential Leases

In the housing market, 12-month leases are most common, but agreements can range from 3 to 24 months or more, depending on mutual terms. Some agreements, like lease-to-own contracts, combine leasing with an option to purchase the property later. Real estate tends to appreciate over time, so the residual value often increases during the lease period.

Commercial Real Estate Leases

Businesses lease spaces like offices, warehouses, or retail stores under stricter, longer-term contracts. Besides base rent, these agreements might include additional costs like insurance, taxes, and maintenance. Different types of commercial leases structure these costs differently.

Types of Commercial Real Estate Leases

Gross Lease

Also known as a full-service lease, a gross lease bundles most costs (taxes, insurance, maintenance) into a single rental payment. Tenants enjoy simplified budgeting, though landlords may build higher operating costs into the rent.

Net Lease

In a net lease, tenants cover additional expenses beyond base rent. There are three common types:

• Single Net Lease (N Lease): Tenant pays rent plus property taxes.

• Double Net Lease (NN Lease): Tenant pays rent, taxes, and insurance.

• Triple Net Lease (NNN Lease): Tenant covers rent, taxes, insurance, and maintenance costs. NNN leases are common in commercial buildings and favor landlords by shifting more costs to tenants.

Some NNN leases are bondable, meaning terms cannot be changed—even with unexpected cost hikes—until the lease expires.

Modified Leases

Modified gross and modified net leases find a middle ground between gross and net leases. Terms can be negotiated to split expenses like insurance and maintenance between tenant and landlord. These leases offer flexibility but should be carefully reviewed, as definitions can vary depending on the agreement.