Effective financial management and informed decision-making regarding capital assets are critical to a healthcare organization’s financial success. An important decision organizations face is whether to purchase or lease equipment, which directly impacts operational efficiency, cash flow, and long-term financial health. VMG Health’s Capital Assets Valuation team collectively holds over 50 years of healthcare valuation experience and thousands of fixed asset valuations, including lease analyses for health systems, hospitals, imaging centers, ASCs, and physician practices. In this article, we outline key considerations when deciding whether to lease or purchase equipment, including the types of leases, the role of fair market value (FMV) assessments, and the pros and cons of leasing versus ownership.  

Types of Equipment Leases 

There are several types of equipment leases, each catering to different business needs and financial strategies. The two most common types are:

     1. Operating Lease:

Operating leases are short-term agreements in which the lessee rents equipment for a period shorter than its useful life. At the end of the lease period, the equipment is returned to the lessor. Operating leases are typically used for equipment that may become outdated quickly, such as computers, office equipment, and vehicles. The agreements: 

  • Last from one to five years 
  • Do not include the option to purchase the leased item(s) at the end of the lease (though some operating leases may include an FMV purchase option, which typically includes stipulations about returning all equipment in the lease) 
  • Typically requires lower monthly payments

     2. Capital Lease (Finance Lease):

A capital lease is a longer-term agreement that allows the lessee to own the equipment at the end of the lease period. These leases are generally used for assets with long useful lives, such as machinery and heavy equipment. Capital leases are structured similarly to loans, and the lessee has the option to purchase the equipment at a nominal amount at the end of the lease. These agreements: 

  • Often last 10–20 years 
  • Include the option to purchase equipment at the end 
  • Require that equipment is recorded as an asset on the lessee’s balance sheet 

At the core of every purchase or lease decision is the equipment cost. When acquiring equipment, whether purchased or leased new, the common starting point is the original acquisition cost. For used equipment, FMV estimate is often used to determine the current value, which is similar to opinions used for financial accounting, tax reporting, and other purposes. FMV is defined as the amount a willing buyer would pay a willing seller for an asset, assuming neither party is under duress, and both have reasonable knowledge of relevant facts. The age of the asset plays a key role in establishing potential lease terms, including whether the new cost or market value is used as the baseline. When acquiring equipment, whether purchased or leased new, its condition and age affect the structure of monthly payments and the prospective lease period. 

Residual Value 

Based on the expected lease period, the lessor will estimate the asset’s expected residual value, which is the expected FMV at lease expiration. Equipment age, condition, and technological advancements can all impact residual value. 

Market Interest Rate 

Many lease interest rates are derived from like-term treasury rates, which are then adjusted to reflect the lessee’s credit quality, the risk involved, and other premium adjustments, including the lessor’s required rate of return. 

Maintenance Agreements 

Leases specify who is responsible for maintaining the equipment during the lease period. The lessee is typically required to follow, and bear the cost of, the manufacturer’s maintenance guidelines to ensure the equipment remains in good working condition. For certain assets, such as surgical robots, MRIs, and CT scanners, annual maintenance costs can be substantial. Failure to adhere to the equipment maintenance guidelines could result in penalties or early lease termination. 

Benefits of Leasing vs. Ownership 

The financial aspects of a lease, such as payments and interest rates, are important; however, operational terms in the lease are equally critical. These terms can significantly influence a company’s operations, financial health, and flexibility. There are several key benefits of equipment leasing compared to owning an asset, including cash flow management, tax deductions, and flexibility. 

     1. Cash Flow Management:

Leasing allows businesses to conserve cash by making smaller, periodic payments instead of committing to a large upfront cost. This is especially beneficial for startups or companies looking to avoid high initial capital expenditures. According to the 2023 Global Medical Device Finance Report, nearly 60% of healthcare institutions worldwide experienced a 15% increase in equipment expenses over the past two years1. Leasing also locks in the interest rate for the lease period, helping businesses combat inflation and reduce capital expenditures. Improved cash flow management allows businesses to budget effectively and allocate resources more efficiently. Many leases also include maintenance services as part of the agreement, reducing the total cost of ownership.

     2. Tax Deductions:

While you can deduct depreciation and interest expenses from taxable income for owned assets, you cannot deduct principal payments, and depreciation deductions must follow a set schedule according to the IRS. Under IFRS 16 and ASC 842, operating leases are treated like an asset, allowing interest and depreciation to be deducted. Unlike an asset purchase or capital lease, only the present value of the equipment is depreciated over the lease period, not the entire cost.

     3. Flexibility:

A well-structured lease aligns with a company’s financial capabilities, and lease periods can be customized to meet specific needs, whether for short-term projects or long-term use. Technology evolves rapidly, with new breakthroughs entering the market regularly. Leasing allows businesses to upgrade to cutting-edge equipment without concerns about maintaining older, less functional equipment. Most leases offer the option to upgrade to newer equipment at the end of the lease period. Reviewing the terms of purchase or renewal options is important, as they can affect future capital expenditures. 

Making the Right Choice 

Equipment leasing is a valuable tool for businesses seeking operational flexibility, better cash flow management, and a means to avoid the burden of asset ownership. By understanding lease structures, the role of fair market value, lease periods, and residual values, healthcare organizations can make informed decisions that meet their long-term needs.