You are probably familiar with equipment leasing as a means for businesses to fulfill equipment needs and preserve working capital, but have you ever thought of equipment leasing from the other side of the transaction – as a potential investment?
Equipment leasing funds allow you to pool your money with other investors to assemble a range (or portfolio, if you will) of capital equipment that can be leased to businesses, and eventually sold off or depreciated out after a particular number of leases. The equipment may even be sold directly to the lessee as part of a lease-to-own program. Equipment can range from railcars, ships, and heavy construction equipment to specialized medical/analytical equipment or major office equipment.
Typically, equipment-leasing funds exist for a set length of time (often between 7-10 years). During the offering period, the sponsor of the fund issues a prospectus or similar document to attract investors. This document will describe the overall business plan, the general market and type of equipment to be purchased and leased, experience of the fund sponsor, and risk factors, among other information.
Most funds are “blind-pools”, meaning the sponsor does not have a set plan but will take advantage of whatever equipment or market provides the best investment opportunity in their view. Funds will also diversify purchases to reduce the risks of an oversaturated or poor market segment resulting in idle equipment.
After the offering period is complete and purchases are made, the operating period of the fund begins. The intent is to receive a steady stream of rental income. This period lasts for around five years until the liquidation phase begins and the used equipment is sold on the secondary market.
Where does this fit in your portfolio? It fits in a similar realm as real estate investment trusts (REITs) -- an inflation hedge that does not correlate directly with the stock or bond markets. They are not particularly volatile, so they help to stabilize a portfolio. On the other hand, they are not generally liquid, so you need enough other assets in liquid form that you can afford to sock away cash in the equipment funds.
Investment performance is difficult to compile and compare for equipment leasing funds -- as they are typically private placements -- but sponsors say annual returns of 6-9% range are common. The prospectus will often list an expected range of returns, with an expected minimum value as well as a maximum value that will be returned before funds are reinvested to purchase additional assets. However, as with any speculative investment, there is no guarantee what the level of return will be or that there will be a positive return at all.
There are multiple risks that can cause you to get poor returns or lose money outright – such as idle equipment from poor investment choices, abuse or destruction of leased equipment, defaulting on payments or bankruptcy of lessees, early termination of the fund, obsolescence of equipment or excessive asset management fees. There could be difficulties with reclaiming assets; you cannot just send the local auto and appliance repo man to recover railcars or complex medical or analytical equipment.
The tax effects are not straightforward with equipment leasing funds, so it is best to consult a professional for the specifics of your case. For example, the distributions may or may not be considered a return of capital as opposed to a simple return on investment.
You can generally depreciate your share of the equipment costs at an accelerated rate, just as if you had purchased the equipment for your own business use, but the leases must meet the IRS definition of a “true lease”.
These are direct investments and thus income (and any losses) are pass-through – meaning that they are taxed at the individual income level of the owners (you) and not at the corporate level. In essence, this avoids double taxation, but does make the tax situation even less straightforward.
Equipment lease funds are not for everyone, but for investors with sufficient funds to handle limited liquidity and the need to balance out a more volatile portfolio, they can be a useful complement. As with any investment, do your homework to be sure the investment meets your criteria, investigate the track record of the fund sponsor, and take the time to understand the risks and the tax ramifications in detail.