Among contractors’ most challenging business decisions during this economic downturn is what to do with their equipment fleets. Should they offload older machines? Should they buy used? Should they rent more frequently?
Contractors must assess a variety of options to ensure they are equipped for success.
Proactive Asset Management
Amid the uncertainty surrounding the economy and the future of the nonresidential construction sector, 38 percent of contractors plan to acquire equipment this year, according to the 2009 Wells Fargo Construction Industry Forecast. The survey—based on more than 900 responses from U.S. construction contracting and equipment distribution companies gathered during October and November 2008—also found more than one-third of equipment buyers plan to expand their fleets, while 61 percent expect to maintain their current fleet size.
In this fluctuating environment, the bottom line is that contractors must manage their equipment assets more proactively, says Ed Powers, general manager and vice president of Komatsu’s construction division.
“Choices are being made to sell under-utilized equipment, which in turn is providing opportunities for contractors to acquire good used equipment,” Powers says. “New equipment sales have suffered due to the decrease in project opportunities for our customers and the increased availability of late model pre-owned equipment.”
Indeed, more contractors are in the market for used equipment than at any point in the last decade, according to Wells Fargo Construction. The survey found 48 percent of contractors planning to purchase equipment in 2009 will buy only pre-owned equipment; 32 percent will buy only new equipment and 20 percent will acquire both new and used equipment. This represents a dramatic shift from 2008, when 47 percent planned to buy new and only 20 percent were in the market for used equipment.
“New equipment benefits from improvements in design, manufacturing and durability,” Powers says. “Increased cycle times, modular component construction, increased operating systems and improved fuel economies keep a job on schedule and at the lowest operating expense.”
But, when financing is an issue, used equipment “provides an excellent compromise between capital investment, productivity and reliability,” Powers says.
Additionally, for the first time in the Wells Fargo Construction survey’s 33-year history, contractors are using equipment that, on average, has been in service for more than a decade.
“Contractors are not trading their machines as frequently and are hanging on to them … until they have more insight as to what the future will bring,” says Larry Cutliffe, vice president of marketing for Milton CAT, Milford, Mass., which sells and rents Caterpillar equipment through dealerships across New England.
Time to Buy
If a contractor has confidence in its workload and can obtain the necessary credit, now is an ideal time to buy due to favorable discounts.
“We’re actually buying more right now because prices are so good in this economy,” says Jon Shaw, president of Shaw Brothers Construction, Gorham, Maine. The heavy/highway and sitework contractor owns more than 100 pieces of equipment, buying and trading throughout the year to get rid of machines that have logged lots of hours and gain ones with better technology.
“We buy 99 percent of our equipment because we think it’s cheaper,” Shaw says. “When we need it, we have it. It has our stickers on it, the attachments we want and our radio in it.”
In general, it makes sense to purchase a piece of equipment if it will be used for more than 900 hours a year, according to Nathaniel Brookhouse, director of sales support and marketing for Sunbelt Rentals, Fort Mill, S.C.
Put another way, ownership is preferred if the piece of equipment will be used more than 75 percent of the time, says Nick Mavrick, vice president of marketing, strategy and sales for Volvo Construction Equipment Rents, Asheville, N.C.
The majority of fleets contain both owned and rented equipment, with Wells Fargo Construction reporting contractors will use their own (purchased) equipment to meet 83 percent of their needs and rented equipment to meet 7 percent of their needs this year.
Rentals Rev Up
Although rentals don’t comprise the majority of equipment transactions, the rental industry is gaining momentum. According to Mavrick, the North American rental industry nets about $32 billion (up from about $9 billion in 1992) and is growing about 7 percent per year.
Currently, about one-third of all equipment is rented in the United States, says Per Ohstrom, vice president of marketing for RSC Equipment Rental, Scottsdale, Ariz. That fraction is doubled—or more—in places like Germany, Japan and the United Kingdom, a trend Ohstrom attributes to stricter regulations on energy efficiency. He expects the United States to reverse to one-third owned and two-thirds rented during the next dozen years.
The downtrodden economy may boost the rental industry as well.
“We’ve seen a significant shift in renting more,” Cutliffe says. “Contractors don’t want to have a long-term commitment in terms of an installment payment.
Because a contractor outsources the capital for rented equipment, it doesn’t bear the burden of costs associated with ownership: storage, maintenance, transportation and insurance.
“We bear the real burden,” Brookhouse says. “You as the renter are just paying for the piece of equipment
to do a particular job. When you’re finished, you just call it off rent and we come get it.”
This flexibility is particularly advantageous for smaller contractors, which can use rented equipment to bid on projects that may be too large for their own equipment fleet. Plus, as the economy forces contractors to branch out into work they haven’t yet performed, renting allows them to try something out and, if it works, buy based on their job outlook.
“The key is to realize when rental volume can be offset with a unit purchase,” Powers says, adding that a rental purchase option allows a contractor to build equity in a unit when long-term utilization is not currently apparent. “As the owner’s potential utilization increases, his risk of ownership lessens. If future utilization does not increase, he can return the unit with no obligation other than the initial agreement.”
What Contractors Want
In addition to flexibility and cost-efficiency, here are a few needs contractors seek to meet when renting equipment:
- Availability/Productivity: On-time delivery of reliable equipment, “so they’re not paying for unproductive manhours,” Brookhouse says.
- Technology: Ability to conduct business on the Internet; GPS-enabled delivery so contractors know when a piece of equipment will arrive; and equipment management software tools that allow contractors to locate equipment, track usage, monitor and allocate costs, minimize idle time and coordinate fueling.
- Product support: Safety training and certification; 24-hour service; financing assistance; technical support in the field and in the shop.
Specialization is key as well.
“Most rental companies are constantly investing in new fleets and a large variety of fleets,” Brookhouse says. “This allows contractors to get a piece of equipment that is expertly tailored to complete a specific job, and it’s more than likely they’ll get a newer piece of equipment than they own.”
Plus, contractors now can work more effectively with a single piece of equipment.
“Contractors used to have one piece of equipment they would find a way to use for everything,” Mavrick says. “Now, equipment has all sorts of attachments, so contractors can work more efficiently because they’re using a more efficient tool.”
Adds Cutliffe: “We’re all in this together. If we can keep customers going now, they’ll be better off on the other side.”
New England (Conn., Maine, Mass., N.H., R.I., Vt.)- Ten percent of contractors expect to buy new equipment, with an average budget of $140,000—about $30,000 below the national average.
- Contractors from this region are the least frequent renters of construction equipment.
Middle Atlantic (N.J., N.Y., Pa.)- One-third of contractors will buy used equipment—about twice as many as a year ago and well above the 26 percent national average.
East North Central (Ill., Ind., Mich., Ohio, Wis.)- Fewer contractors than the national average (14 percent versus 20 percent) will buy new equipment, but their budget for new equipment is $225,000 compared to the national average of $170,000.
- Nineteen percent of contractors will rent more equipment in 2009 than in 2008—about twice the national average.
West North Central (Iowa, Kan., Minn., Mo., Neb., N.D., S.D.)- Twenty-seven percent of contractors will buy new equipment—the largest percentage of any region.
- Almost half of contractors plan to increase the size of their rental fleet—the largest percentage of any region.
South Atlantic (Del., D.C., Fla., Ga., Md., N.C., S.C., Va., W.V.)- Sixteen percent of contractors plan to buy new equipment, spending an average of $66,000—well below the national average of $170,000.
- Fifty-six percent of contractors expect to increase the size of their equipment fleet, compared to 36 percent nationally.
East South Central (Ala., Ky., Miss., Tenn.)- A survey-high 15 percent of contractors expect to rent more equipment in 2009 than in 2008.
West South Central (Ark., La., Ok., Texas)- Contractors spend an average of $209,000 on equipment purchases—almost $40,000 above the national average.
- A survey-high 33 percent of distributors expect new equipment sales to increase 24 percent on average.
Mountain (Ariz., Colo., Idaho, Mt., Nev., N.M. Utah, Wyo.)- Contractors meet 13 percent of their needs with leased equipment—the highest of any region.
Pacific (Alaska, Calif., Hawaii, Ore., Wash.)- Seventeen percent of contractors plan to rent more equipment—about twice the national average.
- Fifty-four percent of contractors that will acquire new or used equipment this year plan to increase the size of their fleet, compared to the national average of 36 percent.
Source: Wells Fargo Construction Industry Forecast
The decision to lease or buy equipment depends on many variables and can change from year to year, as well as on an equipment-by-equipment basis. Whether it’s a general contractor that doesn’t require much equipment or a heavy/highway contractor with equipment-related costs that comprise up to 50 percent of the total job cost, a sound lease-versus-buy analysis is crucial to making a smart decision.
Leasing Advantages
• Lower down payments. Most lease contracts require little or no down payment. For a cash-strapped business, this may be the only viable financing choice.• More flexibility on monthly payment requirements. Often a lease can provide lower monthly payments, but the residual buyout provisions at the end of the lease term may be larger than with traditional financing.
• Keep bank lines open. Most banks maintain a credit limit for each borrower. Financing a piece of equipment with a bank loan could count against a contractor’s total credit availability. A lease from another financing source can allow a contractor to preserve its borrowing power.
• More favorable financial position. Because leased assets and their corresponding liabilities generally are accounted for on an “off balance sheet” basis, the lease may not count against a contractor’s overall debt position. (Recently, sureties have begun including operating leases in debt coverage ratios, so this may no longer be the advantage it once was.)
• Potential tax advantages. Depending on a contractor’s profitability, legal structure and the state in which it operates, leasing may provide tax advantages. (Recent bonus depreciation laws, however, have mitigated this advantage.)
Purchasing Advantages
• Lower interest rates. The difference between lease rates and borrowing rates can be significant. Banks typically charge lower rates of interest than leasing companies because banks assume lower levels of risk by requiring 20 percent to 30 percent down payments.
• Ability to depreciate the value of the asset. Particularly with increased Section 179 expensing and bonus depreciation, as allowed by the Internal Revenue Code, it is often possible to deduct 100 percent of certain assets in the year of purchase—even if the contractor has yet to make its first
payment.
• Asset control. As the owner of an asset, a contractor has more control in a purchase. This provides more flexibility if it decides to sell the asset before the finance term expires.
Other considerations beyond finances come into play. For instance, a contractor may be better served by a lease if it has a special need for a piece of equipment on a certain project, but cannot reasonably project its future needs. However, a contractor should strongly consider purchasing if it has developed a trend of buying equipment and keeping the utilization high.