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Types of Lease – Lease Financing | Financial Management

Types of Lease 

A lease is a contract between the owner of an asset (the lessor) and the user of the asset (the lessee),under the contract the lessor grants the lessee the right to use the assets for an agreed period of time and in return, the lessee agrees to make a series of periodic payments (or lease rent) the lessor.

Leasing Types

We can classify leases in a number of ways but some of the major types of leasing are as follow:

  • Operating Leases/Service Lease/Maintenance Lease
  • Financing Leases
  • Sale and Leaseback
  • Direct Lease
  • Leverages Leases/ Lease Lender

Types of Lease

Operating Leases/Service Lease/Maintenance Lease:

Operating Leases as a Types of Lease

➨ An operating lease is a lease contract relatively for short period of time. The term of this type of lease is shorter than the assets’ economic life.

➨ Generally, Operating lease is cancellable with proper notice, operating leases require the lessor to maintain and service the leased equipment, and the cost of the maintenance is included in the lease payment.


Company A, a retail business, decides to lease a fleet of delivery vehicles instead of purchasing them outright. They enter into an operating lease agreement with Company B, a leasing company specializing in vehicle leases. The terms of the lease agreement include:

  1. Lease Term: The lease is for a period of three years.
  2. Monthly Payments: Company A agrees to make monthly lease payments to Company B, covering the cost of using the vehicles.
  3. Maintenance and Insurance: Company A is responsible for maintaining and insuring the vehicles during the lease term.
  4. End-of-Lease Option: At the end of the three-year term, Company A can return the vehicles to Company B without any further obligations.

During the lease term, Company A records the monthly lease payments as operating expenses on its income statement. The leased vehicles do not appear on Company A’s balance sheet because it does not assume ownership.

Benefits of operating leases for Company A include flexibility, as it can update its vehicle fleet without a long-term commitment or the financial burden of purchasing the vehicles outright.

Additionally, since the assets are off the balance sheet, it may present a more favorable financial picture to investors and creditors.

This example illustrates the basic structure of an operating lease, where a company leases an asset for a specific period, makes regular payments, and returns the asset at the end of the lease term.

Financing Leases/Capital Lease:

Financing Leases as a Types of Lease

➨ A financing lease is a lease contract relatively for a long period of time. The lessee is obligated to make payments until the expiration of the lease contract.

➨ The expiration of the lease contract approaches the useful life of the asset.

➨ In other words, the total payments over the lease period are sufficient to amortize the original cost of assets and provide a return to the lessor.

➨ Some financial leases provide for a renewal or repurchase option at the end of the lease period.

➨ In the financial lease contract, the lessor does not provide for maintenance service.


Let’s say a small business wants to acquire a piece of machinery worth $50,000 but doesn’t have the upfront capital to purchase it outright. The business enters into a financing lease agreement with a leasing company.

  1. Lease Agreement: The leasing company agrees to purchase the machinery and leases it to the business for a fixed term, let’s say five years.
  2. Lease Payments: The business agrees to make monthly lease payments to the leasing company, which will cover the cost of the machinery plus interest. The total payments over the lease term might amount to $60,000, for instance.
  3. Ownership Transfer: At the end of the lease term, the business has the option to purchase the machinery for a nominal amount, often called the “residual value.” Let’s say the residual value is set at $5,000.
  4. Financial Implications: Throughout the lease term, the business records the lease payments as both an expense (for the usage of the machinery) and a liability (representing the obligation to make future lease payments).
  5. Ownership Transfer Decision: If the business decides to exercise the option to purchase the machinery at the end of the lease term by paying the residual value, it becomes the owner of the asset.

In this example, the financing lease allows the business to use the machinery without the need for a significant upfront payment.

At the same time, it provides the leasing company with a return on investment through lease payments and potentially a final buyout amount. Financing leases are often used for high-value assets like equipment, vehicles, or real estate.

Sale and Leaseback:

Sale and Leaseback as Types of Lease

➨ Sales and Leaseback is a lease contract where one sells an asset and leases it back for the long-term; therefore, one continues to be able to use the asset but no longer owns it.

➨ Under a sale and leaseback arrangement, a firm sells an asset to another party (prospective lessor) and this party immediately leases it back to the firm.

➨ In the transaction, the lessor normally pays a price close to the assets fair market value.

➨ The lease payments are set a level that will return the full purchase price of the assets to the lessor plus provide a reasonable rate of return.

For e.g. Insurance Companies, finance companies, and independent leasing companies, etc. are involved as lessor in sale and leaseback arrangement.

A leaseback arrangement is useful when companies need to untie the cash invested in an asset for other investments, but the asset is still needed in order to operate.

Leaseback deals can also provide the seller with additional tax deductions. The lessor benefits in that they will receive stable payments for a specified period of time.

Direct Lease:

Direct Lease as a Types of Lease

➨ A direct lease results when a lessor owns or acquires the assets that are leased to a given lessee. In other words, the lessee did not previously own the assets that it is leasing.

➨ The lessor may be the manufacturer of the assets, financial institution or professional lessor.

Example: Suppose you are a business owner looking to lease office space for your company. You find a suitable property owned by a landlord who is open to a direct lease.

After negotiating the terms and conditions, you and the landlord agree on the lease terms, including the monthly rent, lease duration, and any specific provisions related to the use of the space.

Once the agreement is reached, both parties sign a direct lease contract outlining the agreed-upon terms.

In this scenario, there is no involvement of a third party, such as a real estate agent or broker, making it a direct lease between you (the lessee) and the landlord (the lessor).

Leverages Leases/Lease lender:

Leverages Leases as a Types of Lease

➨ Leverage lease is a lease agreement that is partially financed by the lessor through a third-party financial institution.

➨ In a leveraged lease, the lending company holds the title to the leased asset, while the lessor creates the agreement with the lessee and collects the payment. The payments are then passed on to the lender.

➨ Leveraged Leases are popular especially in structuring leases of very expensive assets.


Triple net lease: Tenant pays all the expenses including real estate taxes, tax insurance, and maintenance.


  • Tamplin, T. (2023, September 8). Lease | Definition, Types, Components, & Analysis. Finance Strategists.
  • Team, C. (2023, November 29). Lease. Corporate Finance Institute.

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