Local authorities have a range of options open to them to fund capital expenditure. Usually this will focus on the most appropriate source and type of borrowing, the most popular being the PWLB lending facility, offering loans of up to 50 years, or short-term borrowing from the LA-LA market.
That makes sense when considering the overall capital programme, but within this there are also opportunities to consider other ways to fund asset acquisition. Lease financing has always been a common option, especially for shorter life assets such as IT equipment and vehicles, but it has perhaps not been as popular in recent years compared to decades past.
Where there is a significant amount to be spent on these types of assets – an authority’s vehicle fleet being a prime example – it’s important to determine the optimal fund route and authorities should consider undertaking option appraisal analysis of borrowing versus leasing.
Many will be doing so already but one area where we think this analysis has become more interesting is for commercial electric vehicles (EVs). Councils are striving to meet carbon reduction or net zero targets and switching to EVs will play a role. In part, the opportunity lies in the potential second hand value of these assets – the ‘residual value’ (RV) of each vehicle - which represents a future cash flow back to the asset owner when considering the whole-life cost of funding. Until relatively recently, many lessors were reluctant to make RV investments in EVs, with uncertainties around secondary values and in a still-developing market. And while it remains a bit of a mixed picture, we have observed this approach changing and some lessors being comfortable financing these vehicles and taking on a residual value position.
This type of arrangement usually allows lower lease rentals to be offered and represents a transfer of risk – RV risk – to the lessor, as the asset can be returned to them by the lessee at the end of the agreed lease period, and the lessor then needs to sell it to recover their residual investment. Arlingclose has found, where lessors take on the RV risk, funding cost can be comparable to PWLB equivalents when factoring in the potential value of risk transfer.
The second-hand market for vehicles has been volatile in recent years, with prices high during the pandemic and something of an unwinding since (the UK inflation stats showing second-hand car prices fell for the seventh consecutive month and by 8.4% in the year to December 2023). Also given a rapidly changing vehicle technology market, we would judge uncertainty to be elevated. So it may be a reasonable time for authorities to consider whether leasing could offer more certainty.
There are of course other important factors, not least the risks associated with using leasing, which should be built into decision making. Arlingclose can help local authorities consider these and undertake option appraisal analysis to assist in determining the optimal funding solution for vehicles and other assets, which could include UK Infrastructure Bank funding. Please contact us for further information.