Lease rental discounting (LRD) has emerged as an innovative funding tool that allows businesses to raise working capital against their leased rental receivables. By availing LRD, companies can get immediate access to a large lump sum of capital to fund growth plans or working capital needs. The loan provider advances funds based on the discounted value of future rental income and collects rent directly from tenants as per the lease agreement.
However, applicants should avoid some common mistakes when opting for funding through LRD to ensure that it remains a viable long-term financing option.
How to Avoid Lease Rental Discounting Mistakes
Below are some of the common LRD errors that you should avoid before taking a lease rental discount:
1. Not Understanding LRD Fully
One of the biggest LRD mistakes to avoid that applicants make is not developing a comprehensive understanding of the LRD process before signing the agreement. They need to understand key aspects such as:
● Discount rate: The rate at which future rental income is discounted to arrive at the loan amount. Opting for very high discount rates can reduce loan eligibility.
● Risks: Potential lease rental discounting risks, such as tenant vacating premises or rental default, which can impact loan repayment.
● Charges: Administrative fees, legal charges, valuation charges etc levied by loan providers.
Clarity on all key aspects ensures applicants make informed financing decisions that meet their capital needs without adverse financial implications.
2. Overestimating Rental Income Projections
In their enthusiasm to achieve maximum loan eligibility, some applicants overestimate the rental income potential of their leased property. They exaggerate income estimates in the documents, which causes problems later.
If the actual rent received post-disbursement is lower than the estimated figure, it falls short of the loan repayment instalments. This gives rise to the risk of default to the loan provider. Applicants should be realistic with their rental income projections and provide authentic rent agreements as proof to get their LRD applications approved.
3. Not Accounting for Income Fluctuations
Leased property rentals are seldom stable and predictable over long durations. Tenants may terminate leases prematurely, rents may need downward revision upon lease renewal, or the property may require major repairs that impact rentals. By not accounting for such uncertainties in projections, applicants can end up in trouble later.
It is wise to keep some extra money by not borrowing the maximum loan amount allowed under LRD. Smaller loan repayments help protect against possible drops in rental income.
4. Multiple LRD Against the Same Property
Disclose all existing loans on the property to lenders to maintain transparency and avoid legal or financial issues. If loan providers discover this aspect later, it can lead to legal LRD loan issues, higher interest rates, default risks and delayed funding.
Applicants should always provide complete information on prior funding availed against the property for the proposed LRD. Seeking multiple LRDs by keeping financiers unaware raises transparency concerns and amounts to unethical financial conduct.
5. Not Checking Loan Provider Credentials
While the urgent need for capital may prompt quick LRD decisions, applicants should not fail to run a thorough check on the loan provider’s credentials and stability. Opting for LRD from new, unknown financiers without carefully researching their financial position, lending policies, interest rates, and track record can be risky.
If the loan provider runs into financial difficulties or closes down later, it can abruptly stop future rent transfers, leading to cash flow issues and the applicant's default. Checking credentials beforehand provides more prudent options.
6. Not Reading Term Sheet/Agreements
Once the LRD eligibility amount is decided, loan providers present a detailed term sheet and legal agreements for review and signature. In their hurry to obtain funds, many applicants neglect to read these documents diligently. This can result in unpleasant surprises later regarding interest payouts, repayment schedules, fee structures, etc.
Carefully review all loan documents as well as the agreements to fully understand terms, fees, and obligations before signing. This prevents them from becoming ensnared in difficult financing terms due to oversight or ignorance.
Conclusion
Lease rental discounting allows companies to get funds by using the rental income from their leased properties without selling them. However, applicants should avoid the above common mistakes in lease rental discounting to ensure LRD remains a viable, long-term funding option. Avoiding overestimation of rentals, accounting for uncertainties, checking credentials thoroughly, and reading agreements carefully is crucial for a smooth LRD process. Following prudent practices makes LRD mutually beneficial for both applicants and financiers.
Businesses should consider various working capital financing options with flexible terms to support their operational and growth needs.
