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Will a Rise in Rental Prices Be a Driver of Sales? 

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With optimism at a 20-year high, it would be easy to read the headline from the 42nd annual Wells Fargo Construction Industry Forecast, agree that the industry is looking good, and move on to other things. However, there is more to examine. What are your customers and competitors telling you about their intentions as they relate to rental activity?
 
Let’s start with your competitors: More than half say they will increase the size of their rental fleets this year, which has been occurring for years, if not decades, except for the period of the Great Recession.

Following several years of distributors and rental companies planning to increase their fleets, just over half (55 percent) plan to add to their rental fleet availability, and another 38 percent indicate they will maintain the size of their existing fleet. Only 7 percent intend to shrink the size of their fleet. 
 
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Does this mean there will be an oversupply of equipment available for rent, driving prices down? Don’t bet on it.

At the time of the survey, 65 percent of distributors were currently renting more equipment heading into 2018 than they were the prior year. We noted at the time that this was a rebound from the previous year. In addition, there is a robust amount of construction activity creating more demand this year. On the non-scientific side, the distributors we speak to across the country indicate that rental activity in the first five months of the year was strong, and in some cases, demand exceeded availability for certain asset types – and this is with significant weather issues in many parts of the country. The same dealers report that there has not been a significant increase yet in rental rates across the industry. 

Is this the year the industry will see a general increase in rates, and what would the impact be? The answer is complex and depends on a variety of factors, but as any market observer knows, price is dictated by three key components: 

Base cost

We know that the price of modern construction equipment continues to increase, and with the recent activity relating to steel tariffs, products might very well get more expensive still. 

Cost to carry the product

Two major components of carrying-cost continue to rise. The first is the cost of skilled labor to service and maintain the equipment. The shortage of technicians and mechanics is well documented. There aren’t enough people to do the work, and those who are available are paid handsomely for their skills.

The other cost that hasn’t received as much attention is the cost of interest to carry a large rental fleet. The industry has enjoyed years of historically low interest costs. Many rental fleets are funded with borrowed money, and a large portion of the borrowed money is repaid with interest based on a floating rate, mostly 30-day LIBOR-based. If you haven’t followed this index lately, as of this writing, the 30-day LIBOR is up 92 basis points in the past year and 59 basis points in the past six months. This means a typical rental unit costing $100,000 will cost $920 more per year to carry than it did a year ago. Is this significant? Assuming 80 percent utilization to maintain the same profit margin, the company carrying that unit will need to charge almost $100 per month more for that unit. Depending on how the rental rate is set, that increase alone could be between 2 percent and 3.5 percent monthly. 

Availability versus demand

Some manufacturers are reporting difficulty keeping up with orders, and this is confirmed by distributors and rental companies. While there is intention to increase the general size of the rental fleets, the ability to do so may be limited by availability from factories.  
 
Let’s talk about your customers. They are the end users of construction equipment. You know who they are. You know they are busy. You know they are working. In the Construction Industry Forecast, they told us that they are generally optimistic, which means they will likely need to use more construction equipment. Rentals have become an increasingly important component of their equipment fleet management strategy. 
 
Approximately four out of five end users surveyed said they rented equipment in 2017 and intended to continue. The top reasons for renting are flexibility to return and the availability to obtain what they need and when they need it. Only 4 percent indicated that they rent due to low rental rates. 
 
We also asked respondents what would happen if rental rates were to increase this year, and they answered definitively. More than one in four (26 percent) said that even a small increase of less than 5 percent would make them consider buying instead of renting. Another 37 percent said that an increase between 5 percent and 15 percent would make them consider buying. These are not insignificant numbers when you consider the other factors we’ve already discussed: equipment costs are increasing, carrying costs are increasing, availability in some cases is limited, and demand is increasing. 
 
The factors that would reasonably lead to an increase in the rental rates charged to the end users are in place. The suppliers of rental equipment will make decisions on whether or not their cost increases should be incorporated into the rates. If it happens, the decision point will be put to the end users, who – if they act as they said they would – may very well buy at higher levels than in previous years. 
 
About John Crum

John Crum has worked in the construction equipment finance industry for the past 28 years, holding a variety of positions in sales and credit management. He joined Wells Fargo Equipment Finance in May 2006 and currently serves as national sales manager of its Construction Group, overseeing originations activities in the U.S. To contact John, email him at John.D.Crum@wellsfargo.com. 
 

About Wells Fargo Equipment Finance

Wells Fargo Equipment Finance provides competitive fixed- and floating-rate loans and leases covering a full range of commercial equipment for businesses nationwide as well as floor planning and inventory financing, and vendor programs in selected industries in the United States and Canada. Wells Fargo Equipment Finance is a leading bank-affiliated equipment leasing and finance business in the United States by asset portfolio and annual originations, with more than 335,000 customers and 2,500 team members. Wells Fargo Equipment Finance is the trade name of the equipment finance businesses of Wells Fargo Bank, N.A., and its subsidiaries. Canadian business is transacted by Wells Fargo Equipment Finance Company.

The opinions expressed in this document are general in nature and not intended to provide specific advice or recommendations for any individual or association. Contact your banker, attorney, accountant or tax advisor with regard to your individual situation. The opinions of the author do not necessarily reflect those of Wells Fargo Equipment Finance or any other Wells Fargo entity. 
 

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