Lease Rental Discounting: Meaning, Process & LRD Loan Benefits

Businesses need large capital reserves for smooth operations – to purchase assets, meet working capital needs, manage cash flow, or expand the business. However, limited cash reserves or longer sales cycles can put a strain on your finances. And you end up looking for an alternative source of finances.

Here, if you own a commercial property, you have the opportunity to monetise the rents received on this property through lease rental discounting. Lease Rental Discounting is a tool to secure a term loan using the rental receipts as collateral. It is a lucrative option for small businesses to fund their capital investments or fulfil their working capital requirements.

How Lease Rental Discounting Works (Process & Example)

Lease rental discounting is the consideration between the borrower who owns the property, the tenant who leases the property, and the financial institution. The owner uses the monthly rent receipts drawn from the lease as collateral for the loan. And the lender evaluates the long-term cash flow of the borrower and sanctions an LRD-based loan for the amount.

In other words, the lender “purchases” the rent receivables from the borrower and sanctions a loan amount after deducting the time value of money. The loan is payable to the lender by the rents promised – which the tenants directly deposit with the lender and not the borrower/lessor.

Lease rental discounting is a profitable financial alternative to explore if you want to quickly meet your business’s short-term financial needs.

Lease Rental Discounting Example: Step-by-Step Case

Here, we’ll walk through a lease rental discounting example. 

Assume the owner of a commercial property, leases it to a tenant. There is an 8-year agreement, with ₹3 lakh per month as rent. The long-term lease and rent make the property suitable for lease rental discounting.

The owner approaches a bank, which assesses the lease tenure, tenant credibility, and rental stability. 

Over eight years, total rental income comes to ₹2.88 crore (₹3 lakh × 12 months × 8 years).If the bank offers financing (at a 70% loan-to-value ratio) the eligible loan amount would be approximately ₹2.01 crore. The tenant’s rent is credited to the bank account, from which EMIs are deducted, enabling the lease rental discounting loan.

Key Features of Lease Rental Discounting (LRD) Loans

1. Agreement among three parties

Under lease rental discounting, the loan is not secured by the property but by the expected rental cash flow. The lender agrees to offer a discounted amount of the rent receivables as a loan to the borrower. And the tenant signs the rental agreement with the lender, agreeing to make the rental payments directly to them once the deal is in force.

This agreement streamlines the loan process as the rent is transferred to the lender directly as EMIs against the loan repayment. 

2. Competitive interest rates

In most cases, the lender extends lease rental discounting on rented commercial or industrial properties. Since the returns from these sources are quite high, businesses can secure affordable loans at competitive interest rates.

3. Dual use of property

Lease rental discounting enables owners to use their property more effectively. Business owners have the opportunity to secure a loan against the property and, at the same time, leverage the rental cash flow to acquire another loan – thus, enhancing their liquidity.

4. Balanced cash-flow

Most lenders offer extended loan tenures to cover the higher loan amount. The regular rental income repays the loan in the form of EMIs, and the business owner does not have to worry about the repayment. This ensures a balanced cash flow for the business.

Types of Properties Eligible for LRD Loan in India

Lease rental discounting is generally offered on properties that earn regular and stable rental income. Banks will first evaluate the property’s value, location, and lease terms before approving the loan.

Here are the properties eligible for lease rental discounting loans:

• Commercial properties: These include offices, retail spaces, malls, and warehouses.
• Residential properties: These include flats or villas. They can qualify if the properties are rented to financially stable tenants with valid agreements. 
• Industrial properties: Industrial properties generating steady rent, or those leased to corporate or government bodies are preferred.

What can increase chances of lease rental discounting loan approval? Prime locations, long-term leases, and clear ownership documents improve approval chances.

Eligibility & Pre-Requisites For Lease Rental Discounting Loan

In this section, we will discuss what is lease rental discounting’s eligibility criteria.

1. Corporate tenants

As lenders use the future cash flow estimates to sanction a loan today, lease rental discounting is only valuable where the cash flow is certain. As a result, lenders approve a loan against rent receivables where the tenants are financially sound to meet the rental obligations.

2. Longer lease term

Lessors can avail of lease rental discounting against a property with a longer lease tenure. Since LRD is a high-financing option with longer repayment tenure, lenders don’t offer short-term discounting on lease rentals. 

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Benefits & Use Cases: When To Use Lease Rental Discounting

Since LRD is a multipurpose loan, the funds can be used for any productive purpose.

• Business Expansion

A long against rent receivables is an ideal option when the lessor is looking to lower their personal expenditure when investing in more properties. Property owners can use the funds to grow their business of any kind. This gives them the advantage of meeting their business needs without straining their finances.

• Repayment of loans

Property owners can easily leverage these funds to refinance or repay their existing debts. With longer repayment tenure and attractive interest rates, lease rental discounting becomes an affordable choice to repay high-interest loans easily.

• Purchase new property

Lease rental discounting is an attractive financial option for borrowers whose primary income source is rental payments. So, to enhance their portfolio and generate additional sources of rental income, the lessor can purchase a new property with these funds.

Moreover, with an LRD-based loan, the existing property becomes a source of loan repayment as the lessor need not pay EMIs from his pocket. This is an intelligent way to expand a rental business.

Risks & Key Considerations with Lease Rental Discounting

When considering lease rental discounting, borrowers should carefully evaluate some of the risks:

• Since loan repayment depends on tenant payments, any delay or default can disrupt the repayments. It’s necessary to have a reliable tenant who pays rent on time.
• Another concern is fluctuation in interest rates, which can also impact repayments.
• Pre-closure penalties may apply if the lease ends or if the loan is repaid early. This ultimately increases overall costs.
• Changes in rental amounts during the loan tenure can affect cash flows.

Borrowers should understand what is lease rental discounting, look for reliable tenants, and assess lease stability before choosing a lease rental discounting loan.  

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Documents Required for Lease Rental Discounting Loan

When applying for a lease rental discounting loan, lenders will look for the following documents:

1. Property Documents: Title deed, previous sale deed, property tax receipts, and municipal approvals to confirm legal ownership.
2. Lease Agreement: A registered lease covering the loan tenure, including rent, lock-in period, and other terms.
3. Financial Documents: Income tax returns, bank statements, and profit and loss statements to evaluate repayment capacity.
4. Credit Check: Credit score and credit report from agencies such as CIBIL to assess repayment history.
5. KYC Documents: PAN card, identity proof, address proof, and recent passport-sized photographs to meet KYC requirements.

Conclusion

Lease rental discounting helps you make the most of your rental income and is an efficient tool for companies to navigate any financial requirement. Get in touch with experts at Tata Capital for further guidance on loan tenure, interest rates, and more!