Sale Leaseback Transactions – How Corporate Real Estate Can Survive During the Pandemic and Future Years

Given the challenges of our current pandemic (since March 2020) it will be more important than ever for companies to find niches of opportunities to build on their real estate skills. Investment in real estate sale leasebacks could be the answer for some companies.

Leasebacks – A Popular Financing Vehicle Option

Leasebacks have been a popular financing vehicle for major corporations providing a more expedient and less costly method of obtaining capital in contrast to the more conventional and lengthy process of traditional real estate mortgage and bond financing techniques.

In a sale leaseback transaction, the property is sold for 100% of its full cash value. Simultaneous with the sale, a building is leased back to the seller under a long-term net lease, plus additional optional renewal periods. With this arrangement, a corporation can receive 100% financing at current market conditions.

This greater liquidity provides the corporation with a favorable debt to equity ratio, which results in lower debt to the company. The cash generated from the transaction can be applied to other options, such as corporate expansion and improvement on earnings. On the horizon, Owners/Tenants need to be aware of the new lease standard that all leases must be capitalized and placed on the books as well as the corresponding liability moving forward. This accounting procedure takes effect for years ending after December 15, 2022.

Sale leasebacks also provide operational flexibility. For example, a tenant can sublease any portion of the property and retain any all profits from the subleases, substantially lowering its occupancy costs. The tenant is also able to budget occupancy costs by knowing the fixed increases each year for inflation.

Other, Less Obvious, Considerations

On the other hand, the seller realizes business, legal and tax advantages through the sale leaseback transaction. First and foremost, the sale leaseback creates monetary value on an essentially illiquid, nonearning real estate asset. Even if residual upside caused by inflation or real growth is assumed as earnings, these earnings should be less than the company’s return on equity. If it is not, the company should cease their building operations and become a real estate holding company.

Along the same lines, the stock market has never been able to properly value real estate rich companies. Even if the company has excellent real estate that has realized significant appreciation, it is more likely the stock market has not monetized this value. Second and perhaps more important, the real estate sale leaseback may be the only form of protection for lease provisions. The Seller has the same assurance of occupancy for the term of the lease in the property as if they still owned the property. This fixed rental, permits payment of rent in devalued dollars, in the event inflation increases.

It is important for the investor to purchase the asset for an amount as close to fair market value as possible. Since most income producing property is acquired using the income approach, it is critical the rent is at market or, even better, less than market. Buying the property on this method ensures a fair market value for the lessee, but limits exposure to the buyer. Here is a good rule to follow: The riskier you perceive the transaction to be, the more generic the use of the realty must be. Properties viewed as ideal sale Leasebacks are a company’s corporate headquarters (office), a data center operation or distribution/warehousing facilities.

So, What Are the Advantages vs. Disadvantages of Acquiring and Retaining Ownership in Real Estate

ADVANTAGES
  • Cost recovery is realized through depreciation, if accelerated methods are used, depreciation is generally subject to recapture when property is sold.
  • Interest payments are tax deductible.
  • Appreciation escalates as a result of supply, demand and inflation factors
  • There is personal freedom to sell, mortgage, refinance or improve the property.
DISADVANTAGES
  • The equity invested in real estate is not available for other business purposes.
  • There is a reduction in the amount of borrowing capability by the amount of debt encumbering the property.
  • Depreciation benefits are exhausted after 39 years on commercial property.
  • Special attention is required to operate as a separate business, for example property management functions.

In summary, for companies to keep pace with today’s environment, the sale leaseback concept should be considered during the times where real estate is corporately owned. Real estate can be a liquid asset that can become a substantial source of cash for many firms. These transactions will provide excellent financial and operational benefits to corporate tenants who have limited financing alternatives, yet provide favorable rewards to the investor.

If you need more advice on how a sale leaseback might benefit your corporation, contact Verity to speak with an experienced real estate advisor.

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