Sale Leasebacks May Be ReturningEric Odum MIBS
September 29, 2008 — 1,906 views
Sale Leasebacks May Be Returning
In a sale-leaseback, a business can sell real estate they own and then rent the property back from the investor/buyer under a long-term net lease, which term usually runs for 15 or 20 years plus extensions and options. Sale-leasebacks can be as short as a 5 year term, as well. Real estate can make up a large portion of a company's asset base, which is particularly true in small businesses. The economic climate right now is such that traditional sources of capital have become more difficult and expensive to obtain now. Many private and public companies are focusing on their asset base and cost of capital trying to figure out the best strategy for their growth and expansion.
With tight credit markets sale-leasebacks can be a viable option for sourcing capital. Equity from the sale frees up capital for re-investment for business expansion and growth and repayment of debt. A sale-leaseback could offer added financing flexibility with a large institutional buyer that is willing to negotiate and has access to superior finance terms. Additionally, the seller can relieve themselves of burdensome balloon structures and call provisions that typically accompany real estate loans. Another reason, sale-leasebacks could be beneficial for businesses is because they can provide an exit strategy in an individually or family owned business, by separating a significant asset (the real estate) from the balance sheet and making the business more saleable down the road. In many cases, removing the real estate and accompanying debt can improve the company's balance sheet and improve credit standing.
Besides providing a source of capital, sale-leasebacks can also offer some distinct tax advantages to business owners due to the difference in categorizing payments of debt versus lease payments. The business in a sale-leaseback reports lease payments as a fully deductible expense. With conventional mortgage financing, a borrower deducts interest and depreciation only, and not the amount that represents the repayment of principal.
Other Tax Considerations
Depending on how long the property has been owned, the seller in all likelihood will be giving up the depreciation write off.
Timing Gain and Loss Recognition
A seller can use the sale to off set gains and losses, while retaining use of the property. Selling the property at a gain, can be used to offset annual losses or carry-forwards. Likewise, if the property is sold at a loss, this can be used to reduce tax liability.
In all probability, the recapture of past deductions, such as depreciation, will trigger a tax liability for the seller and should be considered in the decision process.
Risks for Sellers to Consider
Of course like everything else there are some risks associated with sale-leasebacks. Businesses principals have to be careful who they do a sale-leaseback transaction with and how they structure the deal. Structuring deals at less than arm's length (with related entities or family members), can draw unwanted attention from the IRS. For public companies, structuring deals for the sole purpose of inflating profits will draw ire from the SEC. Businesses facing operational cash flow challenges should think twice before doing a sale-leaseback. Chances are the new lease payments will be higher than the mortgage payments, placing additional stress on cash flow, if the cash retained from the sale is to be immediately invested back into other areas of need for the company.Undoubtedly, their will be a loss in flexibility associated with change in property ownership. This could be an issue in the event that the business needs to relocate closer to a large customer or if improvements need to be made to the property.It should also be noted that in the event of buyer bankruptcy, the trustee in the bankruptcy may reject lease renewals or additional options.
An example of how sale-leasebacks are working in the marketplace is The Investment firm of W. P. Carey & Co. LLC's (NYSE: WPC) $28 million dollar sale -leaseback financing deal with Sabre Industries, Inc. , whereby W.P. Carey & Co. LLC acquired two of Sabre's key industrial facilities in Alvarado, Texas and Bossier City Louisiana. Chad F. Edmonson, Director of W. P. Carey & Co. LLC. stated that "With the acquisition of two of Sabre's key facilities, we have been able to provide the funds necessary to recapitalize their balance sheet and grow their business. At a time when capital is extremely difficult to find, we are pleased to continue to partner with strong firms like Sabre by providing resources to support their ongoing growth initiatives and longer term business plans."
In summary, while there are lots of factors to consider before engaging in a sale-leaseback arrangement, the structure is one that should be considered in the current tight credit market that we find ourselves. More companies will look to sale-leasebacks to unlock hidden dollars on the balance sheet and provide themselves access to capital that might otherwise be currently restricted. For profitable businesses, those seeking additional cash or those looking to offset income statement activity, sale leasebacks can offer an attractive solution.
Eric Odum MIBS
Triple Net Lease Real Estate
Eric Odum is a veteran in the real estate and financial services industry with over 13 years of experience. Mr. Odum holds a Masters in International Business in Finance from the University of South Carolina (consistently ranked as one of the top International Business Schools by US News and World report).