Sale Leasebacks can be one of the most complex real estate transactions and are often misunderstood.  I have attempted to summarize what a sale leaseback is and its advantages and disadvantages in this Blog.  For more information download our Whitepaper on Sale Leaseback.

What is a Sale Leaseback?

In its purest form a Sale Leaseback is a financing tool. It is a way for a company with reasonably strong credit to free up capital invested (tied-up) in an owned operating property while continuing to be able to occupy and use the property. It is an alternative to mortgaging or selling a property allowing a company to get access to tied-up capital for alternative uses, usually to place elsewhere in their businesses.

Sale Leaseback transactions occur when an investor purchases a property, which is currently owned and occupied by a user.  At the time of the sale, the parties enter into an operating lease where the user becomes the Tenant of the property and leases it from the Investor, who has now become the Landlord.

This method of acquiring capital is often an attractive alternative to conventional financing which encumbers the real estate when listed on the balance sheet as a primary liability, whereas an operating lease can be indicated as a footnote. In many cases the cash raised from the Sale Leaseback transaction exceeds the book value of the asset being sold!

Typically, Sale Leasebacks are triple net leases with repair and replacement obligations for 10 years or more. Normally there are restrictions on the type of renovations that a tenant can undertake during the lease term. Depending on the type of asset, length of lease term, buyer’s perspective and other factors, these obligations can range from mundane to onerous.

There are numerous accounting and federal tax issues that must be considered in structuring a Sale Leaseback to assure for financial reporting purposes the leaseback will be an OPERATING (i.e. off balance sheet) lease as opposed to a CAPITAL lease. Generally, Sale Leasebacks are structured as operating leases and shown on the balance sheet only as a footnote.

Advantages of a Sale Leaseback to the Seller/User

• A non-liquid real estate asset is converted to cash.
• User retains control and utility of the property.
• User can effectively “depreciate” (i.e. write-off) the land involved as the lease payments cover the use of the land and building, and are tax deductible.
• If leasing back at the “right” rent with lower After Tax NPV, which can result in making a smart economic decision.
• Removes a capital asset from the balance sheet at book value and replaces it with cash realized from the sale.
• Improves cash position thus freeing up cash for other investments.

• Effects an attractive exit strategy for a user that may not otherwise be able to sell the real estate readily.

Disadvantages of a Sale Leaseback for the Seller/User

• Tax impact may be substantial if the property has been owned for a lengthy period and/or the book value is low compared to the selling value.
• Loss of flexibility to renovate or rehab the property as well as being locked into a lease at a specific location. Users may also lose the ability of retaining occupancy of the property at the end of its term as the investor may have other plans for the property. Subletting may be more difficult. Note: Most investors (buyers) in a Sale Leaseback require a minimum 10 year lease commitment.
• User can no longer include the real estate in the sale of its business and forfeits any future appreciation.
• P&L (Profit & Loss) cost typically is higher, thus impacting the earnings per share.
• EBITDA (Earnings before interest, taxes, depreciation, and amortization) may be lower since including rent in a leaseback whereas depreciation of an asset is not included in EBITDA.
• Risk factor at the end of the initial lease term similar to re-investment risk since the lease rate and term must be renegotiated.
• Possible reassessment of real estate taxes based on the sale price, which may be inflated due to the sale price. Note: In a Sale Leaseback, typically the NNN rent is directly related to the sale price.

Sale Leasebacks can be one of the most complex real estate transactions and are often misunderstood.  I have attempted to summarize what a sale leaseback is and its advantages and disadvantages in this Blog.  For more information download our Whitepaper on Sale Leaseback.

Lucernex also provides a product, Lx Leaseback, for sale leaseback analysis.