In essence, a sale-leaseback is an alternate type of financing tool for firms that may otherwise have difficulty accessing standard credit markets. It allows a company to reallocate its capital by transforming a real asset into available cash without any significant disruption to the firm’s ordinary business model.
This method of acquiring capital is often an attractive alternative to conventional financing. Traditional mortgage financing encumbers the real estate and establishes a primary liability on the firm’s balance sheet. A sale leaseback Financing structure can be structured as an operating lease and merely indicated as a footnote on a corporate balance sheet rather than as a primary liability. Additionally, the seller (or would-be borrower) thwarts any legal restrictions or covenants ordinarily imposed through traditional debt financing.
From a financial perspective, because of the increased security required by institutional lenders, the financial tax benefits of depreciation to a new owner (which may offset required rental rates), and the potential for appreciation in the value of the property, a user’s cost of a mortgage borrowing will exceed the rent that an investor/purchaser will require.
Further, the selling organization realizes 100% of its tied up capital (less capital gains tax which can be sheltered separately) – not a 75% or 80% portion as would be the case through more typical financing models. is realized, and the operating lease may not have costs associated with corporate or personal credit worthiness. Although the additional capital and cost reduction from a Sale Leaseback can be used to grow a business, the financial appeal of a Sale Leaseback is balanced and heavily weighed against strategic and operating considerations.
Managing questions to be considered before entering a Sale Leaseback are numerous and range from the quality of a building’s infrastructure to the value provided by the surrounding neighborhoods. If any of these issues are at risk to be inadequate, the liquidating firm must question the impact of that factor on the desired lease conditions associated with the Sale Leaseback.
What is the anticipated use of the proceeds from the sale, and in turn, what will the projected return on that money be irrespective of the source of that money?
How to create an "apples-to-apples" comparison;What kinds of costs should be compared to various scenarios (e.g., image, goodwill, pure profit, etc.);What numbers need to be examined – Is it all about IRR or corporate longevity of assets?Sale Leaseback accounting under GAAP;How to factor in "opportunity cost " vs. income derived from the sale;
Other Issues for the Seller/Tenant to consider:
What is the term to be found?Is there a viable alternate location today and if so, what is the value of the building today on the open market if vacant? What does the financial comparison of stay vs. relocate into an owned or leased location now indicate?How much free cash can be leveraged against the property today and at what interest rate for a term similar to the possible leaseback?Will conventional financing impact the creditworthiness of the corporation or any of its principles?Will the lease be NNN or a hybrid? How reliable are maintenance costs on the building?Will the Landlord or Tenant be entitled to the depreciation expenses incurred on future building improvements?
Critical Financial Metric for Sale-Leaseback:
The Net Present Value (NPV) before and after taxes is probably the best single item comparison metric to review if considering a sale-leaseback transaction. It serves to adequately assess the sensitivity of the price points since it takes into account the time value of money, thus adjusting for a high building sale value used at the end of the analysis period when comparing various financing alternatives.
Example of Sale-Leaseback Valuation:
In the illustrative figures above, the Net Present Value indicates that the Sale Leaseback, combined with the acquisition of the new business represents a beneficial financial scenario for the firm, it is critical to breaking down the contributing factors of this Net Present Value calculation.
Although management indicates that the new acquisition is predicted to provide a 24% return on investment, is this a sustainable rate of performance? Although the calculation above only utilizes a three-year performance cycle, if a 24% annual gain is sustained over the anticipated 20-year holding period, the numbers become exponentially for the new business venture.
Additional factors such as lease rate, NNN reimbursements, depreciable basis, asset decision-making ability, etc. should be considered before entering into the Sale Leaseback scenario. Businesses contemplating a sale leaseback transaction should not do so based solely on the Net Present Value calculations.
Ideally, the firm would retain full ownership of the building and utilize a more traditional mortgage financing alternative to engaging in the new business venture. However, if a choice to retain ownership of the building is directly weighed against the acquisition of the new business, and if the business reliably predicts future returns, then Management should pursue the alternative financing structure provided to the company via a sale-leaseback structure.
Got it? If not, contact Brad Kuskin and he’ll gladly walk you through the intricacies and considerations of a sale leaseback transaction….or he will find you a buyer through the KW CRECO Network.