An intriguing opportunity exists for businesses that own the real estate they occupy.
The weakened economy of the last several years has left many businesses seeking additional sources of financing for a myriad of uses ranging from acquisitions to operating capital. As of July, applications for commercial financing had reached the highest levels in three years. Although standards have been easing, this demand has largely been met by stricter requirements that have eliminated many prospective borrowers. Yet, businesses seeking capital may not have needed to look any further than their own building by using a strategy called a sale-leaseback.
In its most basic form, a sale-leaseback occurs when a company sells its real estate to an investor, who rents it back to the seller in return for monthly payments over the term of the lease. The amount of the payments and the term of the lease are both predetermined. In essence, it resembles a financing arrangement more than a real estate deal and offers several privileged benefits to the business.
The principle value of a sale-leaseback is the conversion of non-productive real estate equity into capital that can be invested into income producing assets or operations. However, several other benefits have been realized as a result of this type of transaction, including mitigation of risk related to declining real estate values, more favorable tax treatment, and an increased focus on core business activities rather than real estate management.
The day after the sale, the business operates exactly as before. Nothing about the building is physically changed. Customers will see nothing that indicates the building has been sold. The primary change occurs on the balance sheet.
Sale-leasebacks are not just a tool utilized in difficult economic or financial situations. It is a strategy that has been utilized in all environments by many major corporations as a way to free capital for more productive use. Many retailers, restaurants, and financial institutions that consumers use every day are not owned by the company with their name on the front of the building. In fact, many businesses of varying size no longer own the facilities that they occupy. Rather, they have chosen to reclaim the equity that exists by selling the real estate to an investor while retaining the use of the property.
Is a Sale-Leaseback for Your Business?
In order to determine if your business should consider a sale-leaseback transaction, you should review the following factors:
- Real estate should be a significant amount relative to total assets; the absolute size is unimportant;
- The potential GAAP and tax gains in the property;
- The need for additional liquidity to fund strategic initiatives;
- The desire of management to focus more attention on core operations.
There are other factors to consider, but if you answered “yes” to any of the above, you should seriously consider a sale-leaseback. It is important to note that the financial strength of the company and its perceived capacity to continue lease payments over the term of the lease are as important to potential purchasers as the anticipated return. Investors are willing and able to invest in properties with appropriate returns, but only if they believe the company is viable for the term of the lease. A negative perception regarding company strength will likely discourage investor interest.
If a business decides to move forward with a sale-leaseback, the deal must be properly structured to ensure both parties achieve the desired accounting and tax treatment. An experienced CPA is essential and the parties should be sure the transaction conforms to the definition of an operating lease as established by accounting standards. Potential participants should also be aware that draft language has been released that substantially alters accounting rules pertaining to sale-leaseback transactions.
Since this is a sale of the property, proper care must be taken before the transaction can take place. Environmental studies, title issues, and appraisals must be made available to eliminate any potential surprises. Both parties must do the same due diligence as they would in any sales transaction.
Businesses recognizing they can operate without owning, but rather controlling real estate through long-term leases have the opportunity to create a significant competitive advantage by allocating resources more effectively. If your business is tying up several hundred thousand dollars or more in real estate producing returns based on appreciation alone, it may worthwhile to rethink your strategy.
You May Also Be Interested In–
- Commercial Real Estate Market Reports | Local Information, Local Report, Updated Quarterly
- Resource Center | White Papers, Commercial Real Estate Tips, and Investment Information
- Search for Property | Search for Commercial Real Estate Throughout the Valley.
- About Tim Reamer | Your Position Will Always Be Informed and Well Represented
**Originally written for the Shenandoah Valley Business Journal Volume 11, No. 12 Sept. 2011.SHARE