As more and more companies and individuals feel the pain of the worldwide economic slowdown there seems to be a little more interest in the field of sale and leaseback agreements. We will try to clarify exactly what they are, how they can benefit you and the drawbacks.
What is a sale and leaseback?
A sale and leaseback is fairly simple in principle but can be a little more complicated in practice because of a variety of issues. However, in essence the owner of a property would sell to a third party and then arrange a long term lease so that they could use the property, after paying an agreed rent, for an agreed period of time.
This type of transaction became very common in the 1980s and has actually increased in popularity over the last decade. While they are most common in the business arena they do happen in the residential market although not to the same extent.
In order to transact a sale and leaseback the owner would need to value their property and try to make the offer of a purchase and guaranteed lease income as attractive as possible. There would need to be terms as to how the property could be used, who would cover certain elements of cost and also a formulae to use for future rent reviews. All very simple until you then start to look at the positive and negative aspects of a sale and leaseback for those in business :-
Positive aspects of a sale and leaseback agreement
While there may be a number of reasons why someone would look to arrange a sale and leaseback, the more common benefits are :-
Elimination of debt
Over the last few months we have seen more and more business struggling to make ends meet with balance sheets coming under more and more pressure. A sale and leaseback arrangement would bring in a large injection of capital which could be used to repay any debts and give the company a safety net if business levels were to fall even further.
Security of the premises
The very fact that when completing a sale and leaseback you would arrange a long term lease on the property you are in fact guaranteeing that the premises will be available for the sole use of the business for a defined period of time.
While the long term returns on property have been impressive in many parts of the world, property is an asset which normally performs better in the longer term. However, if you were faced with the opportunity of an attractive investment which could create a better return on capital than the property in question, this can often see many people moving towards a sale and leaseback agreement to raise funds.
As we have seen in property markets all over the world there are times when property prices can push too far ahead in the short term and lose touch with reality a little. Many businesses which own their own properties have taken advantage of these market conditions to guarantee a good return for the asset as well as agreeing a long term lease. In these conditions you need to ensure that the lease valuation is not over valued as you could be there for a long time.
Exchange an asset for cash
While this seems a very straight forward comment, there are many companies which will have property on their balance sheet at a price which may be well out of date. The sale and leaseback of the property will allow this asset to be re-valued and liquidated for the long term benefit of a company’s balance sheet and hopefully the operation.
When you own a property there will be a number of costs attached to that asset which you will have to pay on an ongoing basis. However, a sale and leaseback agreement will transfer all of these obligations to the landlord and the business can then offset the rent as an ongoing business expense.
Negative aspects of a sale and leaseback agreement
While the positives out number the negatives there are still certain issues which nee to be considered when looking to sign a sale and leaseback agreement. These include :-
Loss of future gain on asset
While there is never any guarantee that the value of property will appreciate in the long term , by signing a sale and leaseback agreement you are selling the property with no recourse to any future increase in its value. Indeed depending upon the price you paid for the property, indexation and allowances, etc there might be capital gains tax to pay on the asset sale.
The paperwork for a sale and leaseback arrangement can often be complex as there is a need to ensure that both parties get something out of the deal and that these terms are secure in the eyes of the law. This can take time and money with lawyers and accountants possibly involved in considering the arrangement and getting the paperwork together.
Eviction from property
After you have sold your property and signed your lease, you may actually be moved out of the property when the lease expires. Even though this will be years away when you sign the agreement it is something which you need to consider very carefully – moving your business to a new premises can be challenging and often costly.
There may be other positives and negatives associated with individual sale and leaseback agreements but we have covered the more common issues above. It does not matter how you wrap up the arrangement many people consider sale and leaseback agreements to be short tern gain and possibly long term pain although this does depend on the background to each deal. The gain is the injection of cash and the pain is the legally binding lease which is an ongoing cost for a business.
The key to being a successful investor is not only to make the right decisions but to use your asset as well as you can. For the purchasing party to a sale and leaseback they have a property with growth potential and a long term income stream from the lease, for the selling side they can liquidate an asset and still retain long term use via the lease.