These are troubled economic times, and economic uncertainty is driving many strategic and operational decisions. In periods such as these, cash is a prized asset. Selling corporate assets, such as excess real estate, or selling and leasing back corporate real estate, can build liquidity. Investors and institutions seek out corporate real estate that is leased back to the seller - especially if the seller is credit-worthy. The seller can also create value for its own benefit and the buyer's by properly structuring the offering. These transactions can typically be completed quickly due to the attractiveness of the approach to the investors if cash is needed.
The Lease Statement
Deal structure matters in these transactions, and can create value. For the optimal outcome, the lease should span at least 10 years, as longer-term leases create more value. The lease rate should be below market value, as the buyer will discount a value higher than that, while a below-market value will be lost. Above-market values can hinder the buyer's ability to finance the transaction.
The lease should include rent increases of approximately 2 percent to 3 percent annually. Increases can be on a yearly basis or in five-year increments. Flat leases over the term negatively affect valuation. Structure the lease as triple net, with the tenant responsible for all expenses, particularly taxes, insurance, and operating expenses. To further increase value, the seller should consider assuming all capital expenses - roof and structure, for instance - especially for longer leases.
When an organization decides to sell a property, it should use an experienced corporate services and investment real estate broker to help develop and implement the disposition strategy. If that strategy has been well structured and the asking price is at market, the time to close the sale could be as fast as 90 days. An even shorter timeframe is possible if the seller is responsive to the buyer's needs.
Pros and Cons
Sale-leaseback transactions offer significant advantages to the seller's organization:
• Non-liquid assets become liquid cash.
• Cash replaces capital assets on the balance sheet.
• Any debt associated with the real estate is removed from the balance sheet.
• Debt-to-equity ratios improve.
• Lease payments are deductible as expenses.
But there are drawbacks. Generally accepted accounting principles require gains from a sale-leaseback transaction to be deferred from profit and amortized over the period of leaseback. Losses from these transactions must be recognized immediately. Proposed new accounting standards will require lessees to recognize future rent payments as liabilities. And there may be tax liabilities that reduce the sale's net proceeds.
Other negative effects could include the seller's loss of flexibility in the future use of the real estate sold and leased back. As a tenant, they commit to a site at the lease's cost and terms. The company may have to move when the lease expires, unless the lease addresses renewal options. The seller will face penalties if vacating early. And the building's future appreciation accrues to the buyer.
Buyers of corporate real estate assets have clear benefits:
• Predictable, long-term cash flow;
• Returns typically higher than bonds;
• Possible appreciation of value at roughly the rate of the lease increase;
• Low management requirements;
• Rent increases and appreciation that hedge against inflation;
• Some tax shelters from depreciation and other deductible expenses; and
• Positive leverage - especially in this period of high capitalization rates and low cost of debt - that can increase return.
Companies can leverage real estate as part of business strategy. They may develop new facilities for sale and leaseback themselves. Or they can use a joint venture partner to develop, sell, lease back, and share the profits, with the debt on the developer's balance sheet.
Owning real estate seldom offers a company the same returns as its core business. By selling real estate, a company can reduce debt, re-purchase stock, improve financial ratios and the balance sheet, and focus on its core business.
Companies should consider sale-leaseback of existing or planned facilities as a smart financial strategy in economically difficult times. Divesting real estate assets to create returns can ultimately help companies focus on what they do best.