ITRA Global News

Right Now Sale/Leaseback may be the Only Option to Obtain Cash and a Healthier Balance Sheet

October 12, 2009

At a time when banks are not lending, International Tenant Representative Alliance revisits the most efficient option for saving a balance sheet and raising cash.

According to Ronald Pollina, Ph.D., Principal of ITRA / Pollina Corporate Real Estate and Chairman of ITRA, the International Tenant Representative Alliance, if a company possesses a good credit rating, owns and occupies its office or industrial properties, it may benefit from a sale/leaseback transaction “especially given the current global economic malaise.”

The sale/leaseback solution allows a company to sell its property, and remove it from the books while avoiding the costs and disruption of moving while the long-term lease keeps occupancy costs under control.  Thus, a sale/leaseback transaction provides numerous benefits:

    Pollina states that "over the years, sale/leasebacks have helped many companies achieve liquidity, especially in times where credit is tight and cash is scarce."  Another benefit is enabling a company to get out of the commercial real estate business, which for many is a distraction, and allows greater focus on its core business area.

    So the next question is, "Who in these cash-starved times would buy a building and lease it back to a credit worthy tenant?"  Because they have a longer investment horizon than many other investors, the target buyers in a sales/leaseback transaction are pension funds, insurance companies, and other investment groups.  "Possessing cash and desiring a high-grade safe investment, these institutions will accept a lower return-on-investment in return for a low-risk investment," Pollina continues, "and your company's commercial real estate lease provides the target buyer steady cash flow and the long-term appreciation hedge that the property provides against inflation."

    Why would a company choose a sale/leaseback transaction?  Because a sale/leaseback can create increased productivity.  A critical question a corporation may ask is "Does the rent paid plus the loss of depreciation and residual value outweigh the advantages in receiving the net cash proceeds from the sale?"  Many corporations measure their productivity by calculating a return on assets, and a sale/leaseback transaction may allow a corporation to reduce the assets shown on its balance sheet.  A corporation's rate of return -- earnings divided by assets -- increases if the assets decline.  In addition, a sale/leaseback provides an opportunity to maintain operating control as if the company still owned the property.

    The stronger the credit of the seller-lessee and the better the property, the more negotiating leverage the seller-lessee has.  Part of the responsibility of a qualified tenant representative is to find target buyers based on the property and the seller-lessee's credit.  With this in mind, a broker considers buyer-lessors' three principal goals:

      Buyer-lessors want properties with strong residual value potential.  That is a wide range of appeal to many corporate-type users and located on very marketable sites.  Preference is given to freestanding single-user  property buyers will consider build-to-suits.

      Lease terms typically range from 10 - 15 years.  Most buyers prefer leases with increases in the rent ranging from 2 - 4% annually.  Most sale/leaseback transactions involve single-user buildings, pure triple-net leases, and are typically based on then-existing market capitalization rates.  While market cap rates may vary slightly at  any time, the cap rate for a specific transaction will depend on the size and type of the property, the location, and the financial strength of the tenant.  While many terms and conditions are negotiable, little flexibility may be found in meeting all the Financial Accounting Standards Board ("FASB") requirements to qualify as a sale/leaseback.  The further that either purchase price or rent gets from market realty, the greater will be the chance that the transaction will not meet generally accepted FASB principles as a sale/leaseback transaction and it instead would then be treated as a capital lease.

      Pollina provides an astute warning:  "Negotiators on both sides must be intimately familiar with the unique accounting requirements of a sale/leaseback transaction, and the complexities of sale/leaseback agreements.  Clearly because the seller-lessee will be entering into a long-term lease, it is essential that the knowledge of an International Tenant Representative Alliance negotiator be utilized for the creation of both the purchase contract and the lease.

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