Advantages and Disadvantages of Sale and Leaseback Financing

The term sale and leaseback is a transaction where the owner sells their asset to a person or a company and then leases it back immediately from the company or the person that bought it entering a long-term lease agreement. Using sales and leaseback frees up cash for the business, and it will help you measure the cost of financing, acquiring, disposing, and maintaining your assets more effectively. This is a strong alternative to conventional financing, and many companies, such as Skydan Equity Partners, offer this program. It can be beneficial for both buyer and the seller. The seller receives a lump sum of cash quickly, and the buyer acquires a lower-than-market-value purchase price along with a long-term lease at an attractive yield. It this post we will discuss all of the possible pros and cons of a sale and leaseback.

What companies or properties are good candidates for sale and leaseback financing?

  • Properties with single tenants
  • Property types such as office, retail, medical, and industrial
  • Companies with a long and provable operating history as well as a healthy balance sheet
  • Companies willing to enter into leases of at least ten years at the current market rate
  • Companies willing to enter a triple net lease and agree that the tenant will be responsible for any and all operating expenses
Source: Nareit

The advantages and disadvantages of Sales and Leaseback

There are several advantages and disadvantages to sale and leaseback deals. Consider them carefully to ensure you are making the correct decision for your business and commercial property.

Some of the seller advantages:

Converting equity into cash – With sale and leaseback financing, the seller regains the use of capital that would otherwise be tied up in property ownership. At the same time, the seller will retain possession and the continued use of the property during the lease term. Sellers typically receive much more cash with a sales and leaseback option than with conventional mortgage financing programs. Sale and leaseback transactions yield up to 100% of the real estate fair market value, compared to just 60% to 80% when using a typical outright sale.

A sales and leaseback are most advantageous where the property is sold at a small gain or a loss because capital gains tax is reducing the cash from the sale.

Source: Medium

The alternative to conventional financing – The seller can generally structure the initial lease term for a time that will meet its needs without the call provisions, the burden of balloon payments, refinancing, or some other issues of conventional financing. The seller would also avoid the substantial costs of traditional funding like the appraisal fees, points, and some legal fees. Also, the overall economic situation can restrict access to capital markets. This happened in the aftermath of the financial crisis where loans were issued more conservatively than before. It made sale and leaseback transactions a valuable alternative to the more expensive mezzanine financing due to not having a dilutive effect on the seller’s equity.

Improved credit standing and balance sheet – The seller replaces a fixed asset with a current asset. In case a lease is classified as operating, the seller’s rent obligation is typically disclosed in a footnote in the balance sheet. That will result in a seller’s current ratio increase, or the existing assets ratio to current liabilities. This usually serves as the indicator of a buyer’s ability to service his short-term debt obligations. The seller granted a lease will be able to amortize the proceeds from this transaction on their income statement boosting reported earnings, which can positively affect their financial ratios and margins as long as legal requirements and accounting practices concerning sale and leaseback transactions remain unchanged.

Source: The Balance

Premium pricing – Historical evidence shows that a real estate that is subject to sale and leaseback with a dependable rent rate can have up to 13% higher value compared to those that are not subjected to this transaction. This is due to the expected higher cash flow of such property because the long-term lease agreement works against the usual periodic vacancy due to tenant fluctuation, which is common in property markets.

Some of the buyer advantages:

A property tax structured sale and leaseback transaction will prove the buyer with plenty of benefits and advantages.

High return rate – The buyer will receive a higher return rate with sale and leaseback than with a conventional loan. Moreover, the buyer will have the ability to circumvent state usury laws that are limiting the interest rate charged with traditional financing.

Source: New Hampshire Review

Secure and predictable return rate – Long term net lease will enable the buyer to estimate the expected future return rate accurately. The extended term of the lease also provides the buyer with protection from downturns in an inflation hedge and the real estate market.

Avoiding usury problems – With this type of arrangement, the buyer will be able to prevent the state usury problems that are encountered by the lenders when money is tight. The seller and the buyer can establish any mutually agreed upon rent level.

The Disadvantages of Sale and Leaseback

One of the disadvantages is that you’re not the owner of an asset until you purchase it at the end of the lease. This is a minor and temporary disadvantage because you’ll still be having the benefit of using the asset.

Source: Savoy Stewart

A Sale and Leaseback can be a bit more complicated than a regular one. Depending on your situation, it may take a little bit more time to finalize the agreement. This is especially true if your bank has a General Security Agreement (GSA) over your company. That way, a sales and leaseback agreement will require a signed waiver from the bank.

In case you’re looking for a new source of cash, so you’re considering sales and leaseback financing options, it’s essential to take into account both advantages and disadvantages to determine whether it would work for your commercial property. It is also a good idea to examine other possible options, and avoid common pitfalls by consulting your commercial property agent and instructing the help of financial and legal advisors.