Sale and leaseback can unlock opportunity

According to Henry Hollingdrake, it can create new on-hand cash, and by making the lease terms long enough, and due to tax deductibility, the property can amortize over the life of the lease, while providing the business with the capacity to retire debt, for example.

Sale-Leaseback structures can also allow for flexibility in structuring and thus present a number of options to both seller and investor.

Examples of different options in structuring these transactions are; offering a Joint Venture type involvement allowing the seller to perhaps share in a certain predetermined percentage capital growth gain in value, or structure buy-back options on certain pre-determined conditions. Investors can also provide themselves with certain down- side protection; these options are not exhaustive and can be used in combination with each other.

In terms of cash flow processing, a sale and leaseback provides around 80% to 100% financing to the business owner doing the sale, for the purchaser/investor, the property with the long-term lease mean that there is a solid revenue stream. Depending on the local commercial real estate market, the sale-leaseback situation can multiply equity by up to 3 to 5 times, if business has grown around the area of your physical facility. The lease agreement that is structured, should ideally be structured as an operating lease, this helps the utilization of the lease to retire long term and short term debt tied to the property as well as, if possible, other corporate debt, and removes the asset from the balance sheet.

By removing a major asset "off balance sheet", the business can show a higher return on its total assets, and can use its accumulated equity to fund expansions in its core (and more profitable) business. Right now, the market strongly favours sales/leaseback agreements from a sales point of view, in particular with businesses that rely heavily on liquid credit, that are feeling a crunch.

The proceeds of property sales must usually be recycled back into the core business and in effect generate a return on capital at least in excess of the cost of funds, although this is not always the case and is one particular option and opportunity, naturally shareholders/partners merely realising a property investment to best advantage with a leaseback also at times makes financial sense.

Effectively a transaction of this nature must make sense in unlocking greater value for the business; some key ratio’s; that one need take note of and the potential change to them are; debt-equity and return-on-assets ratio’s. Overall and where applicable there should be an improvement in Shareholder Value, such percentages are capable of being identified from the financial statements by applying appropriate financial formula’s.

For some corporates, it can make little or no sense to continue owning freehold property with potentially substantial embedded value. It must however make sense and one needs to take care in these instances not to unduly prejudice the seller.

What we have however witnessed and are seeing on an alarmingly increasing basis, is a lack or expertise or the raising of undue and often incorrect expectations for both sellers and buyers. Examples of this type of dangerous practice could be the overpricing of the asset associated with an unfortunately onerous lease obligation, or ignorance as to the taxation effect of the transaction. From a pure property perspective one needs to take into account, for example, the extent and timing of required renovations or scheduled and unscheduled costly repairs and maintenance that may be required or the current status of the industry in which the seller operates and what view one has on the future of that operating entity in that particular industry.

On the funding side and at times initially ignored or not often understood are early exit or unwind fees in respect of current debt obligations for the seller, in fact it is at this point that one could turn a potential good transaction down or indeed improve the transaction by assessing the impact and working with the existing funder, it can and does however affect current and future yields.

In current market conditions, where you have an interesting mix of 'liquid investors’ and sellers either willing to enter into sale and leasebacks or have selected this as an option to exit. A sale and leaseback arrangement can be a viable alternative to offering stock, or raising debt to fund expansion.

It is imperative that transactions of this nature are structured and advised on by competent and experienced people. People who have had exposure to the investment property market and are equipped with the relevant property fundamentals, financial and legal acumen. This experience and knowledge is critical to identify the opportunity, drive the transaction and ultimately deliver the completed product.

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