Sale-Leaseback is a “alternative”, off balance-sheet financing mechanism used by builders and developers and others with unique, expensive, properties, stereotypically. This is an “alternative” to obtaining bank financing, raising debt capital by mortgaging property or raising equity capital by selling shares. In a Sale leaseback transaction, a Seller, sells property to a Purchaser, and simultaneously leases the property back from the Purchaser(selling shares). The term of the lease and the lease rent is based (Advantages of Sale-Leaseback ) on the sale price and the Purchaser’s expected rate of return from the transaction. Essentially and eventually, the seller of the property becomes the lessee (leaseback tenant)and the purchaser becomes the lessor.
Sale-Leaseback strategy enables the Seller to raise capital without increasing debt burden and this freed capital can deploy for business expansion or other investments with a better rate of return. The Seller may negotiate and have buy-back or right of first refusal provisions so that once the Seller has sufficient capital, they can re- purchase the property.
When the Seller becomes a NNN lease, the Seller must bear the risks of insurance, repair and maintenance of the property minus access to any increase in the value of the property over the lease term.
On the flip side, the Purchaser could restrict the Seller’s rights re: the property. These provisions could include:
(1) undertaking certain business activities (2) sub-leasing of the property; (3) structural changes to the property. (4) additional and enhanced reporting of the Seller’s financials, etc.
Depending on the State or County, there may be several capital gains and transactions taxes considerations. Also, the accounting and tax treatment of each structure could differ based on whether a capital lease or operating lease is used in the transaction.
Since the Purchaser is investing based on, amongst other things, the creditworthiness of the tenant and the stability of its business, the Purchaser can lock in return via fixed rents and rent escalation clauses.
The Purchaser’s primary risk is Seller default risk. That said, this risk is mitigated because of the Purchaser’s right to terminate the lease, with attendant damages clauses, plus the benefit of eventual capital gain in the property. (Sale-Leaseback)
Due diligence is key – besides intensive credit review of the Seller (and leaseback tenant) it is advisable for the Purchaser to conduct due diligence on:
- Underlying contracts – the Purchaser may need to assume the Seller’s position on contracts with contractors and consultants, and so, collateral warranties can be useful to the Purchaser.
- Hazards – when these may lurk, these liabilities could be ‘inherited’ on a purchase of the affected land.( Advantages of Sale-Leaseback )
Our expert advisors at the Triple Net Investment Group have decades of experience in Sale Leaseback transactions of NNN properties, please call to discuss your particular transaction.
