Financing A Healthier Balance Sheet

FINANCING A HEALTHIER BALANCE SHEET

CalculatorAccording to Ronald Pollina, Ph.D., Chairman of the International Tenant Representative Alliance (ITRA), if your company has 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 your 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 your occupancy costs under control. Thus, a sale/leaseback transaction allows you to:

• Reinvest in your business

• Retire debt

• Improve credit rating

• Increase productivity

• Make an acquisition

• Get a better return on capital investment

• Avoid negative impact from depreciation on the financial statement

Since the sale/leaseback option has been around for decades, there’s nothing new or exciting about one. So if you like choices that are predictable and boring and don’t blow up, consider the following conventions.

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 firms is a distraction, and allows greater focus on your 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 sale/leaseback transactions 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 your company choose a sale/leaseback transaction? Because a sale/leaseback can create increased productivity. A critical question your 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 their balance sheet. The 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 you 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 your ITRA broker’s responsibility is to find target buyers based on the property and your company’s credit. With this in mind, your broker considers buyers’ three principal goals:

1. To secure cash flow through rent from the leasing corporation

2. To take advantage of property-ownership tax benefits

3. To acquire long-term property appreciation

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 office space, warehouse/distribution, industrial space, or manufacturing facilities. Certain sale/leaseback 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 reality, 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.” 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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