Owners and investors of more management-intensive commercial properties such as apartments, office buildings, multi-tenant industrial buildings and shopping centers may at some point opt for more passive investment opportunities. One of the most popular and successful alternative investment strategies has been to acquire single tenant net leased investment properties, in most cases via tax deferred exchanges. The market for these “triple net” (“NNN”) investments will continue to be robust as the demand for stable cash flows generated by commercial NNN real estate continues to grow in today’s volatile economic environment.
NNN investment properties are typically occupied by a single credit-worthy tenant on a long term lease where the tenant is responsible for all operating expenses related to the operation of the property. This combination of stable cash flow, long term security, minimal risk and little or no management responsibilities appeals, for obvious reasons, to a broad range of investors. Companies such as CVS, Walgreens, Wal-Mart, Home Depot, Arby’s, AutoZone and Chase Bank are examples of national corporate tenants who secure net leased properties.
Generally, a NNN investment is a commercial property in which the tenant is responsible for the expenses related to its operation. These expenses typically include taxes, insurance, common area maintenance, utilities, and to varying degrees, the maintenance and repairs of the building. Therefore, the annual base rent paid by the tenant is the purest case equal to the actual net return for the property owner. There are many variations of these types of leases (explained fully below), and it is important to review each individual lease to fully understand the Tenant and Landlord obligations, as well as the method and extent of any operating expense reimbursements that may exist.
Although sellers of NNN properties range from individual investors, to Real Estate Investment Trusts (REITs), to lender REO departments, the typical seller is usually a commercial developer who has already — or will be soon — completing a build-to-suit for delivery on a long term net lease. Since the developer has maximized his near-term upside at the time the lease is signed, he is generally interested in realizing his profit immediately through a sale as opposed to a finance-and-hold strategy.
The other major sellers of NNN properties are corporations. Companies regularly elect to sell and lease back their buildings and land as NNN real estate.
Buyers of NNN properties are more numerous than ever before. It is arguable that during real estate downturns, the demand for NNN properties increases. Not only are NNN properties pursued by individual 1031 exchange investors, but institutional investors and their advisors have also become bigger buyers of NNN investments due to a general flight to stable, risk adverse cash flows.
However, in the $20 million and under range, individual investors who are motivated by the tax-deferred exchange will continue to outpace institutional investors in playing the major buying role in the marketplace. While institutional investors are motivated by a desire for a particular IRR, the individual is motivated to avoid the financial pain of paying capital gains taxes. In the majority of 1031 transactions, this desire to avoid a major tax hit motivates an exchange buyer who has recently sold a management-intensive property to justify paying more for what he or she may really want: a credit-worthy tenant backed by a corporate guaranty in a long term, passive investment.
Property types in which NNN leases are found include: free-standing or in-line retail buildings or restaurants, industrial buildings (ranging from bulk warehouse to manufacturing plants), office buildings (varying from local or regional offices to corporate headquarters), and land (either unimproved or land under existing improvements owned by others).
Many investors would rather buy a NNN property that they can reach by car, and for this convenience most will generally pay a premium. However, for the appropriate return, the typical NNN investor will consider a property for sale outside of his or her immediate area. For instance, due to the intense competition for assets in California, a property inside the state generally carries a 50 to 100 basis point premium as compared to similar NNN leases available elsewhere in the U.S.
Another important factor in determining the price at which a NNN property will trade is the credit-worthiness of the tenant. Investors categorize tenants as national, regional or local credits and adjust their cap rates accordingly for this security element.
- A national credit tenant is usually considered to be a publicly-traded company that is making money and has stockholders’ equity or a net worth of at least $500 million. These include the Fortune 500 firms, and investors can expect to pay as much as a 100 basis point premium over other deals for credits of this quality.
- Regional companies may or may not be publicly traded, but are expected to be financially strong with accompanying net worth in the range of $75 million and up. These tenants comprise the majority of the available NNN real estate investments.
- Local companies are expected to be privately held with no significant net worth and are therefore considered to be a substantial credit risk. In these commercial properties, the investor expects greater yields, and the evaluation of the real estate component of the investment becomes increasingly more important.
With the larger national tenants that are rated by the bond rating agencies Standard & Poor’s and/or Moody’s, the security associated with an “investment-grade” rating is in high demand in the marketplace. These ratings range from B- to AAA for Standard & Poor’s, and B3 to AAA for Moody’s. Anything above BBB- for S&P and Baa3 for Moody’s is considered investment grade. Not all of the national tenants are rated, and overall, the majority of properties available on the market are leased to non-rated tenants.
As one may assume, the stronger the tenant, the less likelihood of default or bankruptcy (see the chart below). The credit of the tenant affects many different aspects of an investment, including long-term lease security, possible financing, and asset liquidity.
|Credit Rating||Credit Rating|
|Credit Quality||Standard & Poor’s||Moody’s|
A critical factor affecting the selling price of a NNN investment opportunity is the lease itself. Of primary importance is the lease term, and as a general rule, the longer the better. Investors today are looking for 10- to 15-year primary terms. Investors will generally pay a 50 basis point premium for each additional five years on the primary term beyond a minimum ten-year requirement. Terms for new restaurant and drugstore properties can range up to 20 or 25 years.
The next major quantifiable issue with regard to the lease is its “net” nature. Most deals today are called “triple net”, but may be “double net” because the roof and structural maintenance remains the financial responsibility of the landlord. This means the investment is not truly net to the buyer since reserves must be set aside to provide for repairs. “True triple net” leases, also called “absolute net” leases, are the most desirable lease type from an investor’s standpoint. Management, maintenance, repairs, capital, condemnation, and casualty responsibility belongs to the tenant.
In any transaction, the tenant’s responsibility level can vary from deal to deal and should be carefully analyzed. The value of an asset is directly impacted by the nature of the net lease structure. As the tenant’s responsibility goes up and the landlord’s goes down, the value of the property should go up.
The final significant item regarding the NNN lease and its effect on price is its “upside” or inflation protection. Office and industrial buildings and land deals usually offer stepped-up rent in the form of pre-negotiated fixed increases or increases determined by a formula tied to the Consumer Price Index. Retail deals often have a flat (non-increasing) base rental, but may provide inflation protection through a percentage of sales clause, which may or may not be realistic or achievable. In any case, the cap rate going into the NNN property will be inversely proportional to the size and regularity of the rental increases over the life of the lease.
The following examples outline the basic types of leases typically used in NNN properties:
Double Net (“NN”) Lease
This term, while widely used in the industry, often misleads investors. In a NN lease, the tenant is typically responsible for the payment of taxes, insurance and common area maintenance. However, under this lease structure, the landlord is responsible for the building structure, roof and parking lot repairs. Thus, it is important for an investor to underwrite for this potential future expense by establishing a capital reserve for these types of expenditures not reimbursed by the tenant.
Triple Net (“NNN”) Lease
In a NNN lease, the tenant is responsible for taxes, insurance, common area maintenance, management, and roof/structure/common area repairs. However, under these leases, the method of expense reimbursement may vary. In many NNN leases with national tenants (i.e. Walgreens), the tenant directly manages and handles all repairs for the property, and the landlord essentially just collects the rent. However, in other NNN leases (i.e. leases utilizing the standard AIR NNN form more typically used for single tenant industrial properties), the landlord is directly responsible for the payment of some of the operating expenses related to the property, and then bills the tenant for the reimbursement of those expenses.
Bond Net (Absolute) Net Lease
Under an absolute net lease, the tenant is 100% responsible for all expenses and the management of the property. In addition, in the event of major damage to or destruction of the building, the tenant must continue to pay rent and restore the premises to its original condition.
Also of important consideration when analyzing a NNN investment the available financing for the deal. Cash-on-cash yields are important in this marketplace due to the comparative available yields on corporate bonds and treasury bills. Since the market for these deals is flooded with exchange buyers who have sold a property on which they carried debt, most transactions require a financing element in order to perfect the exchange. Numerous lenders exist for these deals in today’s financing marketplace.
There is a positive correlation between the credit of the tenant and the loan terms achieved. Typically, interest rates are based on the U.S. Treasury rates plus a “spread,” which is based on a premium above the trading of a company’s corporate debentures. The higher the quality of tenant, the lower the spread will be, thereby producing a more desirable interest rate.
The financial standing of the borrower will also affect the loan-to-value debt service coverage ratio (DSCR) and amortization of the loan. Many lenders will not require as much equity from the borrower, nor expect a low DSCR, if the tenant has a good credit rating. A borrower may also be able to attain a longer amortization period with an investment-grade tenant. The lower equity requirement will allow the owner to acquire the property with fewer dollars up front, while the higher DSCR and long amortization term will increase the net cash flow over the life of the lease/loan.
There are many benefits to acquiring a NNN property in a 1031 exchange, including:
- You can sell your existing property, and trade your equity into leased property, thereby deferring capital gains
- Little or no property management
- Income guaranteed by an investment-grade corporation
- Investment backed by “brick and mortar” real estate usually well located with good demographics
- Long term leases with rental increases
- Typically straightforward due diligence process
- Long-term, non-recourse financing available from lending services on a variety of terms and conditions
- Equity can be refinanced out on a tax-free basis after exchange is complete
A 1031 exchange is based on a provision in the Internal Revenue Code (Section 1031) which provides that no gain or loss related to capital gains need be recognized on the “exchange” of any type of property used for business or investment.
A 1031 exchange allows an investor to sell an investment property and defer capital gains and depreciation recapture taxes by reinvesting 100% of their equity into another “like kind” property of equal or greater value.
The theory behind Section 1031 is that when a property owner has reinvested the sale proceeds into another property, the economic gain has not been realized in a way that generates funds to pay any tax. In other words, the taxpayer’s investment is still the same, only the form has changed (e.g. vacant land exchanged for apartment building). Therefore, it would be unfair to force the taxpayer to pay tax on a “paper” gain.
The like-kind exchange under Section 1031 is tax-deferred, not tax-free. When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.
1031 exchanges provide an ideal solution for investors that want to keep real estate in their investment portfolio and:
- Redeploy dormant equity “locked” in their income properties.
- Defer the punitive capital gains and depreciation recapture taxes due when selling investment properties.
- Explore institutional-grade property investment options.
The primary advantages of completing a 1031 exchange include:
- Increasing your buying power through the deferment of federal capital gains taxes, thus allowing you to leverage these savings by putting them into the new property you are purchasing.
- Acquiring a replacement property with greater income potential, such as selling raw land and acquiring income-producing property.
- Consolidating several manage-intensive properties into one passively managed property, such as a net leased property.
- By deferring the tax, you have more money available to invest in another property. Effectively, you receive an interest-free loan from the federal government in the amount you would have paid in taxes.
- Postponing any gain from depreciation recapture.
- Reallocating your investment portfolio without paying taxes on any gain.
Anyone who is considering selling a business or investment property should investigate the merits of a 1031 exchange. By electing to use a 1031 exchange, the savvy investor has an opportunity to reinvest the federal capital gains that he would normally pay on a sale. An investor can consider the savings resulting from a 1031 exchange as an interest-free loan from the IRS in which the principal may be increased through subsequent exchanges, and which may never require repayment if properly planned.
There are five major types of 1031 exchanges:
- Simultaneous Exchange: The exchange of the relinquished property for the replacement property occurs at the same time.
- Delayed Exchange: This is the most common type of exchange. A Delayed Exchange occurs when there is a time gap between the transfer of the Relinquished Property and the acquisition of the Replacement Property. A Delayed Exchange is subject to strict time limits, which are set forth in the Treasury Regulations.
- Build-to-Suit (Improvement or Construction) Exchange: This technique allows the taxpayer to build on, or make improvements to, the replacement property, using the exchange proceeds.
- Reverse Exchange: A situation where the replacement property is acquired prior to transferring the relinquished property. The IRS has offered a safe harbor for reverse exchanges, as outlined in Rev. Proc. 2000-37, effective September 15, 2000. These transactions are sometimes referred to as “parking arrangements” and may also be structured in ways which are outside the safe harbor.
- Personal Property Exchange: Exchanges are not limited to real property. Personal property can also be exchanged for other personal property of like-kind or like-class.
Common misconceptions include:
- There are those who still believe an investor must “swap” properties in order to effect a successful 1031 exchange. Although this was a requirement in the original code, it is no longer required today. An investor is now able to sell his or her property in a normal manner, provided that he or she reinvests the returns of that sale in accordance with 1031 rules.
- Many believe that only investors in large commercial properties enjoy the benefits of a 1031 exchange, but this is not the case. 1031 exchanges apply to all investment properties, large and small. 1031 exchanges result in savings for a corporation selling a large shopping mall, and will also provide benefits for an individual selling a single-family home used as a rental property in a vacation area, or a retail net leased investment backed by a credit tenant.
- Many believe one must acquire a property of similar kind or type in order to qualify for the benefits of a 1031 exchange. While the term “like-kind” exchange is often used in reference to 1031 exchanges, this term simply refers to real property held for business use or investment. An investor can sell vacant land and acquire an apartment building or sell a warehouse and acquire raw land. One can also sell a single property and use the proceeds to invest in three properties, or sell four properties while only acquiring one. Virtually any type of real property used for business use or investment will qualify.
- Many believe that 1031 exchanges are too complicated. This is not the case; in fact, when working with a qualified 1301 exchange intermediary, the process is very simple. The intermediary will keep you aware of the requirements you must comply with and ensure that everything is completed in strict compliance with 1031 regulations.
Aside from the deferment of capital gains tax, some of the other benefits enjoyed by 1031 exchange participants include:
- Increased buying power due to the availability of funds that normally would have gone to pay capital gains taxes.
- Preservation of your estate your selling power is increased since you can offer a more flexible selling price increases your income by exchanging for properties with greater income (More profitable locations, lower operating costs, more rental units or a higher rental income per unit, etc.) relocation of your business or investment property to a more profitable or desirable location. Expand you business into a larger space without tax penalties.
- All of these advantages culminate in the ability to speed wealth accumulation in real property ownership.
There are four major requirements that must be satisfied to complete a valid 1031 exchange:
- Qualifying Property: Certain types of property are specifically excluded from Section 1031 treatment: property held primarily for sale; inventories; stocks, bonds or notes; other securities or evidences of indebtedness; interests in a partnership; certificates of trusts or beneficial interest; and choses in action. In general, if property is not specifically excluded, it can qualify for tax-deferred treatment.
- Proper Purpose: Both the relinquished property and replacement property must be held for productive use in a trade or business or for investment. Property acquired for immediate resale will not qualify. The taxpayer’s personal residence will not qualify.
- Like Kind: Replacement property acquired in an exchange must be “like-kind” to the property being relinquished. All qualifying real property located in the United States is like-kind. Personal property that is relinquished must be either like-kind or like-class to the personal property which is acquired. Property located outside the United States is not like-kind to property located in the United States.
- Exchange Requirement: The relinquished property must be exchanged for other property, rather than sold for cash and using the proceeds to buy the replacement property. Most deferred exchanges are facilitated by Qualified Intermediaries, who assist the taxpayer in meeting the requirements of Section 1031.
There are four general guidelines that must be followed:
- The value of the replacement property must be equal to or greater than the value of the relinquished property.
- The equity in the replacement property must be equal to or greater than the equity in the relinquished property.
- The debt on the replacement property must be equal to or greater than the debt on the relinquished property.
- All of the net proceeds from the sale of the relinquished property must be used to acquire the replacement property.
Once the money is deposited into an exchange account, funds can only be withdrawn in accordance with IRC 1031 regulations. The taxpayer cannot receive any money until the exchange is complete. If you want to receive a portion of the proceeds in cash, this must be done before the funds are deposited with the Qualified Intermediary.
A Qualified Intermediary is an independent party who facilitates tax-deferred exchanges pursuant to Section 1031 of the Internal Revenue Code. The QI cannot be the taxpayer or a disqualified person.
- Acting under a written agreement with the taxpayer, the QI acquires the relinquished property and transfers it to the buyer.
- The QI holds the sales proceeds, to prevent the taxpayer from having actual or constructive receipt of the funds.
- The QI acquires the replacement property and transfers it to the taxpayer to complete the exchange within the appropriate time limits.
The exchange ends the moment the taxpayer has actual or constructive receipt (i.e. direct or indirect use or control) of the proceeds from the sale of the relinquished property. The use of a QI is a safe harbor established by the Treasury Regulations. If the taxpayer meets the requirements of this safe harbor, the IRS will not consider the taxpayer to be in receipt of the funds. The sale proceeds go directly to the QI, who holds them until they are needed to acquire the replacement property. The QI then delivers the funds directly to the closing agent.
The IRS regulations are very clear: the taxpayer may not receive the proceeds or take constructive receipt of the funds in any way, without disqualifying the exchange.
No, as long as the taxpayer has not transferred title, or the benefits and burdens of the relinquished property, she can still set up a tax-deferred 1031 exchange. Once the closing occurs, it is too late to take advantage of a Section 1031 tax-deferred exchange (even if the taxpayer has not cashed the proceeds check).
No, not in most situations. The IRS regulations allow the properties to be deeded directly between the parties, just as in a normal sale transaction. The taxpayer’s interests in the property purchase and sale contracts are assigned to the QI. The QI then instructs the property owner to deed the property directly to the appropriate party (for the relinquished property, its buyer; for the replacement property, taxpayer).
A taxpayer has 45 days after the date that the relinquished property is transferred to properly identify potential replacement properties. The exchange must be completed by the date that is 180 days after the transfer of the relinquished property, or the due date of the taxpayer’s federal tax return for the year in which the relinquished property was transferred, whichever is earlier. Thus, for a calendar year taxpayer, the exchange period may be cut short for any exchange that begins after October 17th. However, the taxpayer can use the full 180 days by obtaining an extension of the due date for filing the tax return.
Unfortunately, there are no extensions available. If the taxpayer does not meet the time limits, the exchange will fail and the taxpayer will have to pay any taxes arising from the sale of the relinquished property.
Potential replacement property must be identified in writing, signed by the taxpayer, and delivered to a party to the exchange who is not considered a “disqualified person”. A “disqualified” person is anyone who has a relationship with the taxpayer that is so close, the person is presumed to be under the control of the taxpayer. Examples include blood relatives, and any person who is or has been the taxpayer’s attorney, accountant, investment banker or real estate agent within the two years prior to the closing of the relinquished property. The identification cannot be made orally.
There are three rules that limit the number of properties that can be identified, and the taxpayer must meet the requirements of at least one of these rules:
- 3-Property Rule: The taxpayer may identify up to 3 potential replacement properties, without regard to their value; or
- 200% Rule: Any number of properties may be identified, but their total value cannot exceed twice the value of the relinquished property, or
- 95% Rule: The taxpayer may identify as many properties as he wants, but before the end of the exchange period the taxpayer must acquire replacement properties with an aggregate fair market value equal to at least 95% of the aggregate fair market value of all the identified properties.
No. Any property that is held for productive use in a trade or business, or for investment, may qualify for tax-deferred treatment under Section 1031. In fact, many exchanges are “multi-asset” exchanges, involving both real property and personal property.
A multi-asset exchange involves both real and personal property. For example, the sale of a hotel will typically include the underlying land and buildings, as well as the furnishings and equipment. If the taxpayer wants to exchange the hotel for a similar property, he would exchange the land and buildings as one part of the exchange. The furnishings and equipment would be separated into groups of like-kind or like-class property, with the groups of relinquished property being exchanged for groups of replacement property.
Although the definition of like-kind is much narrower for personal property and business equipment, careful planning will allow the taxpayer to enjoy the benefits of an exchange for the entire relinquished property, not just for the real estate portion.
A reverse exchange, sometimes called a “parking arrangement,” occurs when a taxpayer acquires a Replacement Property before disposing of their Relinquished Property. A pure reverse exchange, where the taxpayer owns both the relinquished and replacement properties at the same time, is not allowed. The actual acquisition of the “parked” property is done by an Exchange Accommodation Titleholder (EAT) or parking entity.
Yes. Although the Treasury Regulations still do not apply to reverse exchanges, the IRS issued “safe harbor” guidelines for reverse exchanges on September 15th, 2000, in Revenue Procedure 2000-37. Compliance with the safe harbor creates certain presumptions that will enable the transaction to qualify for Section 1031 tax-deferred exchange treatment.
In a typical reverse (or “parking”) exchange, the “Exchange Accommodation Titleholder” (EAT) takes title to (“parks”) the replacement property and holds it until the taxpayer is able to sell the relinquished property. The taxpayer then exchanges with the EAT, who now owns the replacement property. An exchange structured within the safe harbor of Rev. Proc. 2000-37 cannot have a parking period that goes beyond 180 days.
If the reverse exchange period exceeds 180 days, then the exchange is outside the safe harbor of Rev. Proc. 2000-37. With careful planning, it is possible to structure a reverse exchange that will go beyond 180 days, but the taxpayer will lose the presumptions that accompany compliance with the safe harbor.
Yes. This is known as a Build-to-Suit or Construction or Improvement Exchange. It is similar in concept to a reverse exchange. The taxpayer is not permitted to build on property she already owns. Therefore, an unrelated party or parking entity must take title to the replacement property, make the improvements, and convey title to the taxpayer before the end of the exchange period.
A realized gain is the increase in the taxpayer’s economic position as a result of the exchange. In a sale, tax is paid on the realized gain. A recognized gain is the taxable gain. A recognized gain is the lesser of the realized gain or the net boot received.
Boot is any property received by the taxpayer in the exchange which is not like-kind to the relinquished property. Boot is characterized as either “cash” boot or “mortgage” boot. The realized gain is recognized to the extent of net boot received.
Mortgage boot consists of liabilities assumed or given up by the taxpayer. The taxpayer pays mortgage boot when he or she assumes or places debt on the replacement property. The taxpayer receives mortgage boot when he or she is relieved of any debt on the replacement property. If the taxpayer does not acquire debt that is equal to or greater than the debt that was paid off, he or she is considered to be relieved of debt. The debt relief portion is taxable, unless offset when netted against other boot in the transaction.
Cash boot is any boot received by the taxpayer other than a mortgage boot. Cash boot may be in the form of money or other property.
There are four major boot netting rules:
- Cash boot paid offsets cash boot received.
- Cash boot paid offsets mortgage boot received (debt relief).
- Mortgage boot paid (debt assumed) offsets mortgage boot received.
- Mortgage boot paid does not offset cash boot received.
In a sale-leaseback transaction, an owner/user decides it would be beneficial to lease the space it currently occupies and owns, rather than continuing to own it. The property is marketed to an investor who agrees to lease the space back to the selling entity.
The sale-leaseback process involves four steps:
- Purchase: An investor purchases an existing fixed physical facility (but not the business activity conducted in that facility) from an owner/user that is operating its business out of the facility.
- Leaseback: The seller leases back the existing facility for a set term, makes periodic lease payments, continues to own and control the business activity conducted in the facility, and retains all profits generated by the business activity.
- Financing: The seller uses the cash payment from the sale of the existing facility to finance the construction of a new physical facility, to expand the business, or for any other purpose.
- Option: At the end of the lease period, the seller has the option to renew the lease on the existing facility, purchase the existing facility back, or move the business activity out of the existing facility and terminate the relationship.
The three basic requirements a sale-leaseback candidate must meet in order to qualify for the transaction are as follows:
- Physical Facility: The seller must own an existing fixed physical facility that an entity can purchase.
- Lease: The seller must intend to lease back the existing facility from the buyer.
- Credit Rating: In most sale-leaseback transactions, the seller generally must obtain either an investment grade credit rating or credit enhancement from a source having an investment grade credit rating.
A firm could obtain an investment-grade credit rating, or it could use credit enhancement provided by a third party.
- Credit Rating: A credit rating must be issued by the international rating agency of either Standard & Poor’s, Moody’s, or Fitch Ratings. An investment-grade credit rating would be an S&P or Fitch rating of BBB- or higher, or a Moody’s rating of Baa3 or higher. A firm can obtain a “desk-top” review from a consultant to determine if an investment-grade credit rating is possible. The website addresses for the rating agencies are as follows:
Standard & Poor’s: www.standardandpoors.com/
- Credit Enhancement: Credit enhancement is when a firm uses the investment-grade credit rating of a third party to raise its credit rating to investment grade. Examples of third parties that might provide credit enhancement include sovereigns, governmental agencies, insurance companies, and banks.
Often times, an investment group that raises the funds to purchase a firm’s existing physical facility or facilities does so through Wall Street partners and major institutional and individual investors. These entities typically require that a sale-leaseback candidate (or another entity leasing back the existing facility) has an investment-grade credit rating or credit enhancement since these are credit-based leases.
The primary benefits of a sale-leaseback transaction include the following:
- Improved Balance Sheet: By selling appreciated real estate, a long-term liquid asset can be replaced with a liquid asset (cash). In addition, a mortgage appears on the balance sheet as a liability, while an operating lease does not. If you have no debt on the existing facility and build a new facility with the cash from the sale of the existing facility, the new facility will have no debt. The lease on the existing facility will usually be a contingent liability. No debt enhances a company’s balance sheet, credit rating, and ratios (e.g., debt to equity, return on assets, and return on equity).
- Improved Income Statement: The real estate sale can reduce the negative impact of depreciation and interest on your income statement.
- Access to Capital: The equity received from the transaction can be deployed in core operations that yield higher returns than appreciation of real estate. The proceeds also can be used to pay down debt.
- Improved Stock Value: An increase in liquid assets and a reduction in debt can project a better financial picture and result in increased stock value for a public company.
- Better Access to Long-Term Capital: With an improved balance sheet and income statement, a company can improve its credit status.
- 100% Financing: A firm can raise cash equal to 100% of the market value of the existing facility — more than if it borrowed funds against the existing facility. A firm can raise 100% of the cash from a single source. It does not have to raise debt and/or equity financing from multiple sources.
- 100% Tax Deduction: A firm can deduct 100% of the lease payments for tax purposes. With debt financing, a firm can deduct only a portion of the loan payments.
- Favorable Rent Payments: The lease payment may prove relatively inexpensive compared to the return the company gets on the sale of the property.
- Maintain Control and Increase Liquidity: A company will continue to have total control of, and retain all of the profits from, the operation of the business activity conducted in the existing facility. The facility was sold, not the business activity.
- High Return: The cash a firm was has tied up in its existing facilities is typically generating a much lower return than it could yield if the firm reinvested that cash in a new project facility, the expanded its business activities, or engaged in new ventures. By selling and leasing back existing facilities, a firm continus to control and profit from the business activities conducted in the existing facilities, and can reinvest the freed up cash in new high-return activities.
- Leverage: By completing a sale-leaseback, a firm raises the funds needed to expand its business or to invest in new ventures.
- Lower Risk: Many projects are financed with risky short-term debt. Conversely, a sale-leaseback allows a firm to lock into a long-term fixed lease, raise the money to pay off the short-term debt it currently holds, and continue to control and profit from the business activity conducted in that facility.
- Property Management: By selling its real estate and leasing it back from the new owner, a company may elect not to manage the property in an effort to free up time, energy and capital resources.
- Fast Process: Typically, a sale-leaseback transaction only takes 3-6 months once the negotiations have been finalized. It is a relatively simple process and has far fewer requirements than traditional financing methods. At closing, the seller receives full payment for the purchase of the existing facility.
Moody’s Investors Service notes “increasing numbers of corporations are using sale-leasebacks as a way to move the costs of real estate investments off their balance sheets.” They list AT&T, Saks Fifth Avenue, K-Mart, and Wal-Mart as examples of corporations that have sold corporate headquarters or retail stores and leased them back.
A sale-leaseback transaction is uniquely suited to the needs of both large and small corporations and governments with a large investment in physical facilities.
No. A firm can use the cash payment from the sale of its existing physical facility for any purpose. How it uses the cash is totally unrelated to the purchase and leaseback of the existing facility.
A sale-leaseback candidate does not have to own the land. However, investors typically require the ability to obtain a long-term lease on the land.
Upon the expiration of the lease, the firm can negotiate a new lease for the facility, or oftentimes purchase the facility back at a market price. Finally, the firm can move its business activities out of the facility and terminate the relationship.
To inquire for our opinion on whether or not your project is a viable sale-leaseback candidate, please provide the following information: