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Home > Press & Resources > Articles > The Sale-Leaseback Rational - December 2002
THE SALE-LEASEBACK RATIONALE
Major corporations are becoming increasingly aware that ownership of corporate real estate ties up ready capital in assets that produce lower rates of return than those from operations. With ever-increasing pressure to maximize shareholder value and the recent tightening of capital markets, corporate space users are striving to optimize their capital structures while still maintaining optimal flexibility and control of their real estate assets. By selling a property and leasing it back, a company can redeploy the proceeds to more profitable business uses, such as stock buy-back programs, debt restructuring and acquisitions.
Sale-leasebacks continue to gain popularity amongst major corporations, both in the US and Canada, particularly those who are looking to remove real estate assets and real estate debt from their balance sheets. A properly structured sale-leaseback transaction not only generates more cash than conventional mortgage financing, but also significantly reduces after-tax occupancy costs.
The more efficient capital allocation of the sale-leaseback is best understood when compared to conventional financing alternatives. Whether real estate is financed with cash, or with mortgage debt, the return on equity invested is less than the company's investment opportunity rate.
Conventional mortgage debt financing is an alternative to cash ownership, though typically the debt will not exceed 70% of the value of the property, requiring an equity investment of up to 30%. In this case, the total cost of the financing is both the actual debt-servicing costs plus the opportunity cost of the equity, usually equal to the firm's investment opportunity rate. While providing more leverage than all-cash ownership, this form of financing has several disadvantages:
- A mortgage appears on the company's balance sheet as long-term debt
- On an after-tax basis, debt-service payments are typically more expensive than those under a lease agreement
- Financing is limited to only a portion of the value of the asset, requiring the company to divert capital resources away from its primary businesses.
If properly structured, a leasehold interest in a property can benefit the user in substantial ways, primarily owing to the favorable tax treatment afforded to leased property. The advantage comes from the treatment given to rental payments, which are entirely deductible, and often exceed the depreciation and interest deductions which apply to owned property.
Forum Equity Partners' Sale-Leaseback program ("SLB") is a sophisticated yet simple real estate solution to optimizing capital allocation. Under an SLB structure, Forum Equity Partners purchases or constructs real estate assets from highly credit worthy corporations at 100% of the total project cost (if new construction), or 100% of the fair market value (if existing), including both land and building.
An SLB creates a "bond", triple net, or double net lease that fixes the rent for the full term of the lease and leaves the tenant in complete operational control of the property. Forum's SLB structure creates an "off-balance-sheet" transaction that can materially enhance the tenant's financial statements.
Whether purchasing a single asset or a portfolio, Forum can offer the tenant numerous enhancements to the lease in order to maximize the tenant's flexibility and control of the asset in such key areas as liquidity and operational contract.
SUMMARY OF BENEFITS
Lower Occupancy Costs: On an after-tax basis, an SLB normally represents the lowest cost alternative for a user's corporate real estate.
Off-Balance Sheet Financing: A SLB qualifies as an operating lease, and is thus "off-balance sheet." Similarly, there are no mortgages under long-term debt, significantly enhancing a company's financial statements. Debt to Equity, Return on Asset and Return on Equity ratios are all enhanced with a SLB.
100% Real Estate Financing: Forum's acquisition price equates to 100% financing of the value of the asset, compared to traditional mortgage debt financing, which rarely exceeds 70%. In the case of a to-be constructed property, SLB financing would apply to both construction and land acquisition costs.
Elimination of Real Estate Capital Tax and Large Corporations Tax attributable to real estate: Depending upon where the property is situated in Canada, this can drive savings of between 52 and 85 basis points annually.
Complete Operational Control of the Property: There are no restrictions on the Company's use of the property, providing full control of the asset. Expansion provisions can be structured into the SLB at the outset, determined by the company's needs
Complete rental deductibility: Rental payments under a SLB are 100% deductible against the company's taxable income, including that portion attributable to land cost.
Effective land depreciation: The value of the land component is factored into the lease payments. 100% deductibility of the lease costs effectively allows the tenant to depreciate the value of the land.
Flexible Lease Terms: The term of the operating lease is designed to match the need of the asset.
Terms are usually 15 to 25 years, with several renewal options of 5 years each.
Full Inflation Protection: The fixed rent under the SLB structure, with no inflation adjustments, provides with full inflation protection. Fixed rentals also guarantee no surprises if renewing during an overheated market.
Property Management Flexibility: Whether self-managed or performed by a third party property manager, an SLB can meet your Company's needs. Where required, we partner with a best in class property manager.
Transfer of Real Estate Risk: The ownership risks of the assets are effectively transferred to Forum.
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