In recent years, sale and leaseback transactions have increased in popularity; due to the many benefits they have.
In this article, Commercial Property Solicitor Hannah Martin outlines what sale and leaseback is, why it may be a good option for your company and the pros and cons.
What is sale and leaseback?
Essentially, a sale and leaseback is where a company sells commercial property which they own and occupy to a third party who then agrees to simultaneously lease the Property back to the company on completion of the transfer so that they can remain in the property.
The purchaser takes property ownership and becomes the landlord, with the company becoming the tenant.
How does a sale and leaseback work?
The main features of a sale and leaseback transaction are as follows:
- The occupying company enters into a sale and leaseback agreement with the third party
- The occupying company sells the ownership of their building to the third party
- The third party, as the new owner, grants a lease of the Property back to the company
Why would a business enter into a sale and leaseback agreement?
A third party could be any entity, or investor, who is willing to assist and there may be various reasons for a company to enter into such an agreement.
The main reason for a company entering into a sale and leaseback agreement is to gain a cash injection.
This could be the case if a company is struggling, or if they want to fund something (such as the lease of an additional property).
Is sale and leaseback a good alternative to financing?
Effectively, sale and leaseback can be an alternative to financing; the only difference being in the ownership of the property is transferred rather than the company seeking finance in another way, such as obtaining a loan, which they may not be eligible for.
Some companies may also enter these transactions is they are looking to separate its assets from its operating business.
In these types of transactions, the third party is often a company which has been set up by the same shareholders and directors of the selling company.
Is my company eligible for sale and leaseback?
If a company owns and occupies a commercial property, then they are likely to be able to take advantage of this transaction. Often the most suitable companies are those who:
- Own and occupy the whole of a property
- Use the property for commercial use i.e. office or warehouse
- Have a suitable trading history and healthy balance sheet – this will make them more appealing to investors
- Are willing to enter into a lease at market value
What are the advantages of sale and leaseback?
Below, I’ve outlined the main advantages of sale and leaseback to allow you to assess your options.
Cash injection
The main advantage of sale and leaseback is the cash injection. Companies can free up capital, whilst maintaining the right to occupy their property.
As I mentioned earlier, companies can use such a cash injection to fund potential new ventures.
Reduction of risks
Owning freehold property always comes with its own risks and sometimes companies will enter into this transaction to reduce the direct risk on the trading company.
How does sale and leaseback affect debt equity?
The extra cash could also be used to pay outstanding debts and improve the company’s debt-to-equity ratio.
Price fluctuation
In addition, selling a property may prove beneficial for a company as they will no longer be at risk of property price fluctuation. Struggling businesses may not want to risk such price fluctuation.
On the other hand, sale and leaseback can allow a company to take advantage of price fluctuation by selling high at the right time.
Increased liquidity
Another advantage is the additional liquidity that sale and leaseback provides.
The cash amount generated from the sale will be much more useful to the company than the property itself, as it’s not a fixed asset.
Ultimately, sale and leaseback can improve the financial health of the company.
Cost
In comparison to financing, sale and leaseback will cost less as additional fees such as valuation and bank fees aren’t included.
Sometimes the payments due under the lease i.e. rent, works out cheaper than paying interest on a mortgage.
Any lease payments will also be tax-deductible.
What are the disadvantages of sale and leaseback?
In this section, I’ve set out the key disadvantages involved with sale and leaseback; and how your company can mitigate these issues and risks.
Future appreciation in value
Although I’ve talked about the risks of price fluctuation as a reason to undertake sale and leaseback, it could also be a disadvantage.
A company may regret selling their property if it appreciates in value in the future. However, this is always a risk with any property sale.
Company sale
If the business is to be sold in the future, the property will not be included as a sellable asset and won’t factor into the valuation.
Therefore, the sale of the property and business separately may generate less cash than the sale of the assets together.
Lease End
At the end of the agreed lease period, an agreement may not be reached between the landlord and tenant for the tenant to remain in the property.
This is another potential disadvantage of sale and leaseback, as it could result in the company having to move to a different location.
Forfeiture
Furthermore, if there are any forfeiture clauses included in the lease, it may mean that the new owner can take possession of the property before the lease ends.
Or, a break clause could enable the new owner to bring the tenancy to an end before the expiry of the contractual term.
To mitigate this risk, your company should ensure that the lease agreement is reviewed thoroughly. You could also include some lease renewal options in the lease agreement, to ensure that your company will remain in the property.
Control of the property
Finally, new ownership could mean that the company lose some control over how the property is used.
Financial advice
Before entering into such a transaction, we always suggest that you consult an accountant or financial consultant to discuss the cost benefits of this transaction and any potential tax benefits or implications.
Do I need a solicitor for sale and leaseback?
We advise that you instruct a solicitor in this type of transaction as they can help ensure that:
- The terms of the agreement and the lease are fair (including rent and duration)
- Earmark risks and forfeiture clauses
- Discuss the potential for renewal of the lease
- The documents are validly entered into and do what they need to do!
Specialist Sale & Leaseback Solicitors
At Frettens, our bright and experienced team would be happy to advise you on any of the areas outlined above.
If you'd like any assistance with a sale & leaseback transaction, or any other Commercial Property matter, please don't hesitate to contact us.
We offer a free initial chat for all new clients. Call us on 01202 499255 or fill out the form at the top of the page.
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