Of course it is tempting to take a significant transactional profit in such a market and to cash in on this ‘nest egg’. But are the vagaries of the real estate market the only motive for selling corporate real estate? Sale & leaseback is seen by many as a panacea to increase liquidity. In order to make an informed decision, it is important to consider whether a sale & leaseback actually contributes to the primary process of the organisation. In addition to increasing liquidity, there are eight (underexposed) subjects that deserve attention.
One of the reasons for considering a sale & leaseback transaction is thus precisely to raise capital. The sale of real estate has an immediate effect on the income statement: book profit leads to higher corporate tax. Based on the highest tax bracket, this means that 25% of the profit has to be paid in tax. If the real estate is valued too highly in the books, it can lead to an (accounting) loss and this lessens the tax burden. In order to optimise this, it is worth making a distinction between tenant improvements that are not sold and items that belong to the building and are indeed sold.
The sale of real estate also means a change in the assets on the balance sheet. As a result, the financial ratios, such as the solvency ratio, for example, also change. This in turn can have an effect on covenants in loan agreements with the bank.
Organisations that have to account according to the IFRS 16 standard (usually larger companies) are obliged to capitalise current leases on the balance sheet: on the one hand the right of use (assets) and on the other hand the debt in the form of the cumulative rental obligation (liabilities). The net present value of the rent to be paid for the remaining term of the agreement is capitalised. The value in use of the liabilities has been written down according to the annuity method. Companies that account under IFRS must therefore also consider the accounting effect of the sale & leaseback.
By selling and renting back real estate, the risks and charges associated with ownership are also the responsibility of the owner. Consider, for example, major maintenance and replacement investment. But also the risk of depreciation. Of course, these costs and risks are discounted in the rent but it is one less worry for the tenant.
After the one-off proceeds from the sale, there is of course a periodically recurring rental obligation. The rent will usually be higher than the costs directly related to the property. Rent is compensation for the invested capital and risk and the costs of maintenance and replacement. So it means that the operational costs of the organisation will increase.
Often the positive effect of owning real estate is also mentioned. The question is, whether that is valid? After all, the return on capital from the company’s business activities should be significantly higher than the return that can be achieved when investing in real estate. Freeing up resources and investing in the growth of one’s own company will therefore generally yield (much) higher returns.
Rental is in principle just a form of financing company assets. But there are more opportunities for raising debt. Alternative ways to raise money include raising mortgage financing or even a finance lease. With a mortgage it is usually possible to finance a maximum of 70% of the market value of the property. A financial lease is a complex financial instrument but does not offer the flexibility of a ‘normal’ lease.
For many organisations, flexibility is one of the main reasons for renting and not buying real estate. However, that does not apply in all cases. The market conditions and the location in combination with the marketability of the property determine the flexibility. In the case of a generic office or logistics building in an A1 location, ownership is in many cases the most flexible form of use. When it becomes redundant, the property can be sold within the foreseeable future at a competitive price. The flexibility is lower with rent. Often there is a lease term of 5 or 10 years and often without the certainty of being able to extend. Unfortunately, the situation mainly exists in theory: current properties in good locations are often owned by investors and rarely come up for sale with vacant possession. When the property is not generic, for example when it concerns a very specific location, destination or functionality, ownership is less flexible. The sale will be considerably more difficult, as the group of potential buyers will be smaller. In principle, a rental situation offers more flexibility for secondary and tertiary real estate.
Sale & leaseback is therefore more than a simple ‘sales trick’ that quickly and effectively increases liquidity. The decision to enter into such a transaction must be based on a range of factors, with the ultimate question being: how does the transaction affect organisational objectives?
If you want to know whether a sale & leaseback transaction can make a positive contribution to your organisation’s objectives and would like to arrange an orientation meeting, do let us know.
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