A sale/leaseback transaction, in
its simplest form, is a method for a business to raise immediate
cash. When a business owns its real estate (and generally has
substantial equity in the real estate) it can gain a new source
of cash which it can then invest back into the business, payoff
partners, etc. It generally has positive effects on the balance
sheet and by leasing the property for a substantial period of
time; the business retains control of the property.
During this credit crunch, more
and more companies are using a sale/leaseback transaction as the
preferred method of obtaining additional cash for operating
expenses.
Generally, a buyer looks at
three main items in considering the transaction:
1. The market value of the
property being sold, including consideration of the condition of
the property.
2. The fair market rent the property may yield -- the rental
income stream is used to calculate the potential value of the
property being sold.
3. The credit worthiness of the seller.
The first two calculations must
yield similar results -- that is the value of the property based
on the rental income must be close to the market value of the
property. The reason for this is that if the seller goes out of
business, the buyer can reasonably re-rent the property and
continue his/her income stream. Years ago, buyers often
purchased properties solely based on the rental income stream,
without due consideration to the market value of the property.
Unfortunately, a number of these buyers ended up "upside down"
when the seller went out of business. "Upside down" means the
amount of mortgage the owner has on the property is greater than
the current market value of the property.
Here is a simplified example:
Let's say a company owns a 40,000 square foot building and wants
raise cash by using it in a sale/leaseback transaction (assuming
no debt on the building). If the market value of the building is
$50.00 per square foot (equaling $2 million) and the buyer
wanted to buy the building at a rate of return of 10%, the
seller would have to sign a lease paying approximately $200,000
per year, net, for at least 10 years. That amount equals $5.00
per square foot as a rental rate [$200,000 divided by 40,000 sf].
In evaluating this potential deal, if $5.00 per square foot was
indeed the going rental rate, and $50.00 per square foot was a
reasonable sale price in the area, then the buyer could
reasonably expect that $2 million was a fair sale price. Using
this formula, the buyer and seller are generally able to come to
a reasonable conclusion as to the value of the building and the
lease.
Naturally, this is only a very
brief overview of the sale/leaseback process, for more details;
speak with your attorney, accountant and broker.
