Sale and Leaseback

Raising business financeA property sale and leaseback is a technique for releasing the full value of your property into cash by selling it to an investor while agreeing to rent the property back from them on some form of normal institutional lease.

The new owner will then hold this as an investment and will therefore be looking for the rent charged to provide a reasonable current market rate of income, usually referred to as a yield and calculated as a percentage of the price paid.

Yield (%) = Rental income per year
Money invested in buying the property

To make the costs of undertaking such a deal worthwhile, many investors tend to be interested in larger commercial transactions, as a guide, say over £500,000 in value.

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Having said that they are a technique for releasing cash from a property that you own, and of course you don’t have to have actually owned it very long.

A simultaneous (‘back to back’) sale and leaseback where you agree a sale to an investor at the same time as buying the property from the seller can therefore be used as a means of acquiring the use of a property without having to find the cash for the say 30% deposit that would be needed if you were going to buy in the normal way using a commercial mortgage that raised 70% of the property value.

These are often very useful for example in management buy outs (MBOs) or buy ins (MBIs), where there is a need to make the cash available to buy and invest in the business go as far as possible and where this technique avoids having precious capital tied up in bricks and mortar.

Moreover, when valuing a property for lending purposes, surveyors have to work on the basis that a lender may have to rely on their estimate in order to get their money back in the case of a default. If the valuer gives a valuation that is too high they may be at risk of being sued so they will naturally tend, within reason, to err on the side of caution as they have their PII (professional indemnity insurance) policies to think about.

In some cases therefore actual sales price achieved in a sale and leaseback can be well in excess of the surveyor’s opinion as to open market value and the value attributed to the property in the business sale, resulting in an injection of working capital into the buyer’s Newco, either at the outset or later on.

For example, a management team bought out a manufacturing company including its premises which were valued for lending purposes by most valuers at £1.2m before the buyout team, which was looking to maximise their borrowing, found a valuer who would give £1.5m as his opinion. Less than a year later the buyout was in need of cash and sought a sale and leaseback with a target price for the property of £2m. They actually achieved a price of £2.3m resulting in a net injection of cash into the business of over £1m after costs and redemption of the existing mortgage.

The value that can be achieved through a sale and leaseback will be based on the value of the property to an investor which is essentially a matter of:

yield x rent = value

However this simplistic calculation will be affected by three main issues:

1 The local market for commercial property underpins any valuation, as the investor will be concerned with what happens if their tenant defaults. For example, a manufacturing MBI arranged a sale and leaseback at £1.5m to raise cash much like the example discussed above. Only in this case, having paid off its bank loan, the directors then decided they still did not have enough cash to take the business forwards as it was and put the company into administration within weeks of completing the deal. Fortunately for the landlord the directors then bought the business back and continued to operate from the premises.

A valuer will therefore be looking at the local level of demand for this type of property so as to assess the local going market rent and ease of finding a replacement tenant as well as any alternative use that the site may reasonably have such as for property development which might give it an underlying hope value.

2 The prospective covenant. In investing in a property based on a lease which may run for 25 years, the investor is talking a risk in that it may find that at some point in the future its rent may not be paid.

The investor will therefore be concerned with the strength of the tenant’s covenant as renting a property to say a large established company with a strong credit rating and a reasonable expectation that it will be around for 25 years obviously appears to present a lower risk of default than renting to a new MBI with a high degree of other borrowings (highly geared or leveraged) that give it a high degree of financial risk.

The higher the level of risk being taken by the investor, the higher the level of yield that they will therefore be looking to achieve.

3 The lease terms which will be negotiable to a degree will also have an impact. Investors will typically be looking for a normal institutional form of lease which might for example mean a period of 15 to 25 years, with upwards only rent reviews every five years.

You might however want or need to negotiate other terms which are more advantageous to you such as:

  • rent reviews which are not upwards only; or
  • rights of access for third parties such as other lenders as discussed below.

Obviously again, the more you look for terms that are advantageous to you and onerous on the landlord, the higher yield or rent the landlord will want.

Depending in the degree of risk involved you may therefore find a landlord looking to achieve a yield of between 7.5% and 10%.

Investors in sale and leasebacks are often individuals or property companies and not the type of financial institutions that provide mortgages. To reach these investors you can employ a number of different people to try and put a sale and leaseback in place:

Normal commercial estate agents will act to sell your property for you and may charge between 1% and 2% for finding a buyer and will often require marketing costs to be paid up front. Their level of experience of arranging and negotiating sales and leasebacks will vary as will their ability to find an appropriate investor.

There are a limited number of specialist match makers whose business involves building up panels of potential investors and managing transactions through to completion, sometimes in conjunction with firms of commercial estate agents. These brokers will typically charge more than an estate agency, say 3%, but this is on a success fee only basis with no marketing costs and you are also buying their expertise and experience in this particular area.

Finally, there are some internet based property broking web sites on which you can list your property and the terms you are seeking. This approach is usually cheaper than estate agents at 0.75% and enables you to hit an e-mailing list of many thousands of potential investors which should allow you to quickly find out whether there is appetite for your deal. These are however simply marketing and introduction services and will not provide you with any support in negotiating and completing the deal.

When thinking about a sale and leaseback some key issues that you may need to consider are:

As a result of the sale you will obviously lose the ownership of the property and the potential future development value it may have, so this is not a step to be taken lightly. There have occasionally been sale and leaseback arrangements which had a buyback option built in but these are rare.

The potential interaction of any proposed sale and leaseback with the position of other secured lenders which can often lead to problems in completing a deal.

For example, a company looking to complete a transaction ran into problems over both its plant and machinery finance and its invoice discounting arrangements which included an advance against stock. The plant and machinery lender’s terms included a provision that in the event of default or the failure of the business, the lender had a right of access to the property for up to six months in order to be able to arrange and complete a sale of the equipment covered by its charge, while the invoice discounter had a similar provision in respect of stock.

While the company owned the property these clauses were not an issue, but for a landlord with a defaulting tenant, any restriction for up to six month on its ability to obtain vacant possession in order to market and re-let the property, was a major problem.

In the event a negotiated solution was found which involved reducing the lender’s access periods to three months and the company placing part of sale proceeds into a three-month rent deposit.

Finally there may be tax issues to take into account. Obviously the rental that you will be paying for the property will be a tax deductible expense of your business going forwards but more importantly the sale itself may crystallise a capital gain (or conceivably a loss). You should always take tax advice at an early stage in the transaction as there may be steps you can take to either mitigate the liability, or for example by changing your business’s year end, to significantly defer the payment of any tax due.

Pension Purchase

For some businesses it may be possible and appropriate for the pensions scheme to raise a mortgage and to purchase the premises from the company by way of a sale and leaseback much as described above.

This can inject funds into the company from the realisation of the property while the property is under the control of a known party and in some cases the pension scheme may be able to borrow more cheaply than the company can.

To be able to undertake this sort of transaction, the pension scheme must have the appropriate structure and borrowing powers for which you must seek specialist advice and assistance from an Independent Financial Advisor (IFA) experienced in this area.

Information provided is copyright and subject to the Important Notice on the home page.

Of course the information contained in an article like this can never be a full statement of the legal position as the relevant laws are complex and liable to change. This article can only therefore be a general guide as to the issues involved and as these can have serious implications you should always seek appropriate professional advice on your own particular circumstances before taking any action.

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