How and Why it is done
In the typical sale-leaseback, a Hotel or Motel owner sells the real estate (not the business or FFE) used in its business to an unrelated private investor or to an institutional investor. Simultaneously with the sale, the property is leased back to the seller for a mutually agreed-upon time period, usually 20 to 30 years.
The sale-leaseback may include either or both the land and the improvements. Lease payments typically are fixed to provide for amortization of the purchase price over the term of the lease plus a specified return rate on the buyer’s investment.
The typical transaction usually is a triple-net-lease arrangement. Sale-leasebacks often include an option for the seller to renew its lease, and on occasion, repurchase the property.
Raising funds through a sale-leaseback transaction offers property owners a number of important business advantages.
Converts Equity into Cash. With a sale-leaseback, the seller regains use of the capital that otherwise would be tied up in property ownership; at the same time, the seller retains possession and continued use of the property for the lease term.
The seller usually receives more cash with a sale-leaseback than through conventional mortgage financing. For example, if the transaction includes both land and improvements, the seller receives 100 percent of the property’s market value (minus any capital gains tax). In comparison, conventional mortgage financing normally funds no more than 70 percent to 80 percent of a property’s value.
Because capital gains tax reduces the cash from the sale, a sale-leaseback where the property is sold at a small gain or at a loss generally is most advantageous.
Alternative to Conventional Financing. The seller usually can structure the initial lease term for a period that meets its needs without the burden of balloon payments, call provisions, refinancing, or the other issues of conventional financing. Moreover, the seller avoids the substantial costs of conventional financing such as points, appraisal fees, and some legal fees.
A sale-leaseback also usually provides the seller with renewal options, while conventional mortgage financing has no guarantee for refinancing.
Possibility of Better Financing. Under a sale-leaseback arrangement, a buyer may be able to obtain better mortgage financing terms than the property owner. Even if the property owner defaults, the buyer is likely to continue payments to protect its equity. Thus, the lender might be willing to charge the buyer a lower interest rate, which could result in lower lease payments to the seller.
Improves Balance Sheet and Credit Standing. In a sale-leaseback, the seller replaces a fixed asset (the real estate) with a current asset (the cash proceeds from the sale). If the lease is classified as an operating lease, the seller’s rent obligation usually is disclosed in a footnote to the balance sheet rather than as a liability. This results in an increase in the seller’s current ratio, or the ratio of current assets to current liabilities — which often serves as an indicator of a borrower’s ability to service its short-term debt obligations. Thus, an increased current ratio improves the seller’s position for borrowing future additional funds.
However, if the lease is classified as a capital lease, the advantages of the sale-leaseback arrangement from an accounting perspective are altered considerably. Statement of Financial Accounting Standards No. 13 on accounting for leases requires that a capital lease be recorded as an asset and capitalized and requires the obligation to make future lease payments to be shown as a liability.
Now that you know the advantages, please consult your Tax Accountant to find out about the disadvantages to a Sale/Leaseback.
If you would like to continue running your Hotel/Motel but would like to take out your equity in the land and improvements, a Sale/Leaseback may be for you.
We can help you find a Buyer and facilitate the SLB transaction.
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