Jim Umphrey discusses how corporations can lease their property back for investment purposes.
Renewed Interest in Sale/Leasebacks
For a corporation to purchase a property, whether it is a cash sale or the company secures traditional mortgage financing, the company must commit capital to the purchase and “park” that capital in the property for as long as they operate in that facility. This may create an opportunity cost for the company based on the fact that the capital invested in real estate is not accessible to invest its core business—an investment which would result in stronger growth for the company. The company also has the limitation of deducting only the depreciation of the building as well as any interest paid for the mortgage.
Leasing from a traditional landlord is most attractive for requirements which range in term of less than ten years. This type of lease does not typically require any significant up front capital, and provides flexibility as it relates to growth. Additionally, the lease cost is determined through market supply and demand factors. All of the lease payments are tax deductible, including any costs related to the operating expenses of the building.
In the Sale/Leaseback transaction, the corporation would sell the property to an investor and lease back the property for a typical term of 15 years or more. The rent is determined by the credit standing of the tenant, and the final selling price of the property will be a based on a capitalization rate applied to that cash flow. The lower the capitalization rate, the higher the sale price (similar to the method of determining the value of a bond). The capitalization rate is determined by the credit of the tenant, the interest rate environment of the debt markets and the overall condition and location of the property. The mortgage rate for the investor is based on a premium over the 10-year treasury. This key rate has remained very low, providing continued historically low rates for this type of financing. Currently in the Central Massachusetts marketplace, capitalization rates for these types of transactions range from 8% - 10%. Simply stated, if a company paid $500,000 per year in rent for a bond-type structure, they could sell that property in the range of $5,000,000 to $6,250,000. The stronger the credit of the company the lower the capitalization rate, producing a higher end value of the real estate.
This type of structure is ideal for larger companies, which have stable long-term needs for a specific property. The advantages are the ability to extract 100% of the capital out of the real estate, control the increases in the rent payments throughout term of the lease as well having the ability to book the transaction as an “operating lease” which will not be considered to be long-term debt on the company’s balance sheet. One hundred percent of the lease payments are deductible including land and any repayment of principal. The primary disadvantage is that at the end of the term, the company does not own the property, nor have they participated in any appreciation of the property. The offset to this is that the company had full use of the capital to invest in their core business, which should provide a greater rate of return than any appreciation of the real estate.
About the author:
A graduate of the University of Massachusetts in Amherst in 1985 with a degree in Finance. Jim has worked in the real estate industry at Kelleher & Sadowsky Associates specializing in commercial and industrial sales and leasing since 1985. Jim was the recipient of the Costar top 20 award for leasing transactions in both 2003 and 2004. Jim has extensive knowledge of both the industrial and office markets throughout central Massachusetts , and is actively involved in the marketing of many of the areas larger office buildings and industrial parks.
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