8 Common Myths About Sale-Leasebacks

This is the most repeated claim and it is out of date. Under the earlier US lease accounting standard, operating leases were expensed as paid and were not reported on the tenant's balance sheet, so swapping a mortgage for an operating lease made reported liabilities fall. That standard has been replaced.

Under ASC 842, lessees record a right-of-use asset and a lease liability for operating leases longer than 12 months. When a sale-leaseback qualifies as a sale, the seller removes the building from its books, recognizes any gain or loss, and records a right-of-use asset and a lease liability for the leaseback. If the mortgage is paid off, that debt is gone, but a new liability for the lease appears.

It can be worse than that. If the transaction does not qualify as a sale, for instance because the leaseback is classified as a finance lease, accounting guidance treats it as a financing: the building stays on the seller's balance sheet, depreciation continues, and the cash received is recorded as a financial liability.

What is true: a sale-leaseback converts an illiquid building into cash and can retire mortgage debt. Whether your reported liabilities end up higher or lower depends on the facts. Ask your CPA to model it before you decide.

Companies under financial pressure do use sale-leasebacks, and a well-structured one can give such a company room to recover. But the buyer's entire investment depends on the tenant paying rent for many years, so investors prefer sellers with a solid financial record or a strong position in their market. Healthy companies are the easiest to finance this way.

Profitable businesses use the structure to fund expansion, equipment, acquisitions and ownership changes. Treating it as a last resort causes some owners to dismiss a tool that would suit them and causes others to wait until their negotiating position has weakened.

You lose ownership. Control is a separate matter and most of it is written into the lease. Under the net leases used in these transactions the tenant typically runs the building day to day, maintains it, insures it and decides how to operate inside it, much as before.

What changes is that certain decisions now need the landlord's consent, on whatever terms the lease sets. Those terms are negotiable before closing and very hard to change after. The points that determine how much control you keep include:

• How long you can stay, including the number of renewal options and how renewal rent is set.
• What alterations you can make without asking, and the standard the landlord must meet to refuse.
• Whether you can sublet space you no longer need.
• Whether you can assign the lease to a buyer of your company, and whether you are released when you do.
• What you must remove or restore when you leave.

A seller who negotiates these well keeps most practical control. A seller who signs the buyer's form may find it has kept very little.

Price and rent are two ends of the same calculation. An investor sets its price largely from the rent the lease will pay, so a seller can raise the price by agreeing to pay more rent. The larger check feels like a win at closing. The larger rent is then paid every year of the term, and increases compound on top of it.

Industry guidance written for owners warns about this directly: accepting above-market rent in exchange for a higher price can strain the tenant's profitability and leave the building harder to re-lease at market rates. It can also complicate a later sale of your business, because the buyer inherits the lease. Accounting guidance adds that when a sale-leaseback is not at market terms, the sale price is adjusted in the accounting, and a reduction of the stated price is recorded as additional financing.

Compare offers on price, rent, increases, term and repair obligations together. The offer with the top price is frequently not the one that leaves the company best off.

Owners sometimes think of a sale-leaseback as borrowing against the building with rent in place of interest. The comparison is useful for judging cost, and that is where it ends. A loan is repaid and the building is still yours. In a sale-leaseback the building belongs to the investor at the end of the lease and you hold only the rights the lease gives you.

Owners who accept that sometimes assume the door stays open, and that they can add a right to repurchase the building. That has consequences. US accounting guidance provides that a seller's option to repurchase generally prevents the transfer from being accounted for as a sale, and the narrow exception available for other assets does not apply to real estate. Tax treatment can also be affected: the IRS states that rent is not deductible if you have or will receive equity in or title to the property. Discuss any repurchase right with your CPA and attorney before proposing it.

There is no automatic right to repurchase. If the lease does not contain one, the building is the landlord's to keep or sell to anyone. Investors generally resist repurchase options because the option limits what they can do with the property and what a later buyer will pay them for it.

A right of first offer or first refusal, which gives you a chance to bid if the landlord decides to sell, is sometimes easier to obtain than a fixed-price option. Each form of right should be reviewed for its accounting effect as described above.

Under a triple net lease the tenant pays property taxes, insurance and maintenance in addition to rent. Those are costs you already carry as owner, so the comparison that matters is rent against the mortgage payment you are eliminating, with everything else roughly the same.

Two differences are easy to miss. A mortgage payment ends when the loan is paid off, and a paid-off building has no payment at all. Rent continues for as long as you occupy the building and normally rises. Second, a mortgage payment builds equity. Rent does not. The transaction can still be right, but the two payments are not equivalent.

There is no standard sale-leaseback lease. Every investor has a preferred form, written to favor the landlord, and each differs on repairs, replacements, casualty, assignment, default and surrender. The sale is over in a few months. The lease governs your occupancy cost and flexibility for the whole term and any renewals.

That is why TAG represents the occupier in these transactions and negotiates price and lease as a single package. The seller is selling once and renting for years.

• ✓Has our CPA modeled the balance sheet after the transaction under ASC 842?
• ✓Is the proposed rent at market for comparable buildings?
• ✓Which decisions about the building will need landlord consent?
• ✓Who pays for roof, structure and system replacements?
• ✓Can the lease be assigned to a buyer of our business?
• ✓Do we have any right to buy the building back, and what does it do to the accounting and tax treatment?