Can You Buy Your Building Back Later?

Owners who sell a building they have occupied for decades often want a way to get it back. The request is reasonable, and there are three common forms it can take. They are not interchangeable.

• Repurchase option. You have the right to buy the building at a stated time or times, at a price that is fixed, set by formula, or set at fair market value when you exercise. You decide whether and, within the lease's limits, when. This is the strongest right.
• Right of first offer (ROFO). If the landlord decides to sell, it must offer the building to you first, on terms it names or you propose. If you pass, or the two of you cannot agree, the landlord can sell to others, usually not on terms more favorable to the buyer than those you declined.
• Right of first refusal (ROFR). If the landlord receives an offer from a third party that it wants to accept, you may match it within a set period and buy the building yourself.

With an option, you control the trigger. With a ROFO or ROFR, the landlord does: nothing happens unless the landlord chooses to sell. An owner who wants certainty of getting the building back needs an option. An owner who wants protection against ending up with an unknown or unwelcome landlord may be well served by a first offer or first refusal right.

For a company reporting under US GAAP, this is the first thing to understand, because it can change the result of the whole transaction.

Under ASC 842-40-25-3, an option for the seller-lessee to repurchase the asset precludes accounting for the transfer as a sale unless two conditions are both met: the exercise price is the fair value of the asset at the time the option is exercised, and alternative assets substantially the same as the transferred asset are readily available in the marketplace. Accounting guides explain that real estate does not meet the second condition. The FASB's basis for conclusions, as quoted in one guide, says real estate assets will never qualify as substantially the same. KPMG's summary makes the same point from the other direction: with a qualifying fair value option, a transfer may still be a sale if the asset is not real estate.

So even a repurchase option priced at fair market value will generally prevent sale accounting for a building. The transaction is then accounted for as a financing:

• The building stays on your balance sheet and you continue to depreciate it.
• The cash you received is recorded as a financial liability.
• No gain or loss is recognized.
• Payments are split between interest and principal.

The assessment is revisited if facts change. Deloitte's leases guide gives the example of a seller-lessee repurchase option that expires unexercised: at that point control may transfer, the asset and the financial liability are removed, the difference is recognized in profit or loss, and the leaseback is then accounted for as a lease. An option that exists for only part of the term therefore changes the accounting for that part.

A separate issue arises under the lease classification rules. A purchase option the lessee is reasonably certain to exercise is one of the criteria that make a lease a finance lease, and an industry article on the model notes that a fixed-price repurchase option may result in a failed sale on that basis.

Financing treatment may be perfectly acceptable to you. Some owners want the option more than they want a particular accounting result. The mistake is to learn about it from the auditors after closing.

Federal tax law asks a different question: whether the buyer is the real owner or the arrangement is a loan in substance. A Journal of Accountancy article on sale-leasebacks of real property lists, among the tests for a valid leaseback, that if the seller repurchases the property the price must be fair market value and not a discount. It also stresses that no one factor controls.

The Supreme Court's decision in Frank Lyon Co. v. United States shows that an option does not by itself turn a sale-leaseback into a loan for tax purposes. The lessee there held options to repurchase at set prices, and the Court still respected the buyer as owner, pointing among other things to the absence of any understanding that the options would be exercised and to option prices that were reasonable and negotiated at arm's length.

The practical reading: a right to buy back at a bargain, or a deal in which everyone expects the repurchase to happen, is where the tax risk concentrates. Have tax counsel review any purchase right, including how the price is set, before it goes into a letter of intent.

A right of first offer or first refusal does not let you force a sale, and it is a different kind of right from an option to repurchase. The accounting sources we reviewed for this guide address repurchase options specifically and do not state how a right of first offer or first refusal held by the seller-lessee is analyzed. We are therefore not going to tell you how your auditors will treat one. Put the question to your CPA with the proposed wording before you agree to it.

On the business side, the two rights differ in ways that matter.

• A ROFR can discourage third-party bidders, who do not like to spend time and money on diligence only to have their offer matched. Landlords resist it for that reason, and buyers financing or reselling the property may too.
• A ROFO is less disruptive to a later sale, because it is dealt with before the landlord goes to market. Investors accept it more readily.
• Either right needs clear mechanics: what triggers it, how long you have to respond, whether it applies to portfolio sales, transfers to affiliates and foreclosures, and whether it survives the first sale or ends with it.
• Either right should pass to a permitted assignee of the lease, or a buyer of your company will not get it.

A sale-leaseback buyer is paying for the rent and for the building's value at the end of the lease. A repurchase option, especially at a fixed price, caps that end value: if the property appreciates, you take the upside by exercising, and if it does not, the investor keeps the asset. Investors price that, and some will not bid at all.

• Buyers who rely on financing may find their lenders object to a tenant purchase right.
• Buyers who plan to resell see any tenant purchase right as a complication for the next buyer.
• Where a seller option leads to financing treatment, the buyer's own accounting for the transaction is affected as well.

Expect a narrower buyer pool or a lower price for a true repurchase option, less resistance to a fair market value option exercisable at limited times, and the least resistance to a right of first offer. Asking bidders to price the deal with and without the right tells you what it actually costs.

• ✓Why do we want the building back: to own it again someday, to control who our landlord is, or to protect our investment in specialized improvements?
• ✓Would long renewal options at defined rents meet that goal without a purchase right?
• ✓If we want an option, are we and our lenders comfortable with financing treatment in our financial statements?
• ✓How would the option price be set, and has tax counsel reviewed it?
• ✓Realistically, would we have the capital to exercise?
• ✓Would a ROFO give us enough protection at a lower cost in price and buyer interest?
• ✓Has our CPA reviewed the exact wording of any purchase right before it goes into the letter of intent?
• ✓What did bidders say the right is worth when asked to price the deal both ways?

Often the underlying goal is control of the site, not ownership as such, and that can be met with term, renewal options and a first offer right. When we represent a seller, we start with the goal, bring in the CPA on the reporting question, and then test the market on what each form of right costs.