Sale-Leaseback Pros and Cons for Business Owners

You receive a sum of money once and, in exchange, take on a rent obligation and a landlord for many years. Every advantage and disadvantage below is a consequence of that exchange. Reading them side by side is more useful than reading either list alone, because most of the advantages are immediate and most of the disadvantages arrive later.

• Cash based on the property's full value. A sale converts the market value of the building into cash, where a mortgage lender advances only a portion of appraised value.
• No move. Operations, staff, equipment, licenses and customers stay where they are. For a plant with heavy equipment or a medical practice with a built-out clinic, avoiding relocation is worth a great deal.
• The mortgage is retired. Proceeds pay off the loan on the building, removing that debt service and any covenants attached to it.
• Capital moves into the business. Money that sat in real estate can fund equipment, hiring, acquisitions or a partner buyout.
• No refinancing risk on the property. A long lease fixes your right to occupy and your rent schedule for its term, where a mortgage may need to be refinanced at whatever rates exist when it matures.
• Less concentration. Owners no longer hold a large single-property investment whose value depends in part on their own company staying in it.
• A simpler company to sell later. Some buyers of operating businesses prefer not to acquire real estate.

These are real, and for the right company they are decisive. They are also the points an investor or a broker working for the investor will emphasize, so weigh them against the other list with equal care.

• You no longer own the building. The decision cannot be undone unless you negotiated a right to repurchase, and such rights are resisted by investors and have accounting consequences.
• Future appreciation belongs to the landlord. If the property or the neighborhood gains value, you do not share in it.
• Rent is a fixed obligation that usually rises. Leases in these transactions run for many years and normally include scheduled or inflation-linked increases. A paid-off building costs nothing in rent in a bad year. A lease does.
• Less control. Alterations, expansions, signage, subletting and assigning the lease to a buyer of your company generally require landlord consent under terms set in the lease.
• You may keep the costs of ownership without the ownership. Under a triple net lease the tenant still pays property taxes, insurance and maintenance, and in some leases roof and structural work as well.
• End-of-term risk. When the lease and its renewal options run out, staying depends on reaching a new agreement with the landlord at that time.
• Tax on the sale. A gain on the sale is generally taxable, which reduces what you keep.
• Your landlord can change. The investor may sell the building, and you will deal with whoever buys it.

Trade publications that write for investors acknowledge one more risk: a seller may accept rent above the market level in exchange for a higher price, which can strain profitability later. The price is received once and the rent is paid for the whole term.

Three subjects are routinely presented as advantages. Each depends on your situation and belongs with your CPA.

Balance sheet. A sale-leaseback is sometimes sold as a way to reduce liabilities. That is not how current US accounting works. Under ASC 842, when the transfer qualifies as a sale, the seller removes the building, recognizes any gain or loss and records a right-of-use asset and a lease liability for the leaseback. A mortgage may leave the balance sheet while a lease liability arrives. If the transfer does not qualify as a sale, for example because the leaseback is classified as a finance lease, the building stays on the books and the cash received is recorded as a financial liability.

Rent deductions. The IRS states that rent is deductible as a business expense only when it is for property used in the business, that rent is not deductible if you have or will receive equity in or title to the property, and that unreasonable rent cannot be deducted. Whether rent deductions are more or less valuable to you than the depreciation and interest deductions you have today is a calculation, not a rule.

Tax on the gain. The IRS describes a gain as the amount realized from a sale that exceeds the property's adjusted basis, and its guidance notes that part of a gain on depreciated business real estate may have to be recognized as ordinary income under depreciation recapture rules. A building owned for a long time and heavily depreciated may carry a large taxable gain. Confirm the figure with your CPA before you rely on a proceeds estimate.

Ask your CPA for two numbers before you decide: estimated after-tax proceeds, and how the lease will appear on your financial statements and in your loan covenant calculations.

Some of the downsides are inherent in selling. Others are a matter of lease drafting, which is where an occupier-side advisor earns its fee.

• Cannot be negotiated away: loss of ownership, loss of appreciation, the existence of a rent obligation, tax on the sale.
• Can be shaped: the starting rent, the form and size of increases, the length of the initial term, the number and pricing of renewal options.
• Can be shaped: who pays for the roof, structure and major system replacements, especially near the end of the term.
• Can be shaped: your freedom to alter the building, sublet, or assign the lease when you sell the business.
• Can be shaped: the condition in which the building must be returned.

TAG represents the seller who becomes the tenant, so our attention goes to the second group. The sale price is settled once. The lease terms decide how the transaction feels in year eight.

• ✓After the mortgage payoff, costs and tax, how much cash would we actually keep?
• ✓What will that cash earn or save, compared with the rent over the same years?
• ✓Can the business pay the rent, including increases, in its weakest plausible year?
• ✓How would we feel if the building doubled in value after we sold it?
• ✓Which lease terms would we need to make the loss of control acceptable?
• ✓What happens to us at the end of the term and the last renewal option?
• ✓Have our lenders and CPA reviewed the effect on covenants and reporting?

If the advantages still outweigh the costs after those answers, the transaction is worth pursuing. If the case depends on an accounting benefit or on rent you can only just afford, it is not.