Sale-Leaseback vs Refinancing Your Mortgage

A cash-out refinance replaces your existing mortgage with a larger one. You receive the difference in cash, keep title to the building and repay the new loan with interest. A sale-leaseback transfers title to an investor for a purchase price, and you remain in the building as a tenant paying rent.

Owners often compare the interest rate on the loan with the rent on the lease and stop there. That misses most of the decision. The two structures differ on five points: how much cash they produce, what you own afterward, what restrictions you accept, what the money costs over time and how much room you have to change course.

A lender advances a portion of the building's appraised value and sizes the loan to the income available to repay it. A sale-leaseback sells the whole asset. Explainers from Stout and from the law firm Mintz both contrast a typical mortgage at roughly 70% to 80% of appraised value with a sale-leaseback that can be structured for up to 100%. Take those as the authors' general descriptions. What a lender will advance on your building today may differ, so ask one.

Gross proceeds are not net proceeds. A refinance does not involve a sale of the property. A sale-leaseback does, and under IRS Publication 544 gain is the amount realized over the property's adjusted basis, and depreciation taken over the years reduces that basis. For a long-held building, the tax on the gain can remove a meaningful part of the advantage a sale has over a loan. Ask your CPA to estimate it before you compare.

Both routes pay off the existing mortgage first and may trigger a prepayment charge. A sale also carries brokerage and transfer taxes that a refinance does not, while a refinance has lender fees, appraisal and loan closing costs.

With a refinance you still own the building. Appreciation is yours, each payment of principal rebuilds equity, and when the loan is repaid you hold an unencumbered asset. You also keep an owner's freedom to alter, expand or sell.

With a sale-leaseback, the investor owns the building. Future appreciation belongs to the investor. At the end of the lease you have the right to renew if you negotiated it, and nothing else. For a company that expects to operate at the site for decades, that residual value is the main thing given up, and it should be weighed against the extra cash received today.

Commercial mortgages come with conditions beyond repayment. Depending on the lender and loan, these can include financial covenants tested each year, reporting requirements, limits on additional borrowing, a lien on the property and often a personal guaranty from the owners of a closely held company. Many commercial mortgages also mature before they are fully repaid, which means the remaining balance must be refinanced at whatever rates and credit conditions exist at that time.

A lease has a different set of obligations. Stout describes a sale-leaseback as free of financing covenants, and Torys describes these leases as imposing limited financial reporting. In practice, terms vary by investor. Some leases include reporting duties, credit support or a guaranty, particularly for smaller or less established tenants. A lease also restricts things a mortgage does not: alterations, assignment, subletting and how the building may be used.

The fair comparison is specific. Put the actual loan term sheet next to the actual lease proposal and list what each requires of the company and of its owners personally.

A loan's cost is its interest rate plus fees. A sale-leaseback's cost is harder to see, because rent pays for use of the building and for the capital you received. One way to think about it: divide the first year's rent by the sale price to get the investor's initial return, then remember that rent usually rises each year and that you never get the building back.

In its explainer, Stout characterizes sale-leaseback capital as generally somewhat more expensive than senior bank debt and less expensive than mezzanine financing. That is a general observation from one firm. The actual relationship for your company depends on interest rates, your credit and the property at the time you transact.

Taxes affect the comparison in both directions. IRS Publication 334 explains that rent paid for property used in your business that you do not own is deductible, and Stout and Mintz both point out that an owner with a mortgage deducts interest and depreciation where a tenant may deduct the full rent. IRS Publication 946 notes that land cannot be depreciated. Whether the rent deduction is worth more than the interest and depreciation you give up depends on your numbers, and limits may apply. Confirm with your CPA.

A refinance increases debt on the balance sheet and cash by the same amount. The building remains an asset.

A sale-leaseback that qualifies as a sale under US GAAP removes the building and its mortgage and adds cash, and the seller records a right-of-use asset and a lease liability for the leaseback, as the Journal of Accountancy's guide to ASC 842 explains. The lease obligation is on the balance sheet. It is not a way to hide the commitment. Certain terms, such as an option to repurchase the real estate, can cause the transaction to be accounted for as a financing instead of a sale. Ask your accountants how a proposed structure would be recorded and how your lenders' covenant definitions treat lease liabilities.

• Changing your mind. A loan can be prepaid, sometimes at a cost, and the building is still yours. A sale is permanent unless the buyer agrees to sell it back.
• Leaving the site. An owner with a mortgage can sell the building and pay off the loan. A tenant must rely on assignment or sublease rights, or negotiate a termination.
• Changing the building. An owner needs little permission. A tenant needs whatever the lease requires.
• Hard times. A lender may agree to modify a loan. A landlord may agree to modify a lease. Neither is obligated, and in both cases the remedy for nonpayment puts your occupancy at risk.
• Refinancing risk. A lease with a long term and renewal options has no balloon payment. A mortgage usually does.

Request a loan term sheet and a realistic sale-leaseback estimate at the same time, then answer the same questions for each.

• ✓How much cash do we receive after paying off the current mortgage, all costs and, for a sale, tax on the gain?
• ✓What are the annual payments in year one, year five and year ten?
• ✓What financial covenants, reporting duties and guaranties apply?
• ✓When does the obligation mature or expire, and what happens then?
• ✓What do we own at the end?
• ✓What approvals do we need to alter the building, sell the company or leave the site?
• ✓How is it recorded in our financial statements, and does it affect any other loan covenants?
• ✓Is the amount of cash matched to what we actually need?

TAG helps owners make this comparison before committing to either path. We estimate what the building would bring in a sale-leaseback and on what lease terms, so that the alternative to your lender's proposal is a real number and not a guess.