Property sale and leaseback, if structured and implemented properly, offers commercial benefits to seller/tenants and buyer/landlords alike. Sellers can release value while retaining use and possession of property. Buyers can secure a long-term and consistent income stream with the upside of property appreciation and future development options.
In a nutshell, “sale and leaseback” describes a transaction where an owner/occupier sells its property and stays on as a tenant. It’s an arrangement that can release capital for business investment, free a seller of the burdens and risks that come from owning real estate, and deliver steady rentals and speculative opportunities to an astute buyer.
In this Property Reporter, Moulis Legal’s Lauren Gray and Isabel Wormald give their insights into the sale and leaseback structure, examine some risk minimisation strategies, and look at how operators and investors can make the structure work.
What’s all the fuss about?
As competition heats up and profit margins narrow, businesses are increasingly asking themselves the question – what are we good at? Old models of ownership are being eroded by the realisation that property is a business itself, and that organisations that are not in the property business are unlikely to be able to make the best of that asset. The organisation might decide to sell its property to a third party, and at the same time enter into a long-term lease to continue its occupation and the conduct of its business.
And they are becoming increasingly popular, with many companies taking advantage of favourable conditions in the property market to release capital to invest in and operate their businesses.
High profile sales and leasebacks have recently captured a lot of investor interest, in the agribusiness, commercial, and retail sectors:
- Chinese developer Hengmao Group acquired Computershare’s headquarters in Melbourne for AUD88.88 million subject to seven year leaseback through to 2029 at a starting rent of AUD5.3 million annually.1
- Shanghai Zhongfu’s acquisition of the 476,000 ha Carlton Hill property in the Kimberley area of Western Australia, for a purchase price of AUD100 million, accompanied by a 10-year leaseback of most of the uncropped land for the seller to continue cattle-grazing on the land.2
- The David Jones menswear store in Market Street, Sydney – which had not changed hands for almost 80 years – was acquired by Scentre/CBUS Property for AUD360 million, subject to a short term leaseback to DJ’s owner Woolworths until late 2019.3
Here at Moulis Legal in Canberra we have been involved in a number of the very large-scale Commonwealth office sales and leasebacks that have taken place in the ACT, and handled last year’s Tabcorp agency divestment and leasebacks as part of its ACTTAB takeover.
Is it worth it?
This depends on the commercial circumstances, however a well-structured and well-drafted sale and leaseback will clearly offer strong benefits to both parties. The seller can maximise the sale price and simultaneously set favourable or at least suitable commercial lease terms. It is then freed of the burdens of owning, managing and financing its property, and the new rent might be less than the current mortgage repayments. The buyer will realise the benefit of a sale and leaseback structure through the security of a consistent long-term income stream, taking advantage of taxation concessions, and the implementation of its pre-existing systems, processes and management. As well as those benefits, asset appreciation and redevelopment options may subsequently transpire.
A seller does however have to think carefully about the loss of operational flexibility that comes with entering a sale and leaseback arrangement. Selling a property and entering into a long-term lease means the operator is essentially locked into that location until the lease is up. This makes relocations or closures costly, because this would require early termination and accelerated payments under the lease.
Any leaseback should include protective (albeit reasonable) clauses to address this and a number of other commercial realities arising out of this inflexibility. For example, an owner that assumes the role of tenant loses the ability to unilaterally decide to renovate its buildings, as it will normally only be able to do so with the new owner’s consent. The leaseback can be drafted in such a way as to assist in providing the tenant with rights that more closely approximate ownership rights, however this could impact on the value of the deal for the seller by reducing the amount the buyer will be prepared to pay.
A seller/tenant should ensure sufficient protections in the lease if it does not want to lose the tenancy at the end of the initial lease term, by way of a future repurchase option or options to renew.
Conduct due diligence
Before selling, owners should conduct legal and physical due diligence on the property, to flush out any problems that need resolving before going to market.
This due diligence process should include:
- market research, and sufficient understanding of investment yields to justify the arrangement (where necessary, a feasibility study to verify the arrangement from a financial perspective)
- a review of taxation implications in respect of the specific circumstances
- full legal consideration of the proposed terms and options to be included in the lease, including proposed rent, incentives, annual rent reviews, facility management and indexation and fixing of outgoings
- sufficient identification of what will and won’t form part of the “property” to be leased back to the owner upon sale (e.g. land/buildings, fitout, machinery, other infrastructure)
Target the right investor/purchaser
A seller looking to occupy the property in the long term should target the kind of seller that wants a long-term investment. Ideally the lease would include a right on behalf of the tenant to carry out upgrades and expansions so that the property is suitable for the continuing use of the tenant in the long term, and where relevant (e.g. farmland or rural areas) a right of repurchase by the tenant.
Ensure the contract reflects commercial agreement
The key terms of the contract underpinning the sale and leaseback structure should ultimately reflect an appropriate balance between a reasonable rate of return for the benefit of the buyer/investor and sufficient affordability to the seller/tenant.
In terms of costs and payments, a thorough due diligence exercise should help to define any outgoings to be payable (now and into the future) in respect of the property, including by whom, and whether such costs are included as part of the rent.
Be aware of tax implications – upside and downside
Parties should be aware of the taxation implications associated with the structure chosen. Sale and leasebacks carry specific GST, stamp duty, and income taxation implications which should be properly accounted for in the relevant contract. Again, a thorough due diligence exercise and a well drafted contract should both reveal and reflect any of the taxation consequences that the arrangement will attract, either inevitably or by strategic choice.
With a proper amount of planning and risk management, sale and leaseback is likely to be a very good option for organisations that simply do not need to own property to conduct their business. The key is to strike the balance between fairness and reasonableness for the buyer/landlord on the one hand, and sufficient control and certainty for the benefit of the seller/tenant on the other hand. Contract documents should carefully outline the commercial considerations of this option, with appropriate additional risk mechanisms implemented for specific transactions on a case by case basis.