Companies that carry on an operating business that is not in the business of investing in real estate can often help maximize the use of their assets with a sale-leaseback transaction. An owner will sell its real property to investors and retain the benefits of its location through a tenancy, usually a long-term lease with terms of 10 to 20 years.
A typical example would be a company that has, over the years, acquired a number of locations across Canada where it manufactures its products. It has acquired those sites over time and has either constructed or retrofitted buildings to make them suitable for its manufacturing purposes. Such locations were acquired to meet the needs of its operating business and to be close to its customers in locations where it could obtain the raw materials and skilled workers for its manufacturing process. The company acquired those locations using a mixture of the profits from the business (shareholders’ equity) and loans to the company. Being in those locations helped the successful business grow and it is now a strong company with assets, a strong business and good support from its customers. However, it is not a professional real property investor or land developer. Its expertise is in manufacturing, sales and client service and there may be a number of reasons why it wishes to consider a sale-leaseback transaction.
For the vendor, here are some of the possible benefits of a sale-leaseback transaction:
- It eliminates debt and frees up equity either to distribute to shareholders or to use in a more effective, advantageous way.
- It ensures the continued use of those crucial sites for its operating business for the foreseeable future.
- It can obtain greater returns in its core operational business than it can from the ownership of real estate.
- It can eliminate debt and/or free up its ability to take on other debt to assist with the financing of its business.
- It can take advantage of existing positive market conditions.
- It can use the real estate expertise of purchasers to handle future property issues.
- It will be entitled to deduct its rental as an ongoing operating expense and avoid capital tax.
- It can improve its balance sheet by exchanging fixed assets carried at below-market value for cash.
The challenge for the lawyer drafting the documents in a sale-leaseback transaction is to strike a balance between the goal of the broker to have the most marketable product that it can and the goal of the vendor to ensure that it has adequate protections for its business interests in the future. That balance makes these files interesting.
Other Similar Transactions
What is described above is a typical sale and leaseback transaction but each transaction will have its own individual characteristics. Other vendors/tenants in sale and leaseback transactions may have different goals. For example, a company may decide to consolidate its locations into a single location serving all of Canada with a goal of freeing up capital and taking advantage of the existing market conditions. It could carry out a sale and leaseback transaction with much shorter leases with a goal of continuing to provide the operating company with the use of the real estate assets only until the longer-term organizational goal is realized. With that variation, the negotiation on the sale side and lease side is much closer to a traditional property sale and short-term lease negotiation. While that kind of transaction is also technically a sale-leaseback transaction, it has different goals and does not fit as closely with the typical structure this memorandum deals with.
Another approach is to use a sale-leaseback transaction more as a financing technique, much more akin to a build-to-suit arrangement. In this situation, the company has a site that it would like to develop, it arranges for a contractor/developer to buy the land from the company, develop and construct the manufacturing facility and lease it back over a long term lease that will provide the developer/contractor with sufficient funds to pay off its financing and to obtain a reasonable profit from the construction of the building. In these circumstances, the lease is much more of a capital nature, than an operating nature and, at the end of the term, the tenant usually has the right to purchase on a nominal or reduced-cost basis. Again, while technically a sale and leaseback, this transaction is more a financing technique and is not the subject of this paper.
Some Final Remarks
The traditional sale and leaseback may be an excellent way for a company to use real estate that is important to its operations for the foreseeable future, while allowing the company to free up debt and equity capital and achieve some of the various advantages listed earlier. In order to complete such a transaction there are significant marketing and legal issues to be dealt with and it is important for a company to obtain the right advisers so that the transaction is carried out, the value is maximized and the company’s operational interests are adequately protected during the term of the lease.