Most corporations of any size and scale have large investments in the land and facilities necessary for the successful operation of their business. While making corporate investments into real estate assets may seem to be a reasonable strategy at first glance, they are rarely investment or capital driven decisions, but rather operating decisions that in retrospect usually fail to maximize the leverage and value of their land and facilities beyond what is typically provided for within traditional ownership and financing structures. In today’s post I’ll address one of the popular options for leveraging your corporate real estate assets
- Improved Financial Statements: By moving corporate real estate assets “Off-Balance Sheet” financing solutions are engineered that create no mortgage or other indebtedness to be carried as debt on your company’s balance sheet. The immediate boost in cash without offsetting debt can improve the overall financial health of a business. Book income typically increases in the transaction’s early years, with rent payments less than the interest and depreciation under conventional financing. With most sale leaseback solutions, the book value of company assets is effectively understated thereby enhancing your company’s Return on Assets (ROA).
- Financial Flexibility: Corporate real estate transactions are not bound by formalized loan industry or REIT requirements, giving lenders flexibility to meet the operating needs of your business. Rents can be fixed for the full lease term without inflation adjustments or any percentage rent. Rents can also be stepped to be lower in the early years or reset periodically to take advantage of improved credit, interest rates and other conditions. The sale leaseback structure can also be engineered to address seasonal financial variations.
- Operational Control: Even though you no longer own the facility, most lenders offer programs that will allow you to retain complete operational control of the property for as long as it is required in your business.
- Low After-Tax Cost: The lease payment under a sale leaseback structure is fully deductible over the lease term, making the after-tax cost to your company less than with alternative forms of asset-based financing and is also less than the market rent you would typically pay. For federal income tax purposes, a company can only depreciate buildings and other physical improvements, but not land. Most sale leaseback solutions factor the value of the land into the rent. The rent is fully deductible, effectively enabling you to depreciate the cost of the land.
- Credit Tenant Property Can Provide Similar Financial Benefits to the Issuance of Corporate Bonds: If a business is deemed to be a credit tenant or its financial equivalent, its corporate real estate assets can be effectively used to secure management-free cash flow with exceptional liquidity and high leverage performing like corporate bonds while preserving the benefits that real property offers. Because of the secure character of credit tenant property investments, properties can be leveraged far more highly than traditional real estate. Based on the lease guarantee by the tenant, non-recourse financing may be arranged with a 1.0 debt coverage ratio, allowing for financing Up to 100% loan to value. Income from an investment grade tenant over the length of a multi-year lease offers reliable returns comparable to those of corporate bonds. Credit tenant leases are usually written for terms ranging from 10 to 25 years. Lengthy terms eliminate concern about tenant turnover normally associated with real estate ownership.
- Near-Zero Volatility: Many of the corporate real estate programs today offer fixed rent structures providing full inflation protection. Because the key value determinant of credit tenant property is the long-term corporate guarantee, this asset does not experience the cycles affecting other real estate markets. Long-term, highly leveraged financing removes interest rate risk and minimizes pricing volatility. Circumstances affecting traditional real estate, such as changes to surrounding property, local politics and market swings have little impact on credit tenant property values.
- Liquidity: The long-term corporate guarantee of rental income and expense coverage combined with the tenant-based financing enable corporate real estate assets to be traded with exceptional liquidity not typically associated with real property. Most lenders will allow businesses to convert existing fixed real estate assets into cash at fair market value at what may be a premium over book value. Funding can also be used for new construction including the cost of the land acquisition. Proper use of corporate real estate as a financing tool will eliminate the need for a business to tie up capital or credit in land or buildings.
A wide variety of sale leaseback structures are available from lenders who have a practice area dedicated to corporate real estate finance. When developing your capital formation strategy make sure you evaluate corporate real estate assets as a viable vehicle for accomplishing your goals.