Expanding your business? A void direct real estate ownership.Today, a great many companies are recognizing the advantages of not directly owning their own real estate. Corporations can enjoy significant benefits by moving their real estate off-balance sheet, which allows them to invest their capital in other areas and has a favorable impact on their earnings. There are two primary types of off-balance sheet lease structures that exist that provide a good fit for these firms - Credit Tenant and Synthetic Leases. High growth, dynamic firms who need to avoid tying up valuable capital are ideal for these types of transactions. After all, they are in business to develop new products, not buildings. Investing in research and development or business expansion are better uses of capital an produce higher returns than real estate equity. Secondly, real estate adds no incremental Additional or increased growth, bulk, quantity, number, or value; enlarged. Incremental cost is additional or increased cost of an item or service apart from its actual cost. value to a company's stock price. This is important because most technology firms are either public or intend to go public, and public companies are valued on earnings capitalization, not assets. By moving real estate off-balance sheet, technology firms will recognize improved earnings per share and a higher return on assets Return on assets (ROA) Indicator of profitability. Determined by dividing net income for the past 12 months by total average assets. Result is shown as a percentage. ROA can be decomposed into return on sales (net income/sales) multiplied by asset utilization (sales/assets). . Two favorable leasing structures are available today that can help companies avoid direct ownership, leverage their credit for up to 100 percent financing, and still maintain control of the real estate. The Credit Tenant Lease A credit tenant lease is a method of financing real estate. The landlord borrows money to finance the property and pledges as security the rents to be received from the tenant. (i.e. Bondable lease) is a long-term financial vehicle. Typical lease terms range from 18 to 25 years, with rental rates that reflect the company's credit rating and long-term debt Long-Term Debt Loans and financial obligations lasting over one year. Notes: For example debts obligations such as bonds and notes which have maturities greater than one year would be considered long-term debt. rate. For an investment grade company, the favorable credit component can drive rental rates below market rents. This structure provides for 100 percent financing, eliminating the need for capital devoted to real estate. From a tax perspective, the company can deduct the rent payment against its taxable income Under the federal tax law, gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual or entity's tax liability. The essence of taxable income is the accrual of some gain, profit, or benefit to a taxpayer. and, if structured as a sale/leaseback, the gain can be amortized over the lease term. At the end of the lease term, the lessee can purchase the building at fair market value or renew the lease. The drawbacks of this structure are the loss of any residual value Residual value Usually refers to the value of a lessor's property at the time the lease expires. residual value The price at which a fixed asset is expected to be sold at the end of its useful life. that would accompany ownership, commitment to a long-term lease, and full liability under the lease. The Synthetic Lease is a short-term financial vehicle. Typical lease terms range from 3 to 7 years at rates floating over LIBOR LIBOR See: London Interbank Offered Rate LIBOR See London interbank offered rate (LIBOR). . A special purpose entity (SPE SPE - Software Practice and Experience ) is set up to own the property and makes a small equity investment, typically 3 percent. The SPE then funds the balance of the purchase price through debt financing Debt Financing When a firm raises money for working capital or capital expenditures by selling bonds, bills, or notes to individual and/or institutional investors. In return for lending the money, the individuals or institutions become creditors and receive a promise to repay . The lessee pays the interest as rent, which is tax deductible, and possibly some amortization. At the end of the lease term, the lessee has a variety of options: to purchase the property at a price lower than the debt balance; renew the lease by refinancing; have the property sold to a third party at fair market value and either make up any deficiency in the debt balance or realize any gain; or walk away after making a final minimum contingent rental payment. When companies evaluate their real estate needs, they should consider Credit Tenant and Synthetic Lease structures and evaluate them against traditional forms of real estate procurement, i.e., net lease and ownership. In many cases, off-balance sheet structures can provide significant economic, profit and loss, and tax benefits for a company. |
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