Sale leasebacks: strategy for the 90's.

As a commercial real estate broker who specialized in sale leaseback transactions and the leasing of office facilities in Northern New Jersey in the late 1980's, I had the occasion to speak to many financial officers at the CEO, CFO, Treasurer and

Controller level inquiring to the potential of effectuating sale leaseback transactions on corporately owned property.

Very often the responses were quite similar. The perception was that sale leasebacks were for weak companies that needed to raise cash in a hurry. Many of these officers pointed out the residual value of the real estate and the untapped potential therein as a "cost" factor that rendered sale leasebacks uneconomic. They also pointed out that these assets were appreciating, therefore, the sale leaseback transaction gave them short-term benefits with a long term downside (giving up the residual).

Many of the officers I referred to above are no longer gainfully employed at those same corporations. Not only are zeal properties not appreciating, but in many cases may have lost 25 percent to 50 percent of their value. Corporate America, especially here in the Northeast, has undergone such a radical transformation that those of us who are still here sometimes are still dismayed and surprised by the length and the depth of profound change that has taken place in the market.

Concepts like consolidation, "right-sizing", downsizing, cost cutting, trimming the fat, maximizing corporate assets, creating profits, out-sourcing, stock enhancement, balance sheet enhancement, and tax strategies are being pursued with great vigor. Even at the largest and most powerful corporations, there is a profound change in the way they are doing business. Needless to say, at the corporate officer level of major banking institutions and insurance companies, this is also very much the ease.

Today, corporate officers, as well as real estate executives, are looking for ways to downsize their real estate portfolios and cut costs wherever possible and maximize return on assets. This trimming the fat, so to speak, is taking place at every major corporation, every major insurance company and certainly every major bank in the country. While the process is good, it is also painful for many. Today, the corporate officers we speak to are open minded to new strategies that can enhance their portfolio, create value, and cut costs. The sale leaseback is one vehicle that can enable credit-worthy companies to effectuate these changes.

Structured properly and in accordance with FASB guidelines, the sale leaseback is a means of off-balance sheet financing, which can allow the corporation to improve its return on assets, obtain long term low cost financing, enhance the balance sheet, avoid hostile takeovers, create profit, and raise cash.

The key elements involved in working with FASB guidelines for off balance sheet treatment are to make sure that the sale conforms to the test of being a normal sale leaseback which is defined as active use of the property in the trade or business of the seller lessee. Generally, leases are absolute net in nature, and quite often they are bond type net leases. Lease terms generally range from 15 to 20 years and there are no repurchase options, equity participation, bargain rentals or other such devices involved in the lease. In accordance with the guidelines established with FASB 98, such loopholes have been taken out. In accordance with FASB 13, the net present value of the minimum rent during the lease cannot exceed 90 percent of purchase price when discounted at the lessee's so called "cost of funds" and generally the gain on the sale is recognized over the term of the lease.

We understand there are certain types of companies such as mutual insurance companies as well as subsidiaries of companies with foreign parents that may book the gain in the year of the sale. We know of two British companies that have completed sale leasebacks recently with subsidiaries in the United States and due to British Gap Accounting have recognized the gain in the year of the sale.

Sale leaseback buyers are extremely credit oriented and they seek investment grade credit or as close to investment grade as possible when effectuating sale leaseback transactions. Despite today's tough financing climate, it is still possible to finance a long term lease from a credit-worthy company. We know of several major buyers however that specialize in non-credit sale leaseback transactions. Typically, they look much more closely at the value of the bricks and mortar and the purchase price in that event may be at a discount from fair market value rather than a premium as in the traditional sale leaseback. Additionally, the yield to the investor going in (cap rate) will be in the 12 percent range and possibly higher for such lesser credit deals.

As the broker who was involved with the $80 million sale leaseback of the Mutual Benefit Life Headquarters building in Newark, New Jersey, prior to their collapse, I learned a little something about credit. All of the major credit rating agencies, with the exception of Weiss Research, gave Mutual Benefit the highest credit rating possible up until the time of its collapse. Needless to say that event threw a nuclear monkey wrench into the deal.

Major sale leaseback purchasers may pay a premium in relationship to today's fair market value for the privilege of completing a transaction with a company of investment grade credit when a long-term lease, of 15 to 20 years, is structured. There is a limit, however, to how much a company can realize on the sale of a given property. At the end of the day, the sale leaseback investor must be able to go out to at least one MAI appraiser to justify the sale price for the purposes of financing the property, although such appraisals do take into account the financial value of the lease from a credit worthy lessee as a significant contributor to value.