Basics of Sale-Leaseback Financing Transactions

As a result of market conditions, many investors and entrepreneurs are coming up with creative techniques to facilitate loans to borrowers who are unsuccessful in securing a traditional loan from a traditional lender, such as a bank. One such technique is a hybrid of the traditional sale-leaseback transaction. Here is an example of how it works:

Borrower is a manufacturer that owns the real estate from which it operates. Borrower needs additional working capital, but cannot secure further credit facilities from its bank. Borrower has equity in the real estate it owns and occupies, but needs the real estate for its business and does not want to sell the real estate to generate funds to inject into the business. Investor then offers the Borrower to enter into a “sale-leaseback financing transaction,” which would involve Borrower selling the real estate to Investor for some price somewhat less than current market value, and then leasing back the real estate to the Borrower for market rent. The kicker is that the lease would give the Borrower the right to buy back the real estate within some time period, such as 5 years, at the original sale price plus some escalator (maybe 6% per year).

The benefit to the investor is that it is better secured than if it just made a loan and took back a mortgage. Also, if the Borrower does not repurchase the real estate, it gets a windfall from the purchase of the real estate at below fair market value. However, there are a number of tax issues for the Borrower that may not make this the most attractive structure, including:

  • Capital gains on the sale of the real estate
  • Real estate transfer taxes on the sale of the real estate and its repurchase
  • Loss of depreciation deductions with respect to the real estate

Despite these potential tax issues, this structure may end up working well for both parties. Stay tuned for future postings of creative structures that solve all three of the tax issues discussed above.