Sale and Leaseback: Creating Financing from Real Estate

Sale and leaseback is a transaction in which a company sells property it owns to an investor or financial institution and continues to use the same property under a long-term lease. The company receives cash equal to the sale price without losing use of the asset. This makes the technique a serious alternative for companies that want to release capital tied up in real estate, reorganise their debt or fund growth.

How does sale and leaseback work?

The company, acting as seller and tenant, sells a property such as a factory, warehouse, office building, store or parcel of land to a buyer. At the same time, the parties sign a long-term lease. The buyer is typically a real estate investment trust, an institutional investor, a fund, a leasing company or another real estate investor. The tenant pays rent and keeps using the property in its operations.

The key terms of the agreement are the sale price, the lease term, the rent and its escalation mechanism, the allocation of maintenance and insurance obligations, and renewal or repurchase rights at the end of the lease. These terms determine the economics of the transaction.

What are the benefits for a company?

• Liquidity: capital tied up in real estate becomes cash that can be directed to core operations or growth investment.
• Longer debt maturity: proceeds used to repay short-term borrowing can make the financing structure longer-dated and more predictable.
• Operational continuity: the production or retail site is not relocated, so operations continue without interruption.
• Focus: the company concentrates on its core business rather than property ownership.
• Realising asset value: recognising market value can be meaningful for assets carried below market value on the balance sheet.

What balance sheet considerations apply?

The accounting outcome depends on the structure and turns, in general, on two questions: does the transfer qualify as a sale, and how is the lease liability reflected? Under international financial reporting standards, the assessment is whether control of the asset has passed to the buyer. If it has not, the transaction may be accounted for as a financing arrangement rather than a sale. If it has, the tenant generally records a right-of-use asset and a lease liability, and recognises a gain only to the extent of the rights actually transferred.

As a result, the net effect on the financial statements can differ from what management first expects, even though cash comes in. The lease liability may feed into leverage ratios and into financial covenants under some loan agreements. Tax consequences should also be assessed separately, according to the structure and the applicable tax legislation. This analysis should be done before the decision, not after.

What are the risks?

• Loss of ownership: future appreciation in the property’s value accrues to the buyer.
• Rent burden: a long-term lease creates a fixed cash outflow and can reduce operational flexibility.
• Escalation risk: if rent increases are tied to inflation or exchange rates, cost predictability may fall.
• Contract terms: a lack of secured renewal rights at the end of the lease can threaten operational continuity.
• Existing financing: current loan agreements may contain mortgage, security or transfer restrictions.
• Strategic flexibility: future options to use or redevelop the property may be limited.

When does it fit?

The approach suits companies with a heavy real estate base and stable cash flow that do not regard owning the property as strategic. Retail chains, logistics and manufacturing companies, healthcare and education operators and holding companies are typical candidates. It deserves closer scrutiny in the following situations:

• The property is part of the company’s competitive advantage or a unique location.
• Cash flow is not strong and predictable enough to carry the rent.
• There is a significant gap between the sale price and the property’s strategic value.
• There is no clear plan for the use of proceeds.

Alternatives should be compared in the same analysis: a mortgage-backed loan, conventional leasing, transferring the property into a separate entity, or selling a subsidiary each have different cost and control outcomes.

How are lease terms negotiated?

The economic value of the transaction is determined as much by the lease terms as by the sale price. The lease term should match the period the business needs the property; too short creates uncertainty, too long reduces flexibility. Renewal options, the escalation formula and permission mechanisms for alterations to the property should be settled early.

• Escalation: model the cash-flow effect of fixed, index-linked or hybrid structures.
• Allocation of obligations: who bears maintenance, repairs, insurance and property costs.
• Repurchase right: how a future buy-back option would be priced.
• Subletting and change of use: permissions that preserve operational flexibility.

The lease also drives the buyer’s return. Buyers price on the tenant’s credit strength and lease length, so presenting the company’s financial position clearly and consistently tends to support pricing.

What does the process look like?

The process starts with a review of the real estate portfolio and a clear statement of the objective: which properties suit a transaction, where the proceeds will be deployed and what rent burden is acceptable.

1. Portfolio and objective analysis: assess suitable properties, the financing need and the financial impact.
2. Independent valuation: market value determined by an independent valuer in line with applicable regulation.
3. Structuring: design sale price, lease term and rent, and renewal and repurchase options, taking accounting and tax effects into account.
4. Buyer process: approach potential buyers, collect offers and compare competitive terms.
5. Due diligence and agreements: review title, zoning, mortgages and other encumbrances; negotiate the sale and lease agreements.
6. Closing: title transfer, payment and start of the lease, with required agreements from lenders.

A competitive buyer process helps ensure price and rent are set in line with market conditions. For listed companies and related-party transactions, current valuation and disclosure requirements must be observed as well.

At decision stage, it is worth treating the transaction not just as a financing tool but as part of the company’s asset management strategy. Retaining some properties as strategic holdings while placing others in sale and leaseback can be a balanced approach. Timing matters too: interest rates, buyer appetite in the property market and the company’s own financial calendar should be weighed together, ideally planning the transaction before an urgent cash need arises, when bargaining power is stronger.

This article is for general information and is not legal, tax or accounting advice; if you would like to assess the financing potential of your property portfolio, we would be glad to talk with you at Hector Kurumsal.