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COVID-19 has left many businesses in over their heads with debt and with fewer financial options to recover from it. Many are still playing catch-up from nearly six months of partial or complete closures, even with restrictions lifting and the economy back to relative normalcy. With uncertainty around every corner, some companies look at their real estate holdings as potential sources for a quick influx of cash.
Typically, real estate is considered an illiquid asset, but you can use it to your advantage with a sale and leaseback agreement in the right circumstances. This unique type of sale can help your business relieve its debt burden or simply receive cash when you need it most.
The Advantages of a Sale and Leaseback
A sale and leaseback agreement is a type of real estate deal where the buyer agrees to allow the seller to lease the property long-term at a pre-determined rate. As a result, the seller receives an immediate influx of cash which can be used to pay creditors or investors. At the same time, the buyer can invest in a valuable piece of real estate with a tenant that typically has proven success at the location.
The leaseback agreement offers distinct advantages for both buyer and seller, including:
The seller can receive tax benefits from listing rent as a deductible expense, while also freeing up the capital that is tied up in real estate
The buyer receives long-term passive income by investing in commercial real estate with a guaranteed tenant.
The buyer can also reduce their tax burden by listing the property as a depreciating expense.
Sale-Leasebacks are an excellent option for first-time commercial real estate investors and syndicates because they offer guaranteed monthly income. However, there are some drawbacks investors and businesses should be aware of so they can avoid a deal going sour.
Precautions for Businesses and Buyers
Businesses should be careful to use this option, especially if other methods of infusing cash are available. You will be losing a valuable piece of property and don’t want to make the decision solely because you’re in a financial pinch. The IRS will also be looking closely to ensure the deal is fair for market conditions and not exclusively obtained for tax breaks. If you’re considering a sale and leaseback, also consider the possible drawbacks:
When the lease ends, you may have to negotiate a new rent based on different market conditions or find a new building if an agreement cannot be reached. Conversely, if rent prices drop within your long-term lease agreement, you will likely be locked-in to lease rate that is above market
You will not have control over the property, which means all renovations and changes to the property will now have to be approved.
The buyer also faces potential defaults and may have trouble ensuring control over the property as the seller may still act as if it is their own.
The IRS will also be taking a close look to ensure that the sale is not made for tax breaks alone. In order for the sale to be valid, it must meet four qualifying conditions:
The reasonable service life of the property should exceed the term of the lease.
Repurchase of the property by the original seller should be at a fair market price, not at the original or discounted price.
If the lease is renewed, it must be for fair market value.
With these considerations in mind, you should talk to a financial advisor about the potential benefits of a sale and leaseback for your business. We are happy to go over options with you so you can make the best choice for your business.