Sale and leasebacks: sacrifice or a saviour?
James Polo-Richards, real estate lawyer and partner in the commercial real estate team at law firm Wright Hassall, discusses how businesses can raise funds quickly.
The financial support packages offered by the UK government could not come soon enough, as businesses begin to feel the pressure of the coronavirus pandemic.
The urgency of situation has led to companies calling for money to be sent out faster, as the economy becomes more fragile over time and the long-term security of many businesses is under threat.
As the demand for money increases, the property world has been looking for ways to raise additional funds, with the sale and leaseback approach making a strong resurgence.
A sale and leaseback deal involves the owners of a property selling to another party, with an agreement that they will take a lease of the property back. Next is a high-profile example of businesses using this strategy, after announcing plans to market some of its assets.
This process gives businesses an alternative way of raising finances, instead of having to turn to the banks for support. In addition, many property investors – including large funds, private equity houses and smaller individual investors – are looking at a range of opportunities.
For some companies, turning to the banks for support is not an option they want to take, so this process offers a self-sufficient alternative to raise the necessary funds. Many property investors are looking at a range of opportunities and property owners should recognise there are people in the market who have cash to spend.
Many funds, unless they can negotiate or revise terms, may be bound by covenants to spend cash they have raised by a certain date, and individual investors may see little value in the interest rates offered by banks or not be prepared to risk the current volatility of the stock market.
Before making an agreement, there are various key factors that parties should consider.
Release of cash and existing debt. Sale and leaseback deals allow many businesses to convert an asset into cash without losing control of the business. In the same way, where bank debt is secured against the asset, the sale of that asset should enable a company to repay that debt and remove the ongoing need for interest repayments.
Lower costs compared to traditional refinancing. Although engaging with a bank to secure debt against an existing asset may be an option, there are usually higher transactional costs associated with such deals. However, a sale and leaseback agreement should mean each party covers their own costs.
SDLT relief. Providing certain conditions are properly met, the leaseback aspects of a sale and leaseback deal may be exempt from SDLT, meaning that the business will not need to pay any SDLT on the grant of the lease. The sale element is still likely to attract SDLT for the buyer.
Loss of value to the business and director’s duties. The sale of an asset is obviously a key consideration for directors as it could reduce the value of the business in any future business sale.
It is important to remember that while directors owe a duty to the company, where a company falls into financial difficulties and the risk of insolvency is real, those duties can then extend to creditors. In exercising these duties, they need to ensure they are minimising losses.
Before any decision to enter a sale and leaseback arrangement is made, it is best practice for companies to seek professional advice and ensure the approach they are taking is beneficial considering their current position.
Financial covenant and security. From an investor’s perspective, there will obviously be some concerns that companies looking at sale and leasebacks may be struggling financially and unable to honour their commitment to pay rent back long-term.
Holding rent back in escrow or in a rent deposit deed could provide a solution in such cases, as this would give the investor certainty that an element of the rent is already held securely, regardless of the tenant’s performance.
Depending on how much rent is held in this way, the seller/tenant may be quite relaxed; from a cashflow perspective they will know that they won’t actually have to pay any rent for a prescribed period if it has already been escrowed, giving them time to focus on other parts of the business.
As with any transaction it is important to consider all the factors, but sale and leaseback might represent a sensible option for many.