In this article, our commercial property solicitors explain what a sale and leaseback is, whether or not this is the right option for you; including the legal process, the advantages and disadvantages for all parties involved, and the key points to consider when negotiating terms.
What does a sale and leaseback transaction involve?
Essentially, a sale and leaseback is where a business sells their freehold interest in a commercial property that they already occupy to a buyer and then leases the same property back from the buyer. This results in the seller becoming the tenant and the buyer becoming the landlord.
In the majority of cases, a buyer will want to purchase the property at the market value and so the starting point is to arrange for the property to be valued by a qualified chartered surveyor. Equally, the rent will also need to be in-line with open market rent and again, a charted surveyor will be able to confirm the open market rent for the property. The parties involved may wish to obtain at least two valuations before agreeing on the sale price and lease rent.
Once the property has been valued, a seller will need to decide whether to sell your property to a private investor or alternatively, whether to transfer the property through a SIPP which can be an extremely tax efficient way to invest in property.
A commercial property solicitor will need to get involved in the early stages of the transaction as they will need to advise on the terms of the lease and once the parties have agreed the terms, the agent will draw up a document called ‘Heads of Terms’. The lease will then be drafted based on the Heads of Terms.
Finally, once all the above steps have been achieved, the seller and buyer of the property will instruct their commercial property lawyers to prepare the legal documents.
When to consider a sale and leaseback
A sale and leaseback agreement allows a seller to release equity, either to fund the purchase of another property, to re-invest and encourage growth in other areas of the business or simply to help a business that is in financial difficulty and requires a quick release of equity.
Another example of when a sale and leaseback could be considered is when a company wants to separate its assets from its operating business because retaining ownership of commercial property can be considered as diversification away from the business’ core goals.
What are the pros and cons for the seller and buyer?
If your business is looking to sell its property or alternatively if you’re an investor looking to acquire a property, below is a list of some of the pros and cons to help you make an informed decision:
|Pros for a Seller (+)||Cons for a Seller (-)||Pros for a Buyer (+)||Cons for a Buyer (-)|
|It allows a seller to benefit financially from a buoyant property market.||The seller has to give up ownership of the property meaning that they will no longer benefit from the future growth of the property value.||The buyer will benefit from a confirmed income for a fixed period of time (being the duration of the lease).||The property purchase may be subject to SDLT liability depending on the purchase price.|
|The business remains at the property for a pre-determined period of time.||If the seller ever wanted to purchase the property back in the future, the buyer is not obliged to agree to sell it back to them and so a re-purchase is never guaranteed. Sometimes there can be a way around this by including in the lease a right for the seller to repurchase the property in the future. However, the seller is not obliged to agree to include this clause in a lease.||If the buyer is a SIPP, they have increased certainty that the seller will pay the rent and comply with all other tenant obligations and covenants in the lease.||The seller is not always guaranteed to remain in occupation of the property when the lease comes to an end. As such, unless the parties can agree a renewal lease, the buyer could end up owning an empty property and therefore not receiving rent. In addition, if the lease includes a tenant break clause, the seller may choose to exercise that right and vacate the property early.|
|The release of equity enables a business to focus on other areas of growth within the business which could be more profitable and bring a better return for the business, for example, purchasing new technology or machinery which they would ordinarily not be able to afford out of their cash flow.||The lease will be a continuing liability for the seller due to the obligations and covenants included in the lease, for example, ongoing repair obligations and payment of rent at market value. Often, repairing obligations in a lease can be similar to owning the freehold.||The buyer may request a rent deposit from the seller as additional security under the lease. This can be particularly important if the seller is going through financial difficulty and the buyer requires some additional financial assurance.|
|Owning a freehold property naturally comes with its risks and so a seller can sell its property but remain in occupation as a way of mitigating some of that risk.||The seller will have less flexibility and autonomy with regard to any proposed alterations they wish to make as they will first have to obtain the prior written consent from the buyer, who is not obliged to grant the consent.||The buyer is likely to be in a strong bargaining position to negotiate lease terms that work more in their favour because the seller business needs mean that their occupation of the property is vital for their business continuity.|
|A sale and leaseback can be much quicker, easier and often cheaper than applying for bank finance.||The buyer may request additional security on completion of the lease including a rent deposit deed which becomes an additional financial burden on the seller. The seller will have to consider if they can afford to pay the rent deposit and if so, on what grounds can the deposit be returned to them?||The buyer will have limited liability for the property as the obligation to repair and maintain the property will fall on the seller under the terms of the lease.|
|Although the lease is likely to attract Stamp Duty Land Tax (SDLT) liability, the seller may qualify for ‘sale and leaseback’ SDLT relief.||At the end of the lease, an agreement may not always be reached for the seller to remain in occupation of the property. This could result in the seller having to vacate the property and find another suitable location, which could of course have a significant financial impact on the business.|
Considerations for the lease terms
Some key points to consider when you are negotiating the lease terms are:
- How much will the annual rent be and when should it be paid? Irrespective of whether the buyer is a SIPP or a third-party investor, they will require the rent to be based on open market value.
Usually, rent will be payable quarterly in advance on 25th March, 24th June, 29th September and 25th December in each calendar year. However, depending on cash flow, the parties may prefer for the rent to be paid in smaller and more frequent instalments, for example, in advance on the first day of each calendar month.
- How long will the lease term be for? In a sale and leaseback transaction, the lease is usually granted on a long-term basis (usually anywhere between 5 and 35 years). A longer term will be more desirable for a buyer but on the other hand, a longer lease will be a much more significant commitment and ongoing obligation for the seller.
- Will there be any rent reviews? A seller must be mindful that the starting rent will not apply for the whole of the lease term because often a rent review is included in a long-term lease. The rent review will usually be calculated on an upwards only basis, either in line with market value or Retail Price Index.
Another important point to note on rent reviews is that if the buyer does not review the rent on the specified rent review date(s) as set out in the lease, they can still backdate the review. Tenants beware!
- Will there be any break rights? Ideally a seller will want a break right to coincide with a rent review allowing them the opportunity to terminate the lease if the increased rent is unacceptable to them. For a long-term lease, a break right is often included every five years and is subject to certain pre-conditions including a condition that all rent and other lease payments are paid in full at the date that the break right is exercised. A buyer will also require prior written notice of the tenant’s intention to exercise the break right, often in the region of six months. A property agent will be able to advice you on suitable break right conditions.
- What will the repair obligations be? The state of repair and condition of the property will dictate the repair provisions in the lease. For example, if the property is in a poor condition, then a seller will likely want to agree to limit their repair obligations to a schedule of condition.
- Will the tenant be able to make any alterations to the property? The seller will need to consider if they need to make any alterations to the property to suit their ongoing business needs and if so, will these be approved by the buyer and will the buyer require them to remove the alterations when the lease comes to an end?
Is this a good option for businesses in financial difficulty?
Business needs are ever changing and having the ability to unlock capital quickly can be key when a business needs to focus on its debt reduction. In particular, in the current economic climate, a sale and leaseback is becoming a very popular choice for businesses in financial difficulty and can often be a vital saviour for them.
However, a business that is in financial difficulty will still need to carefully consider its ability to pay the rent under the new lease and to comply with all other future tenant obligations and covenants.
The correct allocation of capital is imperative for every business. It does not always make business sense for a business to retain commercial property if the capital could be better utilised in other areas of the business or if the capital is required to save a business from financial ruin. Although you may not be familiar with the sale and leaseback model, the process is becoming increasingly popular and it could provide your business with an alternative way to improve cashflow.
If your business is considering a sale and leaseback transaction, we recommend that you speak to a commercial property lawyer. They can help you understand your ongoing liabilities for the duration of the lease and also your rights when the lease comes to an end.
For further assistance, please do not hesitate to contact one of our commercial property lawyers who would be happy to discuss the process with you.