How Much Rent Should You Charge for a Sale Leaseback?
If you don’t keep them happy, they could quickly become a customer that does not pay or decides to use the court system to adjust your behavior. You try to do things like checking the tenant’s credit and references up front, but no amount of due diligence can completely alleviate these risks. Unlike an apartment complex that can spread out their risk among many different tenants, many landlords own 1 house and have just 1 tenant. To calculate the return on a sale leaseback, called a capitalization rate, you divide the annual income by the price. For example, a property that has annual rental income of $175,000 and costs $2,000,000 has an 8.75 percent cap rate.
In general, leasebacks should cover things like the length of the leaseback, the rental amount, and details about who will cover utilities, maintenance, and insurance costs. However, there may be additional details discussed specific to the property or tenant. A leaseback enables a seller to rent their former property after ownership transfers to the new buyer.
Buyer/Lessor (in millions)
With the advent of ASC 842, the accounting also must be applied for sale-leasebacks of equipment. This may come as a big shocker to those who have not owned a rental property before, but not all tenants are exemplary citizens that always pay on time. Still others will pester the landlord non-stop for repairs or other issues, oftentimes outside of normal business hours; after all, they are a paying customer and you are the one selling the product (rental housing).
If for some reason this payment wasn’t received upfront, the seller-lessee would need to consider whether or not they actually have a present right to payment. In SLB transactions, the sale should comply with the provisions of ASC Topic 606. A leaseback exists when a buyer of property leases that property back to the seller.
For example, developers of master-planned communities will often sell the model home to a buyer before the community is sold out, leasing it back from the buyer for a period of up to two years. In some arrangements, the current lessee will give the option to buy the asset back at the end of the lease. Typically, if the original owner were to buy back the asset, it would take place at the end of the tax year, in case any party were to be audited by the IRS. Leases are legal and binding contracts that set forth the terms of rental agreements in real estate and real and personal property. These contracts stipulate the duties of each party to effect and maintain the agreement and are enforceable by each.
However, if you want a longer leaseback period or want to define the terms of the sale-leaseback further, you can draft a separate agreement that details the rights and responsibilities of the parties. Such an agreement should define duration, rent, maintenance requirements, and other lease terms.
In this scenario, the buyer and seller agree to a leaseback during home sale negotiations, incorporating details in the purchase agreement or adding to a separate contract. After the closing, the seller remains on the property and pays rent to the buyer-landlord for a specified period of time. In many leasing transactions, seller/lessees accumulate a number of similar assets over a period of time and then enter into a sale and leaseback.
Therefore, even if the sale was a valid sale for legal and tax purposes, the asset remained on the lessee’s balance sheet and the sale was treated as a financing or borrowing against that asset. The FASB’s position was based on what was then known as FAS 66 “Accounting for Sales of Real Estate” which highlighted the numerous unique ways in which real estate sale transactions are structured. Additionally, the FASB noted that many such real estate transactions resulted in the seller/lessee repurchasing the asset, thus supporting their view that the sale-leaseback was merely a form of financing.
Companies looking to do sale leasebacks can also research a common market cap rate and use it to price their asset. If they wanted to pay $250,000 a year in rent, and they determined that investors would buy their building at a 9.25 percent cap, they’d be able to sell the property for around $2,700,000, for example. Triple-net leases protect the landlord from any responsibility for the building or its operations. Having the tenant pay all the bills associated with the property makes it easier for the landlord to own the property, which makes them willing to pay more for the building. They also allow the tenant to use their vendors of choice to maintain the building they occupy in the style they decide.
The lease term and rental rate are based on the new investor/landlord’s financing costs, the lessee’s credit rating, and a market rate of return, based on the initial cash investment by the new investor/landlord. Furthermore, several other factors determine the proper accounting for the leaseback phase of an SLB transaction, such as repurchase provisions like call options, forward agreements, and put options. The seller of a home or commercial building may wish to participate in a sale-leaseback because they need more time to move than is permitted under a standard purchase agreement. What’s more, a seller may want to take advantage of a strong real estate market but needs to stay in their home or office for the long-term. While some buyers may not be open to this arrangement, others may be grateful for the rental income.
This section of the leaseback agreement can also address whether the buyer or seller must pay for a monitored security system during the leaseback period. During home purchase negotiations, the buyer and the seller will discuss options for a leaseback.
A leaseback, or a sale-leaseback, occurs when the seller of a home remains a renter in the property after the close of the sale. This gives sellers more time to move or provides immediate income to a real estate investor. Parties should formalize leaseback terms in an official agreement, including rent, duration, and maintenance responsibilities. A “sale/leaseback” or “sale and leaseback” is a transaction in which the owner of a property sells an asset, typically real estate, and then leases it back from the buyer.
- As a result, SLB transactions have lost some of their appeal for seller-lessees, but nevertheless remain attractive for other reasons.
- In an SLB transaction, a seller-lessee sells one of its assets to a buyer-lessor in exchange for consideration and makes periodic rental payments to the buyer-lessor in exchange for retaining the use of the asset.
In this way the transaction functions as a loan, with payments taking the form of rent. Due to the lack of financing available in today’s market, many American businesses are increasingly turning to sale-and-leasebacks to provide quick capital.
When calculating the appropriate rent to charge for a sale-leaseback, consider the cost of holding the property. This includes the buyer-landlord’s daily principle, interest, taxes, and insurance (PITI). Also, determine who will be responsible for utility costs, maintenance-related expenses, and the cost of repairing any damage sustained by the property during the leaseback period. Most real estate contracts will include a provision for how long the seller may remain in the property after closing or for how a short leaseback period should be conducted.
The lease term can range from a few days to several months, though the specific length should be documented in a formal leaseback agreement. Additional terms in the agreement commonly include the amount of rent and the rights and duties of each party. The contents of a leaseback agreement depend on the length of the leaseback, the property, and the complexities of the transaction. In general, the agreement should address terms like the length of the leaseback, the monthly rent, and who is responsible for utilities and maintenance costs. Finally, the lease agreement should include the amount of the security deposit, insurance requirements, and dispute resolution terms.
In an SLB transaction, a seller-lessee sells one of its assets to a buyer-lessor in exchange for consideration and makes periodic rental payments to the buyer-lessor in exchange for retaining the use of the asset. Because ASC 842 requires lessees to recognize most leases (with the exception of short-term leases) on their balance sheets, SLB transactions no longer provide seller-lessees with off–balance sheet financing. As a result, SLB transactions have lost some of their appeal for seller-lessees, but nevertheless remain attractive for other reasons.
Lessee Accounting
What is sale leaseback accounting?
A sale and leaseback transaction occurs when the seller transfers an asset to the buyer, and then leases the asset from the buyer. This arrangement most commonly occurs when the seller needs the funds associated with the asset being sold, despite still needing to occupy the space.
A put option held by the buyer-lessor gives them the right, but not the obligation, to sell the asset back to the seller-lessee. However, if the buyer-lessor has a significant economic incentive to exercise the put option, then sale accounting would not be appropriate, and the transaction should be recorded as a financing transaction. A buyer-lessor has significant economic incentive when the repurchase price is expected to significantly exceed the fair value of the asset at the time of purchase. The classification of the leaseback matters in determining whether sale and leaseback accounting can be applied. If the leaseback is classified as a finance lease (by the seller-lessee) or a sales-type lease (by the buyer-lessor), sale accounting (and, therefore, sale and leaseback accounting) would not be appropriate.
The current tax law permitted the buyer/lessor to treat those assets as new and thus under prior law, qualified for bonus depreciation. The provision followed was commonly known as the “3 month” whereby as long as the sale and leaseback occurred within 3 months of the asset being placed in service, the buy/lessor could also claim bonus depreciation. Accounting for sale-leaseback transactions under ASC 842 aligns the treatment of an asset sale with ASC 606 pertaining to revenue recognition. As such, if a sale is recognized under ASC 606 and ASC 842, the full profit or loss may thus be recorded by the seller-lessee.
Sale and Leaseback Transactions
One of the main reasons a seller-lessee enters into a sale and leaseback transaction is to generate liquidity. As such, a buyer-lessor generally pays the seller-lessee the purchase price of the asset at the start of the transaction.
Depending on the circumstances of a leaseback, there are advantages and disadvantages for the seller-tenant. A sale-leaseback can simplify the moving process for the seller and otherwise provide flexibility during the sale of a home or commercial space. However, a seller may find that the lease terms are unfavorable, and the rental and insurance costs are high. As in a standard rental or lease agreement, it’s necessary to establish who will pay for utility costs during a leaseback period. Typically, the seller-tenant is responsible for utility charges until they move out of the property, including but not limited to water and sewer, electricity, and propane.
Sale-leasebacks are transactions where a business that owns and occupies a piece of real estate sells it to an investor and immediately leases it back, usually for a relatively long period of time. Compared with pulling money out of a corporate asset through a mortgage, sale-leaseback arrangements effectively offer higher rates of leverage. They can also offer more flexibility as well as potentially offering unique accounting advantages.