Sale and Leaseback – Definition
Sale and Leaseback is a simple financial transaction which allows a person to lease an asset to himself after selling it. Under the transaction, an asset previously owned by the seller is sold to someone else and is leased back to the first owner for a long term. The transaction thus allows a person to be able to use the asset and not own it. One usually makes a leaseback transaction for high value fixed assets such as real estate and goods like airplanes and trains. Sale and leaseback is shortly called as leaseback.
For example, X owns a land. Under the leaseback transaction, X will sell the land to Y and will get a lease on the same land from Y for a long term.
A company usually enters a leaseback transaction for accounting and taxation purposes. For example, a company may transfer its asset to the holding company but still will be able to use it. Also, transferring to holding company will allow the parent company to track the assets’ worth and profitability. Another example is, that in case of financial distress or when a company needs money for some purpose, instead of getting a loan or raising money from outside, a company can sell the asset. The buyer of the asset is someone who is only interested in a securing a long term investment and will lease the asset back to the company. This way the company gets the cash influx and will still be able to use the asset.
Sale and Leaseback transactions are common in the Real estate investment trusts (REITs) and Aviation industry.
The person who buys the assets and lets out on lease is called the investor or landlord. The seller of the asset is also the lessee.
Example of Sale and Leaseback
A safe deposit vault given by banks is the classic example to quote. Here banks which initially are the owners of the vaults, sell the vaults to a leasing company at market price which is substantially higher than the book value. Subsequently, the leasing company will offer back these vaults to the same banks on long term basis. The banks will then sub-lease these vaults to its customers.
Advantages to the Lessee
Enables Expansion of the Business
If a company doesn’t have funds to own the asset, it can purchase the asset and enter a leaseback transaction. This way the company can get back 100% of the investment and still be able to use the asset. Similarly, in case when a company already owns an asset but wants some cash for expansion or even regular business use, the leaseback agreement will allow the company to get cash influx. This will also enable the company the to use the asset as before, by paying rent under the lease agreement.
Improve Company’s Balance Sheet
An asset purchased on debt affects the company’s balance sheet. The company can reduce its debt and improve balance sheet health by entering a leaseback transaction. This will improve the balance sheet in three ways. First, the liability on the balance sheet will reduce. Second, there will be an increase in current assets in the form of cash and lease agreement. Third, the asset turnover of the company will improve. The asset turnover will improve as the fixed assets will reduce but the revenue generating capability of the asset will still be in the hands of the company.
Reduction in Tax Liability
This works in two ways, the company which has now sold the asset and has it on lease, does not have to pay tax on any appreciation of the asset and also the rent outlet will reduce the profit in the profit and loss (p&l) account which will in-turn reduce the tax liability. Depreciation charge on the asset would has a similar impact on the p&l account. However, the depreciation amount will be lower than the lease amount. Also, there is no depreciation is charge on real estate assets like land.
One can avoid paying tax on the sale of asset, by re-investing the sale proceeds in the business or by buying another asset.
Once sold, the company is free from volatility risks of the asset that has to be borne in case of cyclical market variations.
Advantages to the Investor
Fair Return on Investment
The investor is buying an asset which the seller will be using in the future. The buyer’s interest will ensure that the asset is a fair investment which will provide a decent return on the investment.
Regular Stream of Income
The buyer does not have to worry about the return, as they have a reliable tenant for a long term. This ensures that the investment earns a fixed return on the property and has a continuous stream of cash flow.