As businesses start to work out how to repair the economic damage caused by lockdown many are looking at ways to release capital from their balance sheets as an alternative to traditional financing routes. One option open to owner occupiers of real estate assets is a sale and leaseback, where an asset is sold (for a capital receipt) subject to a lease back to the seller (allowing operational continuity) at a rent. These transactions are starting to gain traction in the retail and logistics sectors where we are seeing some of the biggest winners and losers of the lockdown emerge. However, as the structure becomes better understood it is clear that adoption will increase.

Here we look at key drivers and considerations for businesses using this mechanism.

Why a Sale and Leaseback?

A sale and leaseback can be used to unlock capital in a business without raising secured debt. It also provides the selling business with occupational continuity and security through the leaseback arrangement (avoiding relocation costs). For the buyer, it is an opportunity to purchase an investment or development opportunity with a built in return from the leaseback.

In current circumstances (Covid-19 lockdown), certain businesses are seeing opportunity for growth (hence the current prevalence in logistics and last mile businesses) and can use this mechanism to re-allocate capital to operational business. Equally, businesses struggling with debt and concerned with associated security can use a sale and leaseback to release that debt and security while maintaining operations.

Common types of Sale and Leaseback

Examples of types of sale and leaseback arrangement are:

  1. occupational leasebacks, where the seller takes a rack rent lease back for a 10-20 year term, typically subject to review, which could be based on the open market, fixed increases or (commonly) index-linked;
  2. long leasebacks (of whole or part), the seller paying a ground rent and potentially a gearing on rents from underlettings;
  3. portfolio arrangements, where a sale and leaseback takes place across multiple sites between the same seller and buyer, potentially involving cross default provisions or asset substitution or swap options.

Some key points

Covenant strength of the seller/tenant will be fundamental to both parties, underpinning the value and therefore the purchase price for the seller and providing income security for the buyer.

Assignment is often restricted for fixed initial periods to ensure the covenant remains ‘on the hook’ either directly or by way of authorised guarantee agreement (for example where the leaseback allows only one assignment during the term).

Operational control and costs of the property will sometimes be retained by the seller/tenant, particularly on a leaseback of whole, for example insurance, maintenance and services and property taxes (sometimes referred to as the triple net lease).

Renewal rights are often included to provide occupational security to the seller/tenant in the longer term.

Buy-back rights may be included at a fixed point in the future, making the transaction a quasi-financing arrangement or it may include a right of first refusal to give the seller the ability to re-purchase the property at market value in the event of a future sale.

Service charge / Estate Management provisions and systems may need to be implemented or provided for if a leaseback is of part only or if there is potential for assignment of parts separately at a later date.

Key tax considerations

The tax consequences will need to be fully understood by the parties and, where necessary or desirable, reflected in the drafting of the agreements. In particular;

  • VAT:
    • whilst any analysis will always be fact dependent, a sale and leaseback of a whole property is unlikely to be capable of being treated as a transfer of a going concern. As a result, where the property is opted or the sale is otherwise subject to VAT, VAT will be due on the sale of the land interest (which in turn would likely increase the SDLT costs for the buyer);
    • where the leaseback is itself valuable (i.e. a lease that a tenant would, in the ordinary course, have paid a premium for), there may well be a “barter” or “part exchange” for VAT purposes, meaning that as well as the supply of land by the seller to buyer, VAT may also need to be accounted for on the lease from buyer to seller.
  • SDLT: sale and leaseback relief may well be available to remove the SDLT charge on the leaseback element.

The direct tax implications of any proposals will also need to be assessed by the parties as well as accounting considerations and the impact on the business balance sheet, for example removing debt and benefitting from rent deductibility.

If you have queries in relation to the above or would like to discuss aspects of sale and leaseback transactions in more detail, please do not hesitate to get in touch with us.

For further information please contact:

Jeremy Walden
Jeremy Walden
Partner and head of real estate, London
+44 20 7466 2198
William Arrenberg
William Arrenberg
Partner, tax, London
+44 20 7466 2574
Simon Elliott
Simon Elliott
Senior associate, real estate, London
+44 20 7466 2978