Leaseback

Leaseback is a financial transaction wherein the company sells its asset and then takes the same on lease from the purchaser. It implies that the seller becomes the "lessee" and the purchaser becomes the "lessor." This sale and leaseback transaction is done on the mutual understanding of both parties, and all the terms and conditions are predefined in the agreement.

The buyer who lets the asset on lease bears the risk of the asset not being in the same condition after the lease period or during the time of settlement. Moreover, it also helps the seller to make gains in an above-market price situation, especially in the case of a real estate leaseback.

• Leaseback refers to a reverse fiscal transaction wherein the company sells its assets and takes a lease on the same from the purchaser. 
• The key elements of Leaseback are the need for capital or those with excess capital looking for good investments, strong tenants, and even high-interest rates.
• Leaseback has several pros, such as it improves the company's balance sheet by avoiding debt transactions, reduces tax liability because lease payments are tax-deductible, and saves time and administrative costs.
• Leaseback transactions also have disadvantages, such as the company not getting the benefit of appreciation, the seller losing control over the asset over time and the sale of assets reducing the company's valuation.

A sale & Leaseback transaction is only an arrangement for reducing capital expenditure without compromising the availability of assets. Organizations with a cash balance shortage and unable to meet day-to-day operating expenses or companies in their initial phase and focusing on business expansion use this type of transaction to unclog their capital assets and use that cash elsewhere.

On the other side, investors enter into this arrangement because they want a good return on their investment. In addition, they feel secure because of the long lease term and are also relieved from all responsibility by mentioning the triple net lease clause in the agreement.

Let us understand the reasons behind choosing a leaseback option perspective of both the seller and buyer.

• Lessee or Seller Perspective: The seller (lessee) wants to free the cash in the property or assets for other purposes but still wants to use such assets or property.
• The Lessor or Buyer Perspective: Generally, purchasers (institutional investors) involved in these transactions are finance companies, leasing companies, or institutional investors looking for a good investment with a good return.

Choosing to enter into a leaseback agreement comes with a set of repercussions that both the lessor and lessee must be aware. Let us discuss few of the most prominent ones through the discussion below.

1. Need of Capital: When a company needs capital for future investments, it will go for leaseback transactions.
2. Excess Capital and Looking for Good Investments: Purchasers or lessors enter this transaction only to make a good return on their investment.
3. Strong Tenant: Investors who buy and give on lease want a relatively more robust tenant who can meet their obligations and safeguard the investments. Similarly, a strong tenant can sell their assets at a higher rate and profit from the transaction.
4. Long-Term Lease: Generally, in sale and leaseback transactions, lease terms are of 10 years or more to benefit the lessor and lessee. The lessee will benefit from using the assets uninterrupted, and the lessor will get the lease rent for a more extended period without risk.
5. Triple Net Lease: This is one of the conditions the lessor wants to include in the sale and leaseback agreement. In a triple net lease, the lessee takes responsibility for incurring operating expenses, maintenance costs, insurance costs, and other costs, just like the owner of the assets. The investor will only enjoy the rental income unbothered.
6. High Interest on Loans: If the rate of interest of the loan is higher than the lease rental expenses, companies can opt for this to reduce the costs.

Let us understand leaseback agreement and its implications with the help of a couple of examples:

Example #1

Best Airlines Inc. runs a fleet of private jets exclusively to cater to wealthy businessmen and political leaders. They provide additional security and excellent hospitality for their clients.

Since its operating costs increase due to its way of operating and the industry’s very nature, its management decided to explore the leaseback option to capture the market and fend off competition.

Therefore, they bought planes, sold them to the leasing companies, and immediately took them back on lease. With that arrangement, the airline company started getting cash-free and spread the cost over the plane's life. They utilize the cash generated from the sale of planes to meet operational costs and reduce liabilities.

Example #2

Life Time Group Holdings owns and manages recreational sports centers and fitness clubs and are based out of Minnesota. In January 2023, the management decided to sell two of its properties and enter into a real estate leaseback deal.

The deal is estimated to be $78 million approximately. According to the leaseback agreement, the first property’s execution shall bring proceeds of $33 million in a two-month time frame.

The reason for the leaseback option being a popular choice of action, especially for capital-intensive industries. Let us explore the advantages and disadvantages of choosing this option through the discussion below.

Advantages

• The seller can avoid the capital cost associated with assets and still use those assets.
• It can save the time and administrative costs associated with the assets as they will be taken care of by the purchaser or lessor.
• Reduce tax liability because lease payments are tax-deductible expenses.
• Reduce the overall income of an organization.
• Improve the company’s balance sheet by avoiding debt by this transaction and increase the current assets generated through selling assets in cash.
• Improve working capital by investing in other things or for day-to-day operating expenses.

Disadvantages

• If the property has a longer life, it will become a costly affair for the seller because the total lease payment will be more than the cost of the assets over the year.
• The company will not benefit from depreciation since they do not own the property.
• The seller would not get the appreciation benefit if the value of assets sold, like land and building, increases in the future.
• The sale of assets will reduce the company's valuation, making it useful for a future loan.
• Loss of control over assets as lease rent will increase at the time of renewal of the agreement.

This has been a guide to what is Leaseback. Here we explain its examples, advantages, disadvantages, and guidelines in detail. You can learn more about financing from the following articles –

• What is a Finance Lease?
• Lease Rate
• Lease Option
• Capital Lease Definition