Sale and leasebacks: sacrifice or a saviour?

James Polo-Richards, real estate lawyer and Partner in the Commercial Real Estate team at law firm Wright Hassall, explains the pros and cons of a sale and leaseback of commercial property

The coronavirus pandemic has caused widespread economic uncertainty, and to help support businesses through this difficult period, the UK Government is offering emergency financial packages.

The Business Secretary recently acknowledged that ‘more money needs to go out faster', with many businesses facing an uncertain future, as the necessary funds could come too late to save them.

To raise cash quickly, the property world has turned to sale and leaseback deals as the severity of the situation continues to escalate. So, what is sale and leaseback and how does it work?

The sale and leaseback
Through a sale and leaseback deal, owners of a property sell to another party, agreeing to take a lease of the property back immediately. One high profile example of this has been Next Plc, who have announced plans to market some of their assets.

This process gives businesses an alternative way of raising finances, instead of having to turn to the banks for support. In addition, many property investors including large funds, private equity houses and smaller individual investors are looking at a range of opportunities.

Many funds, unless they can negotiate or revise terms, may be bound by covenants to spend cash they have raised by a certain date; and individual investors may see little value in the interest rates offered by banks or not be prepared to risk the current volatility of the stock market.

As with every transaction there are advantages and disadvantages which we outline below:

Release of cash and existing debt
For many businesses a sale and leaseback allows them to convert an asset into cash without losing control of the business. In the same way, where bank debt is secured against the asset, the sale of that asset should enable a company to repay that debt and remove the ongoing need for interest repayments.
Lower costs compared to traditional refinancing

While engaging with a bank to secure debt against an existing asset may be an option, there are usually higher transactional costs associated with such deals including being responsible for valuation, arrangement, legal and bank commitment fees. Theoretically a sale and leaseback deal should see each party bearing their own costs.

SDLT relief
Providing certain conditions are properly met, the leaseback aspects of a sale and leaseback deal may be exempt from SDLT meaning that the business will not need to pay any SDLT on the grant of the lease. The sale element is still likely to attract SDLT for the buyer.

Loss of value to the business and director's duties
The sale of an asset is obviously a key consideration for directors as it could reduce the value of the business in any future business sale.

It is important to remember that while directors owe a duty to the company, where a company falls into financial difficulties and the risk of insolvency is real, those duties can then extend to creditors. In exercising these duties, they need to ensure they are minimising losses.

Before any decision to enter a sale and leaseback arrangement is made, it is best practice for companies to seek professional advice and ensure the approach they're taking is beneficial considering their current position.

Financial covenant and security
When it comes to buying an asset, an investor will naturally want some certainty that they will receive payments and there may be a concern that those seeking a sale and leaseback are struggling financially.

In such circumstances, parties will need to consider whether any rent should be held back in escrow or in a rent deposit deed. This would give the investor certainty that an element of the rent is already held securely in the event that the new tenant does not perform.

Depending on how much rent is held in this way the seller/tenant may be quite relaxed: from a cashflow perspective they will know that they won't actually have to pay any rent for a prescribed period if it has already been escrowed.

If they have been able to negotiate a rent-free period as part of the deal this could leave the seller/tenant with a couple of years to focus on other parts of their business.

As with any transaction, particularly those involving business assets, it is important to consider a number of factors, but sale and leaseback could provide a sustainable alternative during an uncertain time for the economy.

James Polo-Richards is a real estate lawyer and Partner in the Commercial Real Estate team at law firm Wright Hassall