June 22 2012
Improving profitability of stockholders' equity
Rationalisation of portfolio management
Strong investor demand for long-term secure investments
Sale and leaseback process
In recent years, sale and leaseback transactions have increased under the tax and legal framework of Article 210E of the General Tax Code. Subject to conditions, this article offered an advantageous tax regime to legal entities for capital gains from the disposal of assets or shares of companies predominantly investing in real estate.
Did sale and leaseback transactions lose their appeal? The consequences of the abrogation of Article 210E should be put into perspective.
On one hand many companies have incurred debts due to the global financial crisis. The abrogation of Article 210E gives them the opportunity to sell and lease back the whole or a part of a property portfolio without major tax consequences. On the other hand, a large number of property assets have become run-down and require renovation work, which is hard to finance in the current financial climate.
Finally, the financial climate may encourage companies to unlock stockholders' equity by extracting the market value from their property. To replace Article 210E, a new tax regime was set out in Article 210F of the code, which will be in force until December 31 2014. Article 210F provides a reduced tax rate applicable to disposal gains on the commercial assets or office assets of property investment companies and any company subject to corporate income tax.
So, optimism is required. This update sets out some examples of objectives for sale and leaseback transactions during 2012.
Given the falling stock markets in recent years and the scarcity of bank financing and refinancing, the transfer of property assets may offer companies an alternative source of liquidity to mortgages. It also allows them to raise capital in order to finance development without the participation of banks or a dilutive capital increase in existing stock market conditions.
Increasing regulatory and environmental constraints have accelerated the obsolescence of existing real estate portfolios. This is particularly the case with many buildings located in Paris or in La Defense, which require or will require important investments.
Rather than assuming the costs and responsibility of a major renovation alone (and thus taking the risk that the market value of the property assets may decrease), a company in this situation may wish to sell all or a part of its real estate (eg, through a property leasing). Thus, the company limits its taxable capital gains while obtaining a renovated building at the end of the work.
Through deconsolidation a company can reinforce its stockholders' equity and accelerate the pace of debt reduction, transferring all or part of its real estate portfolio to a third party. This kind of operation may be necessary in the current climate, in which real estate portfolios are depreciating, leading shareholders to consider opportunities to extract market value from real estate portfolios.
If the main business of a company proves to be more profitable than its assets, it should prioritise its core business. It could improve its competitiveness by reallocating the equivalent value of the real estate portfolio to the financing of its activities, if necessary by redistributing value to the shareholders (eg, through share repurchases or extraordinary dividend payments).
Some companies which own property also manage that property as part of their business. However, if this is not their core business, real estate assets are not always used correctly. By establishing a client/supplier relationship, rather than making in-house provision or using a trust company controlled by the main company, the sale and leaseback of assets can make employees and supervisors aware of the need to change their behaviour. The company can therefore rationalise its workspace and reduce its operating costs.
For regulatory (eg, the EU Solvency II Directive (2009/138/EC)), allocation (eg, asset and liability management) and financial reasons (eg, lack of visibility in the financial markets and volatility), investors are looking for assets that offer predictability and regular income, rather than risky investments. The sale of all or some of its real estate assets (which does not necessarily involve losing control over them) can be a good opportunity for a company to offer on the market real estate products that are transferred to regulated vehicles and which can deliver consistent long-term performance. However, there is one exception: a plant cannot be subject to sale and leaseback in the same way as offices, but requires more complex financing to implement.
In a best-case scenario, tenant creditworthiness and fixed-term leases provide investors with secure returns. In the context of very long-term leases, the location and other characteristics of the building matter less than the landlord's reputation and the financial package. Therefore, a property's value can be maximised by having a high-quality, long-term tenant. This provides a guarantee of future income and a value that the company can hope to capture, at least partially, in the selling price of its portfolio. For example, a logistics company is seeking a new warehouse. The company buys a piece of land without prior economic allocation and builds the warehouse as a traditional property development. Thus, the company creates economic value, which may be monetised through a sale and leaseback operation negotiated to its advantage because it leases the property.
Once the decision to implement a sale and leaseback is taken, what are the next steps? Sale and leaseback operations cover a wide range of legal and financial issues (eg, business, tax, real estate and employment law), which do not share common goals. They derive from financial opportunities, balance sheet imperatives and even management rationalisation. Everything depends on the objective. Does the company want to deconsolidate? Does it want to maintain control of the asset? Is it seeking to extract cash or to improve its investment? Does it want to get the asset back at the end of the lease? The answers to these questions will shape the final arrangement.
In the context of a leaseback, the property is purchased by the landlord, which immediately leases it back to the seller with an option to repurchase it for a nominal value. The property can also be invested in a special purpose entity, whose income is the rent paid by the seller and whose securities are sold to investors in tranches. Leaseback provides that a property and the attached lease rights are acquired by an investor, which enters into a simple lease with the seller. The final question to be answered is which is the most appropriate vehicle for each case (eg, a real estate investment trust, a real estate collective investment vehicle or an unregulated vehicle).
ILO provides online commentaries as specialist Legal Newsletters. Written in collaboration with over 500 of the world's leading experts and covering more than 100 jurisdictions, it delivers individually requested information via email to an influential global audience of law firm partners and international corporate counsel. Please click here to register for the service.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
ILO is a premium online legal update service for major companies and law firms worldwide. In-house corporate counsel and other users of legal services, as well as law firm partners, qualify for a free subscription. Register at www.iloinfo.com.