Sale-leasebacks

accommodate buyer and seller in todays healthcare real estate

market: 7 reasons why they work, 5 pitfalls to note

For many years, low interest rates allowed companies with strong
credit ratings to obtain access to cheap capital through traditional
financing methods meaning there was little enthusiasm for saleleaseback transactions.
But the recent spike in real estate values is once again shining
the spotlight on another useful financing tool: the sale-leaseback.
Corporate and institutional clients are especially finding saleleaseback transactions useful when they seek to cash in on the
equity from their real estate assets in order to grow their
business and reduce some of the debt from their balance sheets;
investors seeking more stable and predictable returns are also
finding sale-leasebacks to be an attractive choice.
Hospital sale-leaseback transactions

The hospital and healthcare segment has become especially

active in the sale-leaseback market in recent years. Hospitals
have proven to be particularly inviting to investors because they
are generally financially sound, have long-term growth prospects,
utilize an established management system and own attractive
real estate. Additionally, many hospitals are contemplating
mergers, which is the ideal time to consider the sale of real
estate and assets to avoid unnecessary duplication and waste of
resources.
The following are some recent hospital sale-leaseback
transactions that have received public attention:
In January 2012, Blue Cross Blue Shield of Minnesota sold eight
buildings totaling 1.1 million square feet, including its suburban
Minneapolis headquarters, to New York-based investment firm
W.P. Carey for an undisclosed amount.
In January 2014, Reliant Hospital Partners, LLC, along with a joint
venture of The Sanders Trust of Birmingham, Alabama and
Harrison Street Real Estate Capital of Chicago, entered into a
sale-leaseback transaction in connection with two hospitals from
Senior Housing Properties Trust of Newton, Massachusetts for $90
million.
In May 2014, Hackensack (N.J.), a joint venture of University
Medical Center and LHP Hospital Group (of Plano, Texas), sold its
hospital in Montclair, New Jersey, to Medical Properties Trust for
$115 million in a sale-leaseback transaction.
In January 2013, it was reported that Spire, the UKs largest
private hospital group, sold a 700 million property portfolio to
two hedge funds and a Malaysian investor in a sale-leaseback
transaction.

What a sale-leaseback transaction looks like and how it is

typically structured
Essentially, a sale-leaseback is an agreement designed to
strengthen the balance sheet. A company sells its property to a
third party and enters into a long-term lease to continue its
occupancy of the subject property. Where the company realizes a
capital gain on the sale, the sale proceeds may be used to
reinvest in the business or pay off debt. This sale then works to
free the seller of the burdens of, and risks arising from, owning,
managing, and financing real estate.
A sale-leaseback can be structured in many ways. In its most
traditional form, a sale-leaseback provides that a purchaserlandlord will obtain legal title to the land and improvements at
closing and will simultaneously lease the asset back to the sellertenant. An alternative form is preferable if the seller-tenant
desires to retain income tax benefits at the property. A seller can
retain tax benefits by conveying the land, retaining ownership of
the improvements, and entering into a ground lease for the land
with the purchaser-landlord. In a ground lease scenario, the
purchaser-landlord must negotiate terms to protect its right to
obtain the improvements to the property upon the expiration or
termination of the lease.
What makes these deals advantageous to both buyers and
sellers? 7 things to know
Sale-leaseback transactions are a compelling investment vehicle
for both buyers and sellers of commercial real estate, for the
following reasons:
1.A sale-leaseback enables a business to leverage its real estate as
a source of capital funds to reinvest, expand its business or to

satisfy debt obligations.

2.The new rent payments may be less than the current mortgage
payments.
3.An owner frees itself of potential liabilities that come with
property ownership, such as building depreciation, debt service
payments, maintenance, insurance, and tax liabilities.
4.The purchaser will take the subject property subject to a longterm lease with the propertys existing occupant.
5.The gain realized from a sale-leaseback transaction can often be
amortized on the corporations income statement, increasing
reported earnings and potentially improving the companys
financial ratios and margins.
6.Rental payments are typically 100 percent deductible against the
companys taxable income, whereas only the interest portion of a
mortgage payment is deductible.
7.Although the rent is ordinary income to the landlord, it is spread
over the lease term with the landlord having a depreciation
deduction to offset the rental income.
5 pitfalls to avoid in a sale-leaseback transaction
A sale-leaseback may not be the right answer for everyone. There
are certain risks and considerations that should be taken into
account when negotiating the contract and the lease. In
particular, the purchaser will need to carefully evaluate the
financial conditions and business prospects of the seller to ensure
its ability to make rental payments throughout the lease term.
Judicial interpretation of tax laws and accounting rules may

impact how the sale-leaseback transaction affects a companys

financial statements. In some instances, courts have held that a
sale-leaseback transaction will be considered a financing device
rather than a sale or a lease, if the tenant retains sufficient
characteristics of ownership over the property. Moreover, the IRS
will review a sale-leaseback transaction to ensure that there is a
legitimate business purpose for the transaction, other than tax
consequences.
Factors considered by courts and regulatory agencies may
include the following:
1.whether the tenant is obligated to pay all of the carrying charges
on the propertys mortgage
2.whether the tenant may repurchase the property at a
predetermined price
3.whether the rental payments were calculated to amortize the
purchase price of the property at an agreed annual rate of return
over the term of the lease
4.whether the rental payments materially exceed the current fair
market rental value and
5.whether the tenant has an option to reacquire the property at a
nominal price.
One final thought
Before entering into a sale-leaseback arrangement, a seller must
consider whether the leaseback portion of the deal is as
desirable as originally contemplated. A subsequent change
in the sellers business plan may occur, or the seller may
determine that it would have been more advantageous to hold on

to the real estate asset, given the limitations and lack of flexibility
that are inherent in a long-term lease. As a result, the seller may
want toconsider incorporating a repurchase option into the
lease, which allows the seller-tenant to either repurchase the
property or terminate the lease at a later time.
DLA Pipers Healthcare team offers experience in issues relating
to sale-leaseback transactions for healthcare industry
participants. Please contact us if you would like to more
information about how the sale-leaseback model might benefit
your business.