Leaseback definition
/What is a Leaseback?
A leaseback is an arrangement under which an organization sells an asset and then leases it back from the buyer. The two transactions are linked into what is known as a sale and leaseback transaction, where the seller becomes the lessee and the buyer becomes the lessor. There is no requirement for the seller to eventually buy back the asset. The intent behind this arrangement is for the seller of the asset to gain immediate access to cash while still using the underlying asset, while the buyer gains a long-term return on its investment. Thus, it is an innovative form of financing for the seller. Leaseback deals are most common in the real estate market, such as when a company sells its corporate headquarters and then leases it back.
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Advantages of a Leaseback
There are multiple benefits associated with a leaseback. First, it is an alternative form of financing for the seller/lessee. Second, it increases the seller’s return on assets, since it owns fewer assets. Third, it reduces the risk of experiencing a decline in the value of the asset. Fourth, the seller has a tax deduction for the lease payments. A leaseback also provides the buyer/lessor with a steady return on investment for a protracted period of time.
Disadvantages of a Leaseback
There are several disadvantages to entering into a leaseback arrangement, which are as follows:
Long-term commitment. A major concern is that the seller is now committed to a long-term lease. This can be a problem if the entity has financial difficulties at some point in the future, and so is unable to make the required lease payments.
No appreciation participation. If the property appreciates in value over time, the seller will no longer be able to participate in this appreciation.
Loss of collateral. The seller no longer has the building asset, which it might otherwise have been able to use as collateral on a loan.
Possible lease rate changes. If the long-term lease rate is not frozen in the leaseback agreement, then there is a risk that the new building owner could arbitrarily increase the lease rate over time.
Example of a Leaseback
A large corporation is experiencing cash flow issues, and the cost of debt is high. Its CFO decides to sell the corporate headquarters building for $100 million and lease it back from the buyer, using a 20-year lease that requires $6 million in annual lease payments. This approach allows the business to have immediate access to $100 million in cash, in exchange for a long-term lease obligation.