Property Leaseback (Restructuring Business Finance)
The most common avenue of raising capital is through debt financing and the traditional method of debt financing adopted by firms is bank borrowing e.g. overdraft facilities or property mortgage. In a healthy property market condition and lower interest rate, property mortgage could be cheaper and the amount of debt could be higher. However, interest rate and property market usually move in parallel direction, thus property value may appreciated in values but the cost of fund has also increased. Under this circumstances, mortgage financing may not be the optimal means especially those firms which are already highly geared due to existing borrowings. In a period where interest rate is on the rise, large corporations may raise debt capital through sale of debenture or loan stocks. To the public, purchasing debenture or loan stocks of such companies means investing in fixed interest securities with guaranteed fixed return and capital redemption. In corporate finance, the object of raising debt capital is to provide finance on terms cheaper than those required by equity shareholders. The strategy is to introduce ‘gearing’ as the mechanism towards optimal financing. That optimal proportion of debt and equity capital refers to the ‘capital gearing ratio’ being the proportion of debt to total capital employed in business ventures. In business finance, the higher the capital gearing ratio employed by the company in its financing strategy, the higher the potential gain to the overall equity interest of the business but the higher the level of risk perceived.
The purpose of sale and leaseback of the firm’s asset is to determine whether such is the optimal means of raising capital compared to other financing alternatives, which involves comparison of costs of financing alternatives. In the sale and leaseback, the owner occupier of a property agreed to sell its interest in the property to an investing institution at a price usually below the market value. In return, the investing institution, agreed to leaseback the property to the firm at initial rental usually below the market rent. By this agreement, the investing institution own the property at a considerably cheaper price and secured rental income whilst the firm gains in term of capital sum it requires to finance its business without having to loose the benefit of occupation. They can utilize the cash to reduce current liabilities, meet working capital requirements, expand business operation and reinvest the surplus. In addition the company’s balance sheets and cash flows are strengthened.
The unpopularity of sale and leaseback in the financial practice in Malaysia may be contributed to the overall country’s economic stability, abundant financial resources and comparatively low interest rate compared to other developed countries. As such, leaseback is considered untimely and would only be turned to as a last resort for only those ailing firms where there are no other capital raising alternatives. To these firms, leaseback in a way safeguard the interest of the company and its shareholders at least from total liquidation and relieve the company from its short term cashflow problem. To some companies, leasebacks is only as a for of ‘lifeboat’ operation until the financial structure of the company becoming stable and sound then, they either acquire new assets or buyback the leaseback property at price reflecting the benefit of marriage value inherent in the property.
Since early 2006, there are increasing numbers of companies chose to de-gear by releasing their property assets through sale and leaseback arrangement. High on the list are Employee Provident Fund (EPF) and Amanah Raya Berhad (ARB) and the number is increasing with the growing of REIT industry.
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With the increasing number of leaseback arrangements, it is however, too premature to conclude that the overall economy and business sector in the country is in unhealthy state. It could be possibly interpreted as a new financial strategy for Malaysian companies to be relieved from unnecessary long-term financial burden out of property ownership. It may be a long term capital management strategy that work well for companies under all economic condition. It should be looked upon as an innovative financial management practice adopted by companies.
From investment point of view, sale and leaseback will provide a ready supply of investment grade properties to investors who seek to increase their property portfolio. This will be the right opportunities for them being flush with funds to purchase long term investments in investment grade properties with secured tenancy and guaranteed income without the hassle of undertaking responsibility on property management.
Sale and leaseback compliments and contributes to the healthy property market since its contractual arrangement does not lead to any mismatching in supply and demand of the property. As the arrangement involves sale and immediate leasing back of existing property between ready seller (occupier/lessee) with ready investor-buyer (landlord), its neither affects the stock nor occupation demand of the property. This in turn will sustain a stable income yield on the property and is an advantage to the investor who hold the investment.
The sale and leaseback arrangement can be instrumental in asset securitization exercise particularly fir the establishment of REIT. The deal would involve the sale of the property to a REIT in return for the leaseback on long term to the previous owner who is now the tenant-occupier. The REIT will benefits in term of secured tenant, guaranteed income and yield.
Sale and leaseback will also create a route for development of Islamic REIT which is structured via Ijarah (leasing) which must represent two separate transactions governed by Syariah rule. The sale of the property is governed by Syariah rule on sale and purchase contract whilst the leasing is governed by Syariah rule on Ijarah.
The deal in Sale and Leaseback usually involve the developer to undertake the project with the aid of short term finance and on completion would sell the property to an investing institution on condition that it will be leased back to the developer who in turn will sub-let the property to occupying tenants. The proceeds of the sale will be used to pay off the short term borrowing spent on the construction. The developer will retain his equity in the property in the form of profit rent as well as ownership in marketable growth asset.
As conclusion, the question of whether leaseback can be an attractive means of raising capital to some firms facing financial constraints, would be dependant and under strong influence of variables like level of interest rates, inflation, rental growth, firm’s trading profitability, capital structure, gearing and business expansion plans.
Although in practice, leaseback is the last means that many firms would opt for, in some way it certainly relieves the financially stricken companies from its cashflow problem. For such companies, leaseback is the optimal means of financing despite the fact that the opportunity cost is high in term of loss of marketable growth property asset. But it could be argued that leaseback arrangement is a short term financing scheme that needs to be used in order to save the most important asset of the company-the business. Since the continued prosperity of the business would further strengthened the firms goodwill and credibility, the loss of property assets in the course of saving or expanding the business should bear no opportunity cost but only temporary and in due course, such company will acquire new assets or perhaps buyback the leaseback property.