20 March 2017
Put simply, a sale and leaseback transaction is the sale of an asset which is then leased back, from the new owner, to the original owner.
These transactions, depending on the underlying purpose (and often the financial position of the parties (usually the seller)), often include terms such as buy back options or first rights of refusal of the asset, giving the seller some comfort that they can (subject to various conditions) get their asset back.
Long popular in Europe and North America, the structure has historically not been a major feature of the real estate industry in the UAE (or the wider Gulf) other than through Islamic Ijara arrangements with Sharia compliant banks. With many (particularly family) businesses being denied access to debt finance as the banking sector in the Gulf contracts, an increasing number of funds (large and small) are stepping into the market to fill the gap through this type of 'pseudo finance'.
What are the benefits for the seller?
There are a number of benefits to a property 'heavy' corporate who may be looking to enter a sale and leaseback arrangement:
This is the most obvious. In its most basic form, the transaction is a disposal of property in return for a lump sum, and the properties still required for operational purposes of the original owner are immediately leased back. The lump sum is used to generate a return to the business in excess of the rents payable following the sale.
In today's market, with many companies suffering a lack of liquidity because of market conditions, it can offer a financial lifeline without disrupting the operational workings of the business.
Outsourcing/streamlining and minimising risk
The transaction is an opportunity for an owner to offload the risks inherent in owning real estate and to outsource their asset management. At the same time, they can streamline their portfolio by disposing of properties they no longer need.
If the leaseback is an operating lease, (as opposed to a finance lease) any profit is recognised immediately on the balance sheet when the lump sum is received and no liability for the future lease payments will feature.
What are the benefits for the buyer?
Strong tenant covenant
The obvious benefit to the buyer in a sale and leaseback arrangement between unrelated parties is that it acquires a let property with a reliable and, often, an institutional tenant. Buyers can take time to do due diligence on a seller/tenant and, most importantly, the buyer is providing funds to the seller which it will be able to use to support itself financially or pay off debt.
Longer lease terms
A feature will also be a longer lease than would normally be the case in the UAE, where most leases are less than five years in length. Increasingly, leases under this arrangement are being entered into for up to ten years, which makes such investments more akin to what is normal in more mature jurisdictions, but with better yield rates.
Favourable lending conditions
Sale and leaseback transactions can also be conducted "internally" in a Propco/Opco arrangement, where an SPV (special purpose vehicle) is used by an entity to separate its real estate assets from its operating business.
The real estate assets would be transferred to a new company within the corporate group set up specifically to own the property (Propco). The operative parts of the business remain in the operating company (Opco). Propco would then lease the real estate assets back to Opco.
In this process, Opco will receive a sum from Propco for the sale of the assets, which it can then use in its normal day-to-day business activities
The benefit to this arrangement is to separate its real estate assets from its operating business so that it can obtain better terms of finance from its lender.
Legal structure and conditions
A sale and leaseback, in its simplest form, will include a property sale contract and lease to be entered into by the seller at the time of completion. There may be a number of other documents which feature in the transaction (potentially including an agreement reappointing the seller as the manager of the property on behalf of the buyer) but in essence these documents will form the basis of the deal.
If an institution is looking to market its portfolio to investors, it will produce a sale contract and style lease as part of its diligence pack. Conversely, if a fund is looking to encourage a seller to enter such an arrangement it will exhibit its standard lease for the seller to consider.
Some of the more common lease conditions in such deals are:
- As discussed above, a lease length of more than five (more likely ten) years.
- Clear exit route in the event of default by the seller. While buyers will be attracted to the idea of one reliable tenant, they will be opposed to the idea of being burdened with a tenant unable to meet its financial commitments.
- Leases must be on institutionally acceptable terms for the buyer's funder (if any) for the transaction (and any future finance provider, should the buyer wish to re-finance at any point in the future). This means the quality of the documentation is key.
- The seller will not want to take on onerous liabilities where it could potentially result in significant expenditure. A stringent maintenance and repairing obligation (particularly in the case of a newer building with liability for inherent defects) is, therefore, likely to oblige them to lay out money on day one in bringing the premises up to standard.
- The seller may require the flexibility of a right to break the lease and perhaps substitute other properties in certain circumstances.
- Having previously been free to do as they choose, the seller may also want to be subject to as few restrictions as possible.
- The seller may require a right of first refusal for the properties. This means that the buyer must offer to sell the property to the original owner before selling to a third party.
- The seller may negotiate a buy back option i.e. the right to buy back the property after a number of years. This is a commercial decision between the parties.
Particular issues to consider in the UAE
A number of peculiarities of the UAE market have implications for those looking to undertake sale and leaseback transactions.
In all the Emirates of the UAE, land ownership is restricted to certain nationalities in one way or another. Dubai and (to a lesser extent Abu Dhabi) are increasingly open to largescale non Emirati (or GCC) investment but each transaction needs to be considered in light of the location of a particular asset and the potential investors into that structure.
Length of lease
There is an ongoing evolution of leasing lengths within the UAE market with the trend being upwards. That being said, tenants and regulators are not used to seeing leases of anything more than five years in most cases. In Dubai, for example, a lease of over ten years must be registered against the title of the underlying land with consequently increased costs and administrative issues.
A great number of the most recent large sale and leaseback transactions have been in the areas of logistics and labour camps. The areas designated for such activities are in the main under long leasehold tenure with restrictions on subleasing to tenants (i.e. the seller). It is therefore necessary to seek consent from the relevant landlords (normally government run freezones) to undertake the transactions themselves.
Related to explicit subleasing restrictions, in Dubai in particular, high subleasing fees to the underlying landlord have historically been a deterrent for the sale and leaseback structure. Such fees can be a charge of up to twenty percent of the rent payable by the subtenant. These need to be factored into the costings for both parties.
As with all transactions in the UAE, registration with local authorities requires a great deal of care and preparation by both buyer and seller to ensure that title to assets is obtained smoothly.
This can involve obtaining pre-approvals from the relevant register prior to completion and careful consideration of powers of attorney and other necessary permissions.
One area of particular difficulty can be the discharging of pre-existing mortgages over assets where procedures are not clear, either from the perspective of the bank or the land register itself.
In short, until the debt markets in the Gulf return to a healthy state, sale and lease backs will form an increasingly important part of the transactional real estate market in the region.
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