The Pros and Cons of Sale and Leaseback Transactions

List of Contents

List of Abbreviations

List of Figures

List of Tables

1 Introduction

2 Financing methods
2.1 External financing
2.2 Internal financing
2.3 Leases
2.3.1 Operating lease
2.3.2 Financial (capital) lease
2.3.3 Practical example operating vs. financial lease
2.3.4 Sale and leaseback
2.3.5 Practical example of sale and leaseback

3 Pros and Cons of sale and leaseback transactions
3.1 Pros for the seller (lessee/occupier)
3.2 Pros for the buyer (lessor/investor)
3.3 Cons
3.4 Practical example direct M&A vs. sale and leaseback transaction

4 Effects of changing laws, regulations, and accounting practices on sale and leaseback transactions
4.1 New IASB & FASB lease accounting standards
4.2 Effects of “IFRS 16 Leases” on sale and leaseback transactions
4.3 Typical sale and leaseback applications in practice

5 Conclusion & Outlook

Bibliography
Printed sources
Online sources
Other sources

Appendices
Appendix 1: Composition of corporate financing for U.S. nonfinancial corporations 1994-2008
Appendix 2: New leasing growth rates by country in 2014
Appendix 3: New leasing volumes (in bn €) per country in 2014
Appendix 4: New leasing growth rates per asset type in 2014
Appendix 5: U.S. Treasury Bill Rates 2006-2016
Appendix 6: Deposit interest rates for corporate customers, New York, Bank of America, 2016
Appendix 7: Example of a sale and leaseback agreement
Appendix 8: Weaknesses of lease accounting standards before 2016
Appendix 9: Overview of “IFRS 16 Leases” effects on a company’s income statement compared to previous accounting standards

ITM checklist

List of Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

List of Figures

Figure 1: New leasing growth rates per asset types and countries 2014 (Source: (Leaseurope, 2015, p. 2))

Figure 2: Structure of a sale and leaseback transaction (Source: Adapted from (Global Net Lease, 2016))

Figure 3: Occurring transfers during a SLBT (Source: (Miletić & Milutinović, 2013, p. 267))

Figure 4: Covenants of loans vs. leases (Source: (Stout Risius Ross, 2011, p. 2))

Figure 5: Previous vs. new accounting for leases (Source: (IASB, 2016, p. 4))

Figure 6: IFRS 16 effects on financial statements of Airline Inc. (Source: Adapted from (IASB, 2016, p. 88))

List of Tables

Table 1: World Corp. Balance Sheet (Source: Own representation based on (Berk & DeMarzo, 2013, p. 24))

Table 2: World Corp. Balance Sheet with effects of purchase/ financial lease (Source: Own representation based on (Berk & DeMarzo, 2013, p. 24))

Table 3: World Corp. Balance Sheet with effects of a SLBT (Source: Own representation)

Table 4: Direct M&A vs. SLBT real estate valuation (Source: Own representation based on (Stout Risius Ross, 2011, pp. 3-4))

1 Introduction

The objective of this work is to analyze and assess the pros and cons of sale and leaseback transactions (SLBTs) from different perspectives. For that purpose, mainly printed sources from leading authors in the area of finance and accounting as well as academic journals will be used. To include latest developments and insights, the author will reference publications by standardization bodies, the Big Four audit firms as well as consulting companies, among others.

At first, the foundational framework will be established, including an overview of available financing methods and a definition on what is commonly understood by external as well as internal financing. The following sub-chapter drills deeper into the matter by defining what leases are and how they can be classified into different types. For that reason, operating and financial leases will be distinguished with reference to common accounting standards. Additionally, a practical example will illustrate this distinction. This is closely followed by the definition of sale and leaseback transactions including the prime characteristics of it. Also, a practical example will ensure clearer understanding.

In the main part the pros of sale and leaseback will be assessed from the perspective of the seller as well as from buyer of the assets. The associated cons will be analyzed thereafter. Another practical example will serve to complement this section.

In the next chapter the possible effects of changing regulations, laws and accounting practices regarding leases and SLBT’s will be outlined. This includes a practical example to illustrate and explain the effects of the new accounting standard “IFRS 16 Leases” on this subject from different perspectives. After that, a concise overview of typical sale and leaseback applications will follow.

Lastly, a conclusion including a personal interpretation with possible problem solving outcomes as well as a future outlook will be given.

2 Financing methods

2.1 External financing

In general, a company’s financing activities can be classified into two areas – internal financing and external financing. External financing defines funding which is not generated by the corporation itself but which is provided from outside.^[1] There are numerous methods of external financing with certain advantages as well as disadvantages, which can on the one hand be classified into equity financing via issuing stock (shares), private equity, venture capital or employee stock purchase plans.^[2] On the other hand funds can be provided via debt financing (borrowing), including medium- and long-term loans, short-term loans, also known as operating loans, like overdraft of the bank account, straight or convertible corporate bonds or trade credits from suppliers.^[3] Other measures include project finance as well as securitization like asset-backed securities (ABSs), asset-backed commercial papers (ABCPs), mortgage-backed securities (MBSs), commercial mortgage-backed securities (CMBSs), residential mortgage-backed securities (RMBSs), credit default swaps (CDSs), as well as collateralized debt obligations (CDOs) like collateralized loan obligations (CLOs), collateralized bond obligations (CBOs) and collateralized mortgage obligations (CMOs).^[4] Additionally, long-term leases can be regarded as a form of debt.^[5] The cost of capital regarding external financing methods is typically higher than internal financing because of transaction costs (agency costs) and interest payments, dependent on the level of risk, existing assets and the capital structure of the company, if applicable.^[6]

2.2 Internal financing

In contrast to external financing describes internal financing the utilization of internally generated funds of corporations to finance investment activities. The sources of this capital can be the corporation’s normal business activities, generating funds from turnover, interest, or extraordinary gains.^[7] Furthermore, retained earnings, meaning keeping the profits within the company and not paying them out as cash e.g. dividends, represents another source for funding.^[8] Cash flow allocated to depreciation serves as another way of providing capital.^[9] As a matter of fact, internal financing is the most commonly used way of providing capital for investments.^[10] This is proven by empirical evidence, showing that internal cash flows account for more than 66% of corporate financing in the United States, Germany, Japan and the United Kingdom.^[11]

Especially small companies are relying to a great extent on internal financing by retention of earnings and therefore less on external financing methods. The study by Carpenter & Petersen finds that this behavior can represent a restraint for a company’s growth potential since the utilization of external financing like equity issues (stock) possesses a greater leverage effect and thus can enable growth rates which are higher compared to the ones when not using external sources of funding.^[12] Another important aspect of internal financing is the sale of assets to use the generated cash flow to finance investment activities, where the assets can both be obsolete or currently used ones.^[13] In contrast to obsolete assets which can easily be sold because they are no longer required, this is not possible in the same way for assets which are currently utilized, but a particular method called “sale and leaseback”, which will be discussed in much more detail in section 2.3.4, provides a transaction which facilitates such an undertaking. Additionally, the liquidation of hidden reserves and the formal recording of the reevaluation in the balance sheet to show current market values provides a source of financing through an increase e.g. an understatement of assets like land or buildings to a historical cost while the current market price of such an asset is substantially higher.^[14] The other way round would be the overstatement of liabilities on the balance sheet. Internal financing instruments commonly induce lower costs of capital compared to external financing, because there are lower or no transaction costs (agency costs) involved, but they can also depend on different legal frameworks and levels of taxation, which can be high e.g. in Germany and thus have an impact on financing decisions.^[15]

2.3 Leases

Instead of using debt financing (borrowing) to make economic use of a property, plant or equipment (PP&E), a company or an individual can decide to use a lease agreement to do so.^[16] When entering in such an agreement for a defined period of time, the user of the PP&E, known as the lessee in that context, has the contractual obligation to make regular (lease) payments for the usage to the owner of the asset, referred to as the lessor.^[17] In contrast to a regular purchase this does not by default result in the ownership of the asset for the user, it only provides the right-of-use (ROU) for the agreed duration. Thus, leasing serves as a financing surrogate due to its similarities to an unpaid loan and its associated series of payments.^[18] Leases with a duration of 12 months or less (including renewal options) are classified as short-term leases, whereas agreements with a duration of more than 12 months are defined as long-term leases.^[19] Leasing is a very common method to finance investments, which is proven by the fact that 85% of companies in the United States use leasing for some or all of their PP&E and that US companies obtain 33% of their productive assets via leasing agreements.^[20] Especially in Europe, leasing volumes grew about 9.5% in 2015 to a total volume of €276 billion, recovering from the sharp decline of about 30% in 2009 due to the global financial crisis.^[21] The distinct new leasing growth rates per asset type and country are shown in figure 1.

Abbildung in dieser Leseprobe nicht enthalten

There are different types of leases, namely operating, financial (capital) as well as leveraged and synthetic leases. The last two will not be discussed in this paper. A special form of leasing is the so called sale and leaseback transaction (SLBT), which will be explained in section 2.3.4. in greater detail.

2.3.1 Operating lease

Operating leases^[22] are short-term, period-by-period, leasing agreements, which are usually shorter than the economic life of the PP&E, that are cancelable by the lessee and where the lessor is exposed to the risk of ownership (e.g. residual value or obsolescence).^[23] The advantageousness of using operating leases is determined by the recurring monthly or annual cost, the regular lease payments, which the lessee has to make. If these are lower than the lessee’s annual cost of buying the PP&E, it does make sense from a financial perspective to set up an operating lease agreement instead.^[24] Therefore operating leases can be regarded as a “lease versus buy” decision. Additionally, the lessor can provide insurance, maintenance, repair or full-service contracts, complementing the leasing agreement. Figure 1 shows the growth rates of new leasing agreements on a country and asset type basis. The International Financial Reporting Standards (IFRS) issued by the IASB classify an operating lease as all leases, which have not to be reported as debt on the company’s balance sheet and therefore are referred to as off-balance sheet (OBS) financing.^[25] The total lease payment is reported as an operating expense (OPEX), where neither a depreciation expense is deducted, nor is the resulting liability of the contractually agreed lease payments shown on the balance sheet.^[26] Details about the nature, extent and terms of this OBS financing have to be disclosed in the notes of the balance sheet.^[27] The fact that these are not shown on the balance sheet in the case of OBS long-term leases^[28], prevents the usual increase of the debt-to-equity ratio (D/E). In the event of paying for the PP&E using debt financing (borrowing) like a loan, not only the reported value of assets, but more importantly the company’s debt would rise. Thus, the assets-to-equity ratio (A/E), among others, would also be affected. Corporate scandals like the Enron bankruptcy have led to the enactment of new rules and regulations, like the Sarbanes–Oxley Act, to improve the precision of financial reporting and making false statements a criminal offense.^[29] Companies are now required to disclose details on OBS financing transactions as well as arrangements, (contingent) obligations and other relationships with not consolidated entities, which may affect (or change) the company’s financial condition now or in the future, regarding revenue, profit, liquidity or capital expenditures (CAPEX).^[30] Consequently, financial analysts, rating agencies and consulting firms have adapted to these developments and now take OBS financing measures also into account when making statements about the financial condition of companies, institutions and others.^[31]

2.3.2 Financial (capital) lease

Financial leases, also known as capital leases, are long-term leasing agreements, which usually last for (most of) the economic life of the PP&E, that are not cancelable^[32] by the lessee and where the user is exposed to the risk of ownership (e.g. residual value or obsolescence) and mostly is obliged to pay taxes, insurance and maintain the PP&E, which is then also termed a net lease.^[33] This type of leasing is the most common way of financing PP&E.^[34] Today, around 85% of those leases agreed upon are leveraged ones.^[35]

The Financial Accounting Standards Board (FASB) clearly defines in its Statement of Financial Accounting Standards No. 13 that a lease must be treated as a financial (capital) lease for the lessee and has to be shown on the company’s balance sheet, if it meets one or more of the following four conditions:^[36]

1. At the end of the lease term the lease transfers ownership of the asset to the lessee.
2. The lease contains the option to purchase the asset at a bargain price which is significantly lower than its fair market value.
3. The lease term equals 75% or more of the estimated economic life of the property.
4. At the start of the lease term the present value of the minimum lease payments is equal to or exceeds 90% of the property’s fair market value.

The contractually agreed lease payments are fixed obligations and due even if the PP&E does not generate economic benefits any longer, equal to instalments when using debt financing (borrowing), like a loan.^[37] Consequently, this is being regarded as just another form of borrowing cash to pay for the PP&E. Therefore, financial leases can be seen as a “lease versus borrow” decision with serious financial consequences if the lessee fails to make the payments (e.g. bankruptcy). From an accounting perspective, the capital lease is being treated as an acquisition (CAPEX), which results in the PP&E to be disclosed on the balance sheet of the lessee as an asset.^[38] As a consequence, the lessee must bear the depreciation expenses, deduct the interest fraction of the lease payment and furthermore show the present value of the future lease payments as liability on the balance sheet.^[39] Beyond, it has also implications on the income statement, where the amortization expenses of the PP&E are recognized, like the depreciation of a “normal” purchase.^[40] Comparing this to operating leases, the financial lease does in fact change the debt-to-equity (D/E) ratio of the company via a rise in debt. Also, the reported value of assets and therefore the assets-to-equity (A/E) ratio increases. Companies are disclosing details on this type of lease in the notes for PP&E as well as under commitments and contingencies.

2.3.3 Practical example operating vs. financial lease

The below example calculations serve to further explain and make the aforementioned differences between operating and capital leases more visible. World Corp. is evaluating how to obtain machines (assets) for an automated production line, totaling USD 200 million. The three possibilities direct purchasing using debt financing, financial (capital) lease or operating lease are being discussed. The current balance sheet of World Corp. is shown in table 1. Total assets as well as total liabilities and equity each are reported as USD 2,000 million, the debt-to-equity (D/E) ratio in this case is 1.22. If World Corp. decides to acquire the machines via purchasing while borrowing the capital (long-term loan), the balance sheet changes accordingly, shown in table 2.^[41]

Abbildung in dieser Leseprobe nicht enthalten

It becomes clear that the purchased assets are reported as an increase in PP&E of about USD 200 million, as well as the same amount as a rise in debt due to the long-term loan. Therefore, not only total assets and total liabilities and equity increase, but also the debt-to-equity ratio deteriorates to 1.44 from 1.22, a change of about 18%. The same effects can be observed if World Corp. uses the financial lease method. In contrast to this, if the decision is made to use an operating leasing agreement, there will be no change in the balance sheet whatsoever (see table 1). This is due to the fact of the operating lease serving as an instrument for off-balance sheet (OBS) financing, as previously outlined in section 2.3.1. Neither are the new machines listed as an asset, nor is the contractual obligation for the recurring lease payments reported as a liability on the company’s balance sheet. As a result, the debt-to-equity (D/E) ratio remains unchanged at 1.22, which does then not accurately represent the reality of World Corp.’s financial conditions.

2.3.4 Sale and leaseback

The previously outlined characteristics of financial (capital) as well as operating leases were mainly discussed to be used when obtaining new assets. Since a company may not always have the need to acquire a completely new asset, there is another possibility, which can be regarded as a combination of leasing and an ordinary sale. A transaction where the company sells one of its own and currently used assets to a buyer and in turn directly leases it back, is called a sale and leaseback transaction (SLBT).^[42] This process is outlined in figure 2.

On the one hand, the company (seller) receives cash from the sale of the asset.^[43] The amount paid by the buyer is usually close to the fair market value of the asset and will be determined after the due diligence has been completed.^[44] On the other hand, it enters into a long-term agreement to lease the asset back, continuing to

Abbildung in dieser Leseprobe nicht enthalten

use it because it is critical for its business operations.^[45] For the lessee this results in the obligation to make the regular payments to the lessor, which are typical for leases. These instalments are fixed in such a way, so that the lessor will receive the asset’s full purchase price over the agreed duration and in addition a premium which represents his return on the transaction.^[46] Due to this construction one could refer to the company which sold and leased the asset back as “seller-lessee” and likewise to the buying company as “purchaser-lessor”. During this transaction, there is also a transfer of ownership from the seller to the buyer and on the contrary the transfer of the ROU from the buyer to the seller, as seen in figure 3.

This type of transaction can be very appealing to unlock value since the company has now the ability to invest the proceeds into the business to generate higher returns on capital, to increase its liquidity^[47] or to use it to repay debt, which can have an effect on its credit rating provided by credit rating agencies (CRAs)^[48] like Standard & Poor’s (S&P) Moody’s or Fitch, and therefore further benefit its financial conditions, e.g. interest rates which have to be paid for its debt or its D/E ratio. This can be seen as the main motivation to use SLBT, and not, as some regard it, to be driven solely by accounting considerations.^[49] An asset in this context does not necessarily need to be a fixed (physical) asset like PP&E, although these are

Abbildung in dieser Leseprobe nicht enthalten

the most common ones, it can also be an intangible asset, in the case of intellectual property (IP) these are patents, ideas, trade secrets, copyrights or trademarks.^[50] Over the last 15 years SLBT’s have become more and more popular among corporations, public institutions, municipalities and even governments. This is on the one hand due to the structural flexibility to suit the needs of both the seller and the buyer, and on the other hand induced by challenging economic circumstances. The latter can lead to traditional methods of debt financing becoming even more complicated, e.g. when the creditor’s balance sheet is deteriorating and loans or bonds with financial covenants^[51] are already in place, which is often true for restructuring cases.^[52] Therefore, SLBT’s provide a viable source of financing under these circumstances. From an accounting perspective, the lease part of SLBT’s can either be structured as an operating or as a financial (capital) lease with the associated implications. Furthermore, SLBT’s can be classified into standard, short-term or partial arrangements.^[53] Since these are mostly used in the context of real estate, this segmentation will not be further discussed.

2.3.5 Practical example of sale and leaseback

Continuing with the example of World Corp. from section 2.3.3 the effects of a SLBT will be outlined in the following. After the purchase of assets for an automated production line, World Corp.’s balance sheet is represented by table 2. It consists on the one hand of USD 200 million in cash and cash equivalents (CCE) as well as USD 2,000 million in PP&E. On the other hand, there are liabilities shown with a value of USD 1,300 million and USD 900 million in equity.

Assuming, the company is able to structure the SLBT in such a way, which would result in the valuation of the newly acquired machines for the production line of about USD 200 million, the same as the original purchase price. In reality, this is not very likely to happen^[54], but for illustration purposes it shall suffice here. Following the statements earlier in this chapter, this will result in a cash inflow of exactly the USD 200 million for World Corp., which can immediately be used for other investments. In this example, World Corp. decides to use USD 100 million to pay off debt immediately, reducing the leverage, and to put the remaining USD 100 million^[55] in virtually default-free^[56] U.S. government Treasury bills (T-bills) with a maturation of 6 months at 0.46%^[57], and not on a savings account due to the current low interest rate environment, which pays a maximum interest rate of 0.04%.^[58]. As these are accounted for as CCE, the amount reported on the balance sheet increases to USD 300 million, PP&E is reduced to 1,800 million while debt decreases to USD 1,300 million due to the repayment. Consequently, this leads to an improvement of the D/E ratio, which was previously 1.44 and is now reported as 1.33. As the SLBT is characterized as a form of OBS financing due to its similarities to an operating lease in this case, it does not have to be reported on the balance sheet. Furthermore, also the A/E ratio as well as various liquidity ratios are improved by this increase in CCE of about USD 100 million. This SLBT balance sheet is shown in table 3.

Total assets as well as total liabilities have both decreased to USD 2,100 million. From a financial conditions perspective, this is the more favorable balance sheet compared to the one in table 2 and shows just slight increases in debt but more importantly, also in CCE, and no change in PP&E, although having extended the automated production line. In the end, this might improve the credit rating as well.

3 Pros and Cons of sale and leaseback transactions

3.1 Pros for the seller (lessee/occupier)

In general, there are ten distinct benefits which the lessee can possibly realize. Whether all apply at the same time or not, depends much on the circumstances under which such an SLBT is agreed upon, e.g. healthy business or restructuring case, as well as the timing, market and geopolitical conditions, legal and accounting frameworks, which can be subject to change, or specific individual goals which are to be realized, including one’s risk-taking propensity.^[59] As a result, not every positive aspect which will be outlined below does in fact make sense for every enterprise, public institution, municipality and or even government.^[60] Also, the effects of such long-term commitments should be taken into close consideration when determining its effects on future commercial operations.

SLBT’s enable the seller to free up (trapped) cash and to reallocate it e.g. for investments into its own core business to catalyze growth or to expand its geographical footprint, where the seller can most commonly generate higher returns, since managing real estate is not regarded to be the core competence of most businesses or institutions, except for those who are specializing in it.^[61] Especially regarding real estate transactions, SLBT’s yield up to 100% of its fair market value, compared to just 60% to 80% when using a typical outright sale.^[62] Historical evidence shows that these additional proceeds can become critical to a company’s survivability, because investments in future growth, R&D and generating game changing innovations, represent more than ever key drivers to remain globally competitive in today’s rapidly evolving marketplace.^[63]

Probably the most common reason to use SLBT is its characteristic as a financing method. As outlined in the example in table 3 in section 2.3.5, the sale of the asset provides the company with a cash inflow which is usually close to its fair market value. This is especially beneficial for companies which are having issues to get another loan due to their financial conditions by having already borrowed large amounts or issued bonds with financial covenants in place, which can, among others, result in a below investment grade rating, everything below BBB or Baa, issued by CRA’s.^[64] The same often applies to companies undergoing a restructuring.^[65] Furthermore, the overall economic situation can restrict access to capital markets, which happened in the aftermath of the financial crisis^[66], where loans were issued much more conservatively than before, making SLBT’s also a valuable alternative to the more expensive mezzanine financing, also due to not having a dilutive effect on the company’s equity.^[67] Examples in the retail sector show exceptionally well how private equity firms extraordinarily frequent take over companies which possess large real estate portions with the intention to use SLBT’s to finance these acquisitions.^[68]

In addition to it, another benefit is provided by enabling the lessee to improve the balance sheet by being able to amortize the proceeds from this transaction on the company’s income statement, boosting reported earnings, which in turn can also positively affect its financial ratios and margins, as long as legal requirements and accounting practices concerning SLBT’s remain unchanged.^[69] Further effects are a decrease in reported PP&E value, putting the assets off-balance, because the SLBT is characterized as a form of OBS financing. Besides, the A/E as well as various liquidity^[70] ratios are improved by a possible increase in CCE or, if the cash is used to repay debt, the D/E ratio. This can improve the company’s credit rating and consequently further benefit its financial conditions, e.g. interest rates, which have to be paid for the debt. Some of these effects are shown in the SLBT example in section 2.3.5.

Another valuable benefit can be seen in premium pricing, which, proven by historical evidence, can lead to up to 13% higher valuation of real estate compared to properties that are not subject to sale and leaseback with a dependable rent rate.^[71] This is mainly due to the expected higher cash flow of such a property because the long-term lease agreement works against the usual periodic vacancy due to tenant fluctuation, which is common in property markets.

Closely related to this pro, are the realizable gains from beneficial taxation treatment of SLBT’s. Under current U.S. legislation and accounting practices, lease payments are reported as an operating expense, which makes them tax deductible against the taxable income, compared to only the interest portion, and when being the owner of the real estate, also the depreciation expense, of a mortgage payment.^[72] This ability to write payments off therefore leads to a greater tax advantage for the lessee and in most cases offsets the sacrifice of interest deduction.^[73] Besides, a corporation which owns real estate with a low tax basis but which is currently making considerable losses, can use a SLBT to offset (some of) the taxable avails from the sale of the asset against its current or carried forward tax losses.^[74] A phenomenon, which is currently seen due to cheap money globally, can lead to an appreciation in the asset’s value. This can have positive effects for the seller in that sense, that a purchaser would anticipate tax savings due to higher depreciation deductions because the tax basis in the property will be stepped-up to reflect the (now) higher fair market value.^[75] This would be particularly attractive for purchasers and conversely (indirectly) raise the value of the seller’s asset.

Additional advantages for the lessee can be seen in the potential to define favorable terms & conditions of the lease when structuring the agreement. This is due to the seller being the lessee at the same time, which provides him with a vigorous position when negotiating with the lessor by enabling him to include specific extension options or early termination clauses, to give him the flexibility he needs for his operations.^[76]

As SLBT’s are in fact not defined as a “financing instrument” in the usual sense, there are no financial covenants associated with it, and therefore the company maintains control over its own business and operations without financial restrictions.^[77] Typically, covenants can have restricting effects on a company’s ability to further increase leverage or leasing, on the level of working capital which must be maintained as well as on investment and dividend policies, which on the one hand shelter against improper deterioration of a company’s financial condition, but on the other hand can increase the probability of default or bankruptcy if the limits are set too narrow.^[78] An example comparison between covenants of loans (senior debt) and a leases is shown in figure 4.

Abbildung in dieser Leseprobe nicht enthalten

Managing or mitigating risk can be another benefit of such transactions by transferring, in the case of real estate, all risks associated with the residual value, e.g. when the property is vacant, to the lessor (owner).^[79] Due to the long-term lease, the lessee is at the same time able to safeguard occupancy rights as well as maximum value.^[80] This risk transfer, except the occupancy rights, does apply in a similar fashion also for assets like a machine, especially regarding the residual value risk, the probability to being able to sell the asset after the end of the lease or its useful life and the thereby achieved price, which can at times even be zero, e.g. if the asset or machine is specifically custom-built and cannot be used by anyone else.^[81]

In contrast to selling a complete company or portions of it, the seller can maintain control over the daily planning and management of the business when using a SLBT instead, especially due to the aforementioned benefit of negotiating favorable terms & conditions of the lease.^[82] In the case of a real-estate transaction, the lessor typically takes a hands-off approach as long as the asset value is not concerned, making the lessee accountable for paying accruing taxes, insurance premiums as well as common area maintenance costs, which is very similar to actually owning the real estate.^[83] This can also include further merits for the lessee in terms of means for further expansion, sublease or the modification of the property, when needs or usage patterns change.

Last but not least, SLBT’s can be favorable due to their relatively swift closing, providing additional time and cost amenities for the lessee.^[84]

3.2 Pros for the buyer (lessor/investor)

There are five major pros for the buyer of the assets in a SLBT. As the lessor operates in virtually the same environment as the buyer, but from the opposite perspective, the context outlined in section 3.1 does equally apply. Furthermore, it is of paramount importance for the investor to conduct his due diligence through a proper structured and consistent approach before underwriting, including (local) market research, information of comparable leases, long-term tradability, and if the asset is land or a building, it can also be extended by location and asset appraisals, as well as regarding the residual value or obsolescence risks and alternative use scenarios.^[85]

Presumably one of the most important aspects for the buyer can be seen in robust performance provided by such SLBT’s. This means, that the stronger volatility in equity markets as well as a wide array in pricing regarding fixed-income securities, act as an inhibitor and thus make a stable and contractually secured return for the lessor in terms of the regular rent payments particularly attractive.^[86] Besides, if the investor is rather risk-averse, as generally most institutional investors are, this long-term lease together with lessees which have an investment grade rating, may be the preferred choice.^[87] In Addition, SLBT’s result in an instant cash return on equity since leases are in place. The performance of such leases is comparable to that of corporate bonds, but with superior characteristics due to, depending on the contractually agreed terms and conditions, the inclusion of a hedge to antagonize inflation or adjustments of the regular lease payments (rent).^[88]

[...]

---

^[1] (Brealey, et al., 2011, pp. G-6)

^[2] (Winkler, 2014a, pp. 6-13) & (Madura, 2015, pp. 523-524)

^[3] (Winkler, 2014a, pp. 15-24), (Brealey, et al., 2011, p. 598) & (Madura, 2015, pp. 522-523)

^[4] (Brealey, et al., 2011, pp. 329, 602-603, 613-615, 779-781 ), (Zhang, 2014, p. 240), (Fabozzi & Kothari, 2008, pp. 5, 31, 151-153, 169, 212-215, 321-322), (Stone & Zissu, 2012, pp. 131-132, 219-220), (Hu, 2011, pp. 15-18) & (Tavakoli, 2003, pp. 6-17).

^[5] (Brealey, et al., 2011, p. 597)

^[6] (Moyer, et al., 2012, pp. 432-441)

^[7] (Winkler, 2014a, p. 25)

^[8] (Brealey, et al., 2011, p. 341)

^[9] (Brealey, et al., 2011, pp. 341, G-8)

^[10] An example of the composition of corporate financing for U.S. nonfinancial corporations can be found in appendix 1.

^[11] (Brealey, et al., 2011, p. 342)

^[12] (Carpenter & Petersen, 2002, p. 307)

^[13] (Winkler, 2014a, p. 28)

^[14] (Collins Dictionary of Business, 2005). This is also related to inflation accounting.

^[15] (Moyer, et al., 2012, p. 441) & (Winkler, 2014a, p. 27)

^[16] (Moyer, et al., 2012, p. 210)

^[17] (Brealey, et al., 2011, p. 353)

^[18] (Schallheim, et al., 2013, pp. 1-4) & (Brealey , et al., 2008, p. 404)

^[19] (Biondi, et al., 2011, p. 865)

^[20] (Berk & DeMarzo, 2013, p. 859)

^[21] (Leaseurope, 2015, pp. 1-3). Further statistics concerning leasing within Europe can be found in appendices 2 to 4.

^[22] Sometimes also called service or maintenance leases.

^[23] (Brealey, et al., 2011, p. 640), (Moyer, et al., 2012, p. 733), (Berk & DeMarzo, 2013, p. 879) & (Damodaran, 2015, p. 290)

^[24] (Brealey, et al., 2011, p. 640)

^[25] (IASB, 2015, p. 24). The IASB (International Accounting Standards Board) is the organization which sets the IFRS.

^[26] (Berk & DeMarzo, 2013, p. 866)

^[27] (Fraser & Ormiston, 2010, p. 61)

^[28] In this context long-term operating leases are meant, which would normally be accounted for as financial (capital) leases according to the four rules mentioned in section 2.3.2, but are via OBS financing avoiding these and are not reported as such, resulting in the mentioned benefits for the lessee like the reduction of leverage.

^[29] (Fabozzi & Kothari, 2008, pp. 19-20), (Horngren, et al., 2012, p. 5) & (Tavakoli, 2003, pp. 271-276).

^[30] (Fabozzi & Kothari, 2008, p. 20)

^[31] (Moody's, 2015) & (CBRE, 2012, p. 3). In fact, adjustments are made to the balance sheet as well as to the income and cash flow statements.

^[32] It might be that a cancellation is possible, but only if the lessee reimburses the lessor for any losses.

^[33] (Brealey, et al., 2011, pp. 626, 632-633), (Damodaran, 2015, p. 290) & (Moyer, et al., 2012, p. 713)

^[34] (Berk & DeMarzo, 2013, p. 859)

^[35] (Moyer, et al., 2012, p. 733)

^[36] (FASB, 1976, p. 8). The FASB is the board which improves the US GAAP (United States Generally Accepted Accounting Principles).

^[37] (Brealey, et al., 2011, p. 623) & (Moyer, et al., 2012, p. 713)

^[38] (Fraser & Ormiston, 2010, p. 60)

^[39] (Berk & DeMarzo, 2013, p. 866)

^[40] (Fraser & Ormiston, 2010, p. 60)

^[41] Technically World Corp. would be able to fund this investment from its cash and cash equivalents, which equal the required sum of USD 200 million, but for illustration purposes this decision is not made.

^[42] (Berk & DeMarzo, 2013, p. 860), (Brealey, et al., 2011, pp. G-5, G-14), (Moyer, et al., 2012, pp. 713-714) & (Wahlen, et al., 2011, p. 478)

^[43] (Rankine & Howson, 2006, p. 104)

^[44] (Moyer, et al., 2012, p. 713). The due diligence in this case can include (local) market research, information regarding comparable leases, sale data, and if the asset is land or a building, it can also be extended by location and asset appraisals (Stout Risius Ross, 2011, p. 4).

^[45] An example of such a purchase agreement included in a SLBT can be found in appendix 7.

^[46] (Moyer, et al., 2012, pp. 713-714)

^[47] (Richter & Timmreck, 2013, p. 436)

^[48] Other credit rating agencies are not mentioned since the above three control approximately 95% of the entire rating business. (Council on Foreign Relations, 2015). Therefore, investors and stakeholders are likely to expect a rating from one of these three players.

^[49] (CBRE, 2012, p. 3)

^[50] (OECD, 2015, pp. 463-464, 471)

^[51] The IASB defines covenants as follows: “Agreements between an entity and its creditors that the entity should operate within specified limits. They are agreed as a condition of borrowing” (IASB, 2015, p. 24).

^[52] (Fodor & Kiely, 2003, pp. 1-2) & (Richter & Timmreck, 2013, p. 436)

^[53] (CBRE, 2012, p. 5) & (Real Capital Analytics, 2016)

^[54] Although it is very unlikely, it is not entirely impossible. In the case that these machines are not custom-built, they could appreciate due to changing market conditions, e.g. rising demands for this machines and delivery or production problems of the manufacturer. This would lead to a shortage in supply or availability of these machines, assuming no one can manufacture them alike, and therefore have an effect also on the price and value of pre-owned machines. Consequently, this appreciation can (more than) offset the depreciation of the asset’s value due to being used.

^[55] Assuming the full amount can be used to buy T-bills, which in reality may not be possible due to limitations on purchase volumes.

^[56] (Winkler, 2014b, p. 7)

^[57] The U.S. Treasury Bill Rates from 2006-2016 for maturation of 6 months as well as 30 years can be found in appendix 5.

^[58] (Bank of America, 2016). Due to World Corp. being headquartered in New York, the interest rate from this area is used. The full details can be found in appendix 6.

^[59] This evaluation includes, but is not limited to, providing a commercial justification regarding internal benchmarks e.g. financial covenants, return on equity, cost of capital or bond rates (CBRE, 2008, p. 9).

^[60] Although many of the examples will be outlined regarding corporations, most of them will be equally or similarly applicable to public institutions, municipalities or governments.

^[61] (CBRE, 2012, pp. 2-4), (Ashiya, 2015, p. 92) & (OECD, 2016)

^[62] (Fodor & Kiely, 2003, pp. 1-2) & (Stout Risius Ross, 2011, pp. 2, 4)

^[63] (Colliers International, 2015, pp. 2, 5)

^[64] (Sirmans, C. F. & Slade, 2010, p. 221) & (Hull, 2015, p. 544)

^[65] (Fodor & Kiely, 2003, pp. 1-2) & (Richter & Timmreck, 2013, p. 436)

^[66] In the current economic climate, this is not a real issue because of the abundance of capital, also more recently termed as “superabundance of capital” due to its vast magnitude (Bain & Company, 2015, p. 1).

^[67] (Stout Risius Ross, 2011, pp. 2, 4)

^[68] (Rankine & Howson, 2006, p. 96) & (CBRE, 2012, p. 1)

^[69] (Stout Risius Ross, 2011, p. 4) & (CBRE, 2012, p. 4)

^[70] (Richter & Timmreck, 2013, p. 436)

^[71] (Sirmans, C. F. & Slade, 2010, p. 222) & (Fodor & Kiely, 2003, pp. 1-2)

^[72] (Berk & DeMarzo, 2013, p. 866), (Colliers International, 2015, p. 2) & (Stout Risius Ross, 2011, pp. 2, 4)

^[73] (Fodor & Kiely, 2003, pp. 1-2)

^[74] (Fodor & Kiely, 2003, pp. 1-2). This moving cause would vanish at the point where the company is not making a loss anymore or as soon as there are no current or carried forward tax losses left.

^[75] (Fodor & Kiely, 2003, pp. 1-2)

^[76] (Stout Risius Ross, 2011, pp. 2, 4)

^[77] (Stout Risius Ross, 2011, pp. 2, 4) & (IASB, 2015, p. 24)

^[78] (Damodaran, 2015, pp. 41-42), (Moyer, et al., 2012, p. 201) & (Wahlen, et al., 2011, p. 380)

^[79] (Ashiya, 2015, p. 107)

^[80] (CBRE, 2012, p. 3)

^[81] (Ross, et al., 2008, pp. 23-28)

^[82] (Colliers International, 2015, p. 2)

^[83] (Stout Risius Ross, 2011, p. 2)

^[84] (Stout Risius Ross, 2011, p. 4)

^[85] (Stout Risius Ross, 2011, p. 4)

^[86] (CBRE, 2012, p. 4) & (Colliers International, 2015, p. 2)

^[87] (CBRE, 2012, p. 1)

^[88] (CBRE, 2012, p. 4)