Valuing a sale and leaseback facility

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Permalink Reply by Rupesh on July 14, 2010 at 12:19pm

this is a crude but simple:

Since, your client has indicated he will buy the asset under the said transactions, based on min return/IRR you require, you structure the transction as a term loan & recover the same as rental ( EMI). In term loan security is mortgaged, while in this case it is transfered in your name. But make sure you load the taxes if any on rentals on your client.

Check the client's worth and of the asset too..

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Permalink Reply by Handerson M on July 19, 2010 at 4:51am

3 issues emerge from your scenario.
First, regarding valuation of the building you may use both the Market value and the discounted cashflows as indicators to the price your client should sell the house at. Similarly, the prospective buyer is likely to use this as parameters for the price he will be willing to pay. In the end, it will boil down to the parties' negotiation skills.
Secondly, it is fairly easy to incorporate the residual value to the DCF calculation. Include it in the 5th Years calculation of rentals and discount it .
Thirdly, I presume your client may be doing this to not only ease his liquidity crisis but post favourable liquidity and gearing ratios. From a finacial reporting perspective A sale and leaseback transaction will be considered as a loan under International Financial Reporting Standards ( IAS 18 Revenue)..needless to add the leaseback seems likely to be considered as a Financial Lease ( IAS 17 Leases) and therefore the impending rentals would appear as Liabilities rather than be expensed year on year.
PS. the last point is useful only if Zimbzbwe is a contracting party to International Financial Reporting Standards and a member of International Accountiing Standards Board ( IASB)

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Permalink Reply by Munakamwe Macdonald A P on July 19, 2010 at 5:01am

Thank you. I am having difficulities actually getting the residual value after 5 years. How do i come up with that value. Bear in mind that the rentals will also be growing.

My client really is heavily geared. Is a leaseback the best method out there to refinance the business. I am looking for 5million. Was consdiering reedmable cumulative preference shares

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Permalink Reply by Ian on July 19, 2010 at 8:33am

Dear Mr. Munakamwe Macdonald,

On assumptions that your client is a privately held company and there sufficient liquidity in the debt capital markets in the country where your client is operating in, one of the alternate funding method you may consider is to structure the sales and leaseback as an operating lease instead of a finance lease and to tap funding from bond issuance.

You may want to help your client to raise funding via the debt capital markets. Your client may sell the building to a special purpose company ("SPC"). The SPC will then raise funding to buy the building from your client via issuance of bonds to potential investors.

Depending on the all-in yield of the bonds to be issued and the the NPV (you mentioned 5 million), you may work out the future residual value of the building. The future value will be agreed between yuor client and the SPC on willing buyer and willing seller basis. You may need to fine tune some parameters to ensure the lease is an operating lease and the SPC to achieve tax neutrality status.

Operating lease will ensure your client achieve off-balance sheet treatment of the building while raising sufficient cash in hand / cash to pay off the existing loan (assuming the building is currently funded with a loan liability). This may improve the gearing ratio of your client.

Operatig lease rental should be tax deductible, This structure may help your clien to lower its taxable profits in years to come with chances to improve the working capital liquidity.

Thank you,
The Author

Disclaimer:
Given laws and regulations varied in different jurisdictions, the above structure is a friendly idea ("the Idea") shared with you and/or any other party on terms that the Author assumes NO whatsover liabilities or any loss you may suffer arising from the use of the Idea by you and/or your client. You and/or your client are advised to sought all neccessary professional opion/advice and/or to discuss the bankability / feasibility of the Idea with your local regulators/authorities, lawyers, bankers, accountant and/or any other relevant parties before adopting the Idea.

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Permalink Reply by George William Bester on July 19, 2010 at 9:04am

Alternative.....In my own country Banks offer what are called Equity release, these are products were the Building is valued by qualified valuers and the bank then can disburse cash of up to 70% of the valuation made. Make some visits to your Bankers and see what products they can offer.

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Permalink Reply by Lucas Baker on July 19, 2010 at 12:59pm

While not having worked on a sale-lease back transaction, I would approach the valuation the same as if you were buying an investment property and planning to rent it out for five years before selling it. This is basically a simplified two-stage dividend discount model, which is what the PE shops that I’ve worked with use. You’ve already done stage one by discounting the rental payments. Valuation at the end of the lease term can be calculated very simply by dividing forecasted rental payments in year 6 by a forecasted capitalization rate (i.e. a discount rate used for the specific property type) … P5 = (CF6 / cap rate). This will give you a basic value at t=5, then discount it back to t=0 if you want to find P0. Look at transactions sales on similar property types or call a few brokers to get an idea of cap rates. I’m sure there are some nuances with the sale-lease back transaction that I’m missing, such as the impact of taxes, but this is where I would start on the valuation side.

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Permalink Reply by Thushantha Pitigala on July 22, 2010 at 1:10am

What about the land value on which this building sits?? By applying the formula CF6/CAP RATE does it take land value as well?? or is it only the bulding? or the business running in it??

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Permalink Reply by Sachidanand (Sacha) Singh on July 21, 2010 at 12:11am

Value the building on the basis of prevailing rate in that locality for that type of construction - say x per square feet.
To make it profitable for the investor fix rent at the prevailing rental say y per square feet. The investor will be getting rental income and appreciation. Since x and y are market driven, assuming there is an active free market in both parts of real estate - capital and rental - there is no reason to suppose that investor would not be getting a fair return for his investment and risks.
If your client's industry is destroyed because of cheap imports lenders may be wary of extending finance - their risk would be much more unless collateralised with real estate in which case your client virtually parts with teh property but does not get full value (of course continues to occupy premises without rent as now).

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Permalink Reply by Howie Lee on July 21, 2010 at 12:25am

I am doing something similiar to this.

The residual value of the building would be after 5 years will really depend on the real estate market. If the RE market tanks and drops below to what your client agreed to pay for, I am sure he will renegotiate for something based on market price.

On the other hand if the trend is for these buildings to appreciate, you're client has made a gain from agreed price to actual price according to market or valuation from valuers.

Back to residual what everyone was saying is true, willing buyer willing seller. But the person purchasing this building to get the leaseback, he should determine this own set of needs. After that has been establish it will be easier to negotiate up to that value with your client. Both parties will be happy.

The banks as I know it will rate the risk according to the investor as it is them that will guarantee the bank. Ofcourse the party leasing will also be a factor, wether they will default. You need to check that because that affects your valuation and financing cost (which year they default in the event). Also how many months or years deposit is given by party leasing is important. You can assign this to bank and you could bring down the interest rate, giving your investor more profit.

You need to share more details.

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Permalink Reply by Ankit Gogia on July 21, 2010 at 11:36am

1. You have the value of the building now the money which you are going to invest in your business and than forecast the cash flows as per your expected cash flow figures which you have of your business and than when projected it for 5 years find the present value using DCF use the same rate you used to calculate the value of the building and you will get a residual value the present value.

Now you can find the adjusted NPV for all your rentals for 5 years by adjusting the factors:
Inflation rate
CAGR of the building increase or decrease in the building prices for last 10 years say
and some other risk factors which you consider as per your requirement.
Than Find the adjusted NPV after adjusting all this figures and now you can compare the value which you will get after discounting and the value which you have calculated in the 1st step the discounted value of all forecasted expected cash flows.

Thanks
ANKIT

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Permalink Reply by Joseph on July 22, 2010 at 11:02pm

Hi guys,

I am going to make it simple, therefore spreadsheet attached (for illustrative purposes only). You will find some comments about my assumptions.

I am not discussing the residual land component (as it will depend on what you can put on the land - i.e. if you can replace a small building office for a A grade 35 floor tower - yep the residual land will be high)

I have assumed the repurchase of the building at the end of year 5 as expected.

Cheers Joseph

Attachments:

• sale and lease back.xlsx, 13 KB

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Permalink Reply by Joseph on July 23, 2010 at 3:08am

Sorry,

By the way, if the intention is not to repurchase the building but to enhance the land by obtaining a planning permit for another building (i.e. commercial/residential), and then sell the site at the end of year 5, then the analysis is different from what I have forwarded to you in my earlier email.

The top end of the residual land value model is different depending on the type of real estate asset you intend to/can buid at year 5. After that the analysis is the same. I have a model somewhere I can dig up for you but in essence it works like that:

commercial

can build: 1000 sqm that you can rent at 100 psm = 100,000
Cap Rate (yield): investor to pay a yield of 8%
Capital value: 1.25m
then work you way down (ie deduct selling costs, dev profit, construction cost, interest etc)
After all costs are deducted you will have a residual land value. that is, the maximum amount a developer will pay for the land taking into consideration his profis and costs.

Essentially, it is a cash p&L and you start from the top and deduct everything to arrive to a residual land value.

Residential

Go and see your planner/architect to see how many units can be built.

research sales price of similar units in the area (if in 5 years assume rate of inflation) - but I would start in today's $.

Then same thing, I would work my way down to arrive to a residual land value based on the developer's expected profit, construction/selling costs/interest etc.

Conclusion:

first analysis as per my spreadsheet (i.e. if you repurchase building)

second analysis - work your way down to arrive to a residual land value

you can then compare the two options

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