Chapter 11 THE SALE-LEASEBACK

Question 1

What is the primary goal of the chapter?

Answer 1

To expand knowledge of mixed-use strategies, particularly the sale-leaseback technique.

Question 2

Define a sale-leaseback.

Answer 2

The sale of an interest in realty and the subsequent leasing back of that same realty.

Question 3

What are the benefits of a sale-leaseback for the seller?

Answer 3

• Generates capital
• Frees up initial investment
• Can adjust sale price and future rent

Question 4

Why might a seller choose to use a sale-leaseback strategy?

Answer 4

To generate capital quickly or to follow a clear investment plan.

Question 5

What factors can affect the success of a sale-leaseback?

Answer 5

The actual terms negotiated between the seller and buyer.

Question 6

What is Frank’s total equity as stated in the chapter?

Answer 6

$840,000

Question 7

Fill in the blank: Frank needs _______ to expand to two new locations.

Answer 7

$300,000

Question 8

What is a triple net lease (NNN)?

Answer 8

A lease where the lessee pays taxes and provides full liability insurance.

Question 9

What are the components of Frank’s real estate owned?

Answer 9

• Land value: $120,000
• Building value: $500,000
• Cash on hand: $220,000

Question 10

True or False: In a sale-leaseback transaction, the lessee owns the fee simple title to the realty.

Answer 10

False

Question 11

What is the difference between fee simple title and leasehold interest?

Answer 11

Fee simple title is absolute ownership rights, while leasehold interest has fewer rights and a finite life.

Question 12

What should Enterprise Ownership negotiate to improve their situation?

Answer 12

The right to buy the land at a future date.

Question 13

What is the significance of a lease with a cost of living index adjustment?

Answer 13

It allows the lease payment to increase in relation to inflation.

Question 14

What does the term ‘leasehold interest’ refer to?

Answer 14

The interest held by the tenant in the property leased.

Question 15

What happens to the leasehold interest if the lease is sold?

Answer 15

The interest passed on is merely the remainder rights in the underlying lease.

Question 16

What can limit the transferability of a leasehold interest?

Answer 16

Provisions in the lease contract.

Question 17

What is a common structure for a land leaseback?

Answer 17

Land is leased to a new tenant who builds their facility on that leased land.

Question 18

What is one potential outcome of a rising real estate market for leasehold interests?

Answer 18

The value of the leasehold can significantly increase.

Question 19

What is a potential pitfall in using a sale-leaseback technique?

Answer 19

Improper use can lead to financial losses.

Question 20

What strategy can Frank employ to balance equity with future upside?

Answer 20

Create two leases with realistic terms that allow for future flexibility.

Question 21

What can the leasehold interest value jump to when monthly rent increases to $50,000?

Answer 21

$6,000,000

Based on an investor yield of 10 percent of the value of the land.

Question 22

How does the length of a lease affect its value?

Answer 22

The longer the lease, the more valuable the ultimate leasehold interest.

Question 23

What is a challenge for lessees in obtaining financing?

Answer 23

The terms of the lease can create difficulties for obtaining additional financing.

Question 24

What does an unsubordinated lease mean?

Answer 24

The owner of the fee retains a first lien position in the land.

Question 25

What factors influence whether a lender will offer a leasehold loan?

Answer 25

* Amount of the loan * Length of the loan term * Strength of the borrower

Question 26

What is subordination in the context of land leases?

Answer 26

An event where one person gives up certain rights to another.

Question 27

In a sale-leaseback, who becomes the leasehold owner?

Answer 27

The previous owner, or fee owner.

Question 28

What are the five ways a lessee can obtain development funds?

Answer 28

* Use all cash with no lien * Obtain a loan without property as security * Find a lender who treats the leasehold as a fee simple * Obtain a loan with something else as security * Get the owner to agree to subordinate to the required financing

Question 29

True or False: Subordinated land leases present a major problem in obtaining financing.

Answer 29

False

Question 30

What is leasehold equity?

Answer 30

The value created by improvements made by the lessee or the relative cheapness of the lease.

Question 31

What happens if a lessee fails to pay rent and the security is insufficient?

Answer 31

The lease may become worthless.

Question 32

What is the impact of a fixed lease term on the ability to obtain financing?

Answer 32

It can make it easier to find a lender willing to take the leasehold interest as security.

Question 33

What must all parties involved in a lease transaction pay close attention to?

Answer 33

The subordination terms.

Question 34

Fill in the blank: A lessor who allows subordination may face a difficult decision if they go into _______.

Answer 34

default

Question 35

What is a key consideration for landowners when leasing to someone requiring subordination?

Answer 35

They may be reluctant due to the risks involved.

Question 36

What can be a consequence of a tenant being behind on rent?

Answer 36

The lessor may incur costs to evict the tenant.

Question 37

What can create substantial risk for a property owner in a lease?

Answer 37

Giving up first position right to the title.

Question 38

What does the value of a lease depend on?

Answer 38

The economic return generated by the rent and the lessee's ability to pay.

Question 39

What is the relationship between leasehold value and the underlying land lease terms?

Answer 39

Leasehold value varies depending on the terms of the underlying land leases.

Question 40

What are the four situations when a sale-leaseback is effective for the seller?

Answer 40

* When the use of the property has more value than owning it * To substantiate the value of the fee by creating a fixed return * The need for capital makes the leaseback more economical * By creating several layers of ownership

Question 41

What is a potential issue with a lease that has a superficially high rent to justify a sale?

Answer 41

The deal might be a sham.

Question 42

How can a lessee calculate leasehold equity?

Answer 42

Establish an interest return realistic to the market.

Question 43

What does the difference between what it costs you and what I pay represent?

Answer 43

Your profit each year for the remaining term of the lease ## Footnote This is referred to as leasehold equity.

Question 44

How is leasehold equity calculated?

Answer 44

Establish an interest return realistic to the market and calculate principal amount based on that return over the lease term ## Footnote For example, if the interest return is 6 percent for a lease of 15 years.

Question 45

What is the constant rate per year for a mortgage at 8 percent with a term of 15 years?

Answer 45

11.468 ## Footnote This is based on 12 monthly installments per year.

Question 46

If you put $12,000 into your pocket each month for 15 years, what is the principal amount calculated using a constant of 0.11468?

Answer 46

$104,638.99

Question 47

What might increase the value of land significantly over time?

Answer 47

Development projects, such as new interstate highways ## Footnote This can lead to substantial increases in land value.

Question 48

What factors can affect the profitability of rental income from real estate?

Answer 48

* Taxes * Insurance * Maintenance costs ## Footnote These expenses can increase with the value of the property.

Question 49

What financing option did Kaiser consider to create capital for a new restaurant?

Answer 49

Sale-leaseback of his existing restaurant ## Footnote This allows him to use the capital from the sale while retaining operational control.

Question 50

What was the appraised value of the land owned by Kaiser?

Answer 50

$135,000

Question 51

What was the appraised value of the buildings owned by Kaiser?

Answer 51

$200,000

Question 52

What was the expected cost of the new restaurant Kaiser planned to build?

Answer 52

$400,000

Question 53

What was the annual rent Kaiser expected to pay after leasing back the property?

Answer 53

$30,000

Question 54

What is a major risk involved in leaseback transactions?

Answer 54

Overstated values of the fee or leasehold ## Footnote Caution is required to avoid potential financial losses.

Question 55

What factors affect the value of leases from a property owner's point of view?

Answer 55

* Guarantor to the lease * Use of the property * Lease conditions * Performance of the lessee * Property condition * Fee versus leasehold * Title subordination to tenant financing * Salability if the tenant leaves

Question 56

True or False: The value of a lease depends solely on the user.

Answer 56

False ## Footnote The value also depends on the use of the property.

Question 57

What is one reason for a seller to consider a sale-leaseback?

Answer 57

Need for capital ## Footnote This can be due to difficulties obtaining conventional financing.

Question 58

What should a buyer consider before entering into a sale-leaseback agreement?

Answer 58

The complexity and need for sound legal advice ## Footnote It may also involve tax considerations.

Question 59

Fill in the blank: The economic life of the property should be beyond that of the _______.

Answer 59

term of the lease

Question 60

What is a sale-leaseback?

Answer 60

A transaction where the seller sells the property and then leases it back from the buyer.

Question 61

What are some advantages of a sale-leaseback for the seller?

Answer 61

* Retains use of the property * Negotiates rent by offsetting sale price * Offers flexible lease terms * Firms up price and value * Provides capital in difficult situations

Question 62

What are some disadvantages of a sale-leaseback for the seller?

Answer 62

* Potential loss of ownership benefits * Loses future appreciation of land * Leasehold value has a shorter life * Declines in leasehold value can result in loss

Question 63

What are some advantages of a sale-leaseback for the buyer?

Answer 63

* Offers low-risk investment potential * Future recoupment of improvements * Appreciation of land and improvements * Excellent investment potential with careful examination

Question 64

What are some disadvantages of a sale-leaseback for the buyer?

Answer 64

* May have to step into a large mortgage * Potential investment without a tenant * Risk if leaseback is by a nonuser

Question 65

True or False: A franchiser's guarantee on lease payments in a sale-leaseback is always reliable.

Answer 65

False

Question 66

Why do lenders initiate leasebacks?

Answer 66

To secure their position in large development loans.

Question 67

What two values must be carefully examined in a sale-leaseback?

Answer 67

* Fee simple value * Leasehold value

Question 68

What is the potential tax advantage when negotiating a sale-leaseback?

Answer 68

Lowering the sale price to reduce gains tax while adjusting rent accordingly.

Question 69

What does lease insurance provide the buyer in a sale-leaseback?

Answer 69

Insurance against the lessee's failure to pay rent.

Question 70

What factors establish the value of security in a sale-leaseback?

Answer 70

* Success of the property * Lessee's ability to pay rent * Value of asset in relation to fee owner's net worth

Question 71

What is one way to restrict a lessee's ability to move their business?

Answer 71

Restricting them from opening a similar business within a certain distance.

Question 72

What are the highlights of a sale-leaseback?

Answer 72

* Generates cash * Provides lease terms to suit lessee

Question 73

When should a sale-leaseback be used?

Answer 73

* When value of use exceeds value of ownership * To substantiate value of fee * When borrowing to raise capital is not effective or available

Question 74

What should buyers look for in a sale-leaseback?

Answer 74

* Seller with successful property use * Potentially successful use needing time or capital

Question 75

What are key negotiating points in a sale-leaseback?

Answer 75

* Term of lease * Sale price * Options like subordination or ownership recapture

Question 76

What is a danger to the seller in a sale-leaseback?

Answer 76

* Gives up advantages of ownership