Real estate sale and leasebacks in a COVID-19 world

In the COVID-19 environment, shoring up the balance sheet is high on the agenda for many corporates. 

Sale and leaseback transactions allow organisations that own and occupy real estate to free up capital by monetising the asset, while continuing to run their business from it. 

The pre-COVID-19 market saw growing demand from institutional investors and fund managers for long-term predictable income. This trend has continued into the COVID-19 market, and sale and leaseback transactions can present an attractive option for this class of investor. 

While sale and leasebacks are not new, a resurgence emerged pre-COVID-19, with a number of deals completing in late 2019 and early 2020, and activity is growing in the manufacturing, industrial, logistics and data centre spaces.

Key considerations for asset owners

Asset owners looking to sell and leaseback an asset should carefully consider the following: 

1. Environmental risk. Environmental risk is often the most contentious risk allocation issue in sale and leaseback transactions, particularly where the site has pre-existing contamination. The most favourable position for a seller is to pass all environmental risk to the buyer and for that liability to remain with the landlord under the lease. 

While this position may, on its face, be appealing to sellers, a more nuanced approach that reflects the seller’s knowledge of the site may prevent a large price reduction that is the likely result of the buyer accepting uncertain remediation liability. 

2. Landlord dealings. Sellers should consider their position on the landlord’s right to deal with its interest in the lease. Some considerations include:

• whether to restrict the landlord’s rights to sell to particular classes of buyer (such as the tenant’s competitors);
  
  
• whether a right of first refusal on landlord sale is appropriate (such rights are typically resisted by institutional grade buyers as they can inhibit an effective sale process);
  
  
• how to enforce any breach of a restriction on landlord dealings (typically, a caveat is the only way of preventing a transfer of land in breach of the lease); and
  
  
• imposing restrictions on the change in control of the landlord.

3. Whole of land lease. Sellers should consider whether all the land is required to be leased back or whether part of it can be carved out and sold as a development asset. When considering this, sellers should:

• ensure the lease includes landlord covenants to ensure the carved out land is used in a way that is compatible with the tenant’s use of the premises; and
  
  
• in relevant jurisdictions, check any technical subdivision requirements that may be triggered by the grant of a part of land lease. 

4. GST treatment. Sellers should consider whether they can legitimately put the lease in place before settlement (and then sell subject to the lease) to obtain the benefit of the going concern exemption. This requires the seller to have an alternative operating entity to be the tenant. 

If there is no alternative operating entity to whom the lease can be granted pre-settlement, the lease will need to be granted from the buyer to the seller after settlement and the supply of the property will be taxable. Here, the main benefit of the going concern exemption is that it reduces the stamp duty (which is calculated on the GST inclusive price) payable by the buyer, which in turn will typically increase the price attainable for the asset.

5. Put yourself in the buyer’s shoes. Sellers should consider the likely priorities and concerns of potential buyers ahead of negotiations. In particular:

• Sellers should conduct a vendor due diligence before putting the property to the market and consider whether a due diligence report is to be made available to bidders. This flushes out any issues that may need to be addressed and enables potential buyers to submit firmer offers having regard to what has been disclosed.
  
  
• Security for seller warranties can be particularly relevant to buyers in a sale and leaseback scenario where the tenant is an SPV of limited substance.
  
  
• In the COVID-19 environment, there will be increased focus on tenant solvency. Landlords may require greater security at commencement or additional security if certain triggers around the tenant’s financial standing are met during the term.
  
  
• Concerns around tenant security may be heightened if the tenant is an SPV or the site is heavily contaminated and the lease provides that the tenant has end of term remediation obligations. 

6. Foreign Investment Review Board (FIRB) approval. Depending on the identity of the buyer, FIRB approval may be required for the acquisition of the freehold by a foreign buyer. There will be heightened scrutiny from FIRB where the asset affects ‘national security’. The concept of national security is constantly evolving and includes data centres and critical infrastructure. In the COVID-19 world, ‘critical infrastructure’ may include key manufacturing sites and supply chain infrastructure, including key distribution sites. The FIRB process needs to be managed at the outset in order to minimise approval times.

This article is part of our publication Continuity Through Crises: Perspectives on business risk, resilience and recovery in uncertain times.