Leaseback

What is Leaseback?

Leaseback is a financial transaction wherein the company sells its asset and then takes the same on lease from the purchaser. It implies that the seller becomes the “lessee” and the purchaser becomes the “lessor”. This type of sale and leaseback transaction is done on mutual understanding of both parties, and all the terms and conditions are predefined in the agreement.

Reasons for Sale/Leaseback Transaction

Key Elements of Leaseback Transaction

The following are critical elements of leaseback.

  1. Need of Capital: When a company needs capital for future investments, they will go for leaseback transactions.
  2. Excess Capital and Looking for Good Investments: Purchasers or lessors enter this transaction only to make a good return on their investment.
  3. Strong Tenant: Investors who buy and give on lease want a relatively more robust tenant who can meet their obligations and safeguard the investments. Similarly, a strong tenant can sell their assets at a higher rate and profit from the transaction.
  4. Long Term Lease: Generally, in sale and leaseback transactions, lease terms are of 10 years or more to benefit the lessor and lessee. Lessee will benefit from using the assets uninterrupted, and lessor will get the lease rent for a more extended period without risk.
  5. Triple Net Lease: This is one of the conditions which the lessor wants to include in the sale and leaseback agreement. In a triple net leaseTriple Net LeaseTriple Net Lease is a type of lease agreement in which the lessee (tenant) agrees to also pay for other property-related expenses such as insurance of the building, maintenance of the building, property taxes in addition to the rent.read more, the lessee takes responsibility for incurring operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more, maintenance costs, insurance costs, and any other cost, just like the owner of the assets. The investor will only enjoy the rental income unbothered.
  6. High Interest on Loans: If the rate of interest of the loan is higher than the lease rental expenses, companies can opt for this to reduce the costs.

Example of Sale and Leaseback Transaction

Now we will understand sale & leaseback transactions with the help of a practical example:

A few years ago, airline companies used this type of arrangement to control the cost of planes and operating expenses. It came as a result of immense pressure to reduce the ticket price to capture the market and competition.

Therefore, they bought planes, sold them to the leasing companies, and immediately took them back on lease. By that arrangement, airline companies started getting cash-free and spread the cost over the life of the plane. They utilize the cash generated from the sale of planes to meet the operational costs and reduce the liabilities.

Leaseback

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Advantages

Disadvantages

Conclusion

Sale & Leaseback transaction is only an arrangement for reducing capital expenditureThe Capital ExpenditureCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year.read more without compromising the availability of assets. Organizations with a cash balance shortage and unable to meet day to day operating expenses or companies which are in their initial phase and focusing on business expansion use this type of transaction to unclog their capital assets and use that cash elsewhere.

On the other side, investors enter into this arrangement because they want a good return on their investment. In addition, they feel secure because of the long lease term and are also relieved from all responsibility by mentioning the triple net lease clause in the agreement.

This has been a guide to what is Leaseback and its meaning. Here we discuss example of sale and leaseback transaction along with advantages & disadvantages. You can learn more about financing from the following articles –

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