What Is a Leaseback Agreement and How Does It Work?
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Summary:
A leaseback agreement, also known as a sale-leaseback agreement, is a transaction in which an individual or company sells an asset and then leases back the right to continue to use the asset. In a sale-leaseback transaction, the seller then becomes the lessee and the buyer becomes the lessor. Sale and leaseback agreements can occur in both residential and commercial transactions.
Selling off an asset, such as real estate, property, or equipment only to turn around and lease it back might seem like a strange concept, but it’s a fairly common practice. And it can often be a mutually beneficial arrangement for both the buyers and sellers of the asset.
We’ll take a closer look at leaseback agreements, explain how they work, some of the industries that employ these leaseback arrangements, and what each party in the sale-leaseback agreement stands to gain from the transaction.
What is a leaseback agreement?
A leaseback agreement, which is also called a sales-leaseback agreement, is a transaction in which a person, business owner, or company sells off a valuable asset but then retains use of the asset through a lease agreement with the new owner. The asset sold is often real estate, a piece of property, equipment, or even intellectual property, in some cases.
When a seller sells off the asset with a sale-leaseback agreement in place, the seller then becomes the lessee or tenant of the property (whether the property is a house, equipment, or other asset). In turn, the buyer of the property then takes on the role of the lessor, landlord, or, essentially, a leasing company.
The leaseback agreements can be either short- or long-term, depending on the context. In general, residential lease agreements are relatively short-term (but not always), whereas sale-leaseback agreements in business often extend for many years.
How residential leaseback agreements work
Residential sale-leaseback transactions are pretty common and often are put in place when a seller needs the sale to go through, but, for various reasons, can’t vacate the premises immediately after closing on the sale, explains Ian Katz, a real estate agent with Compass Real Estate.
“(It’s) a legal agreement between the seller of a property and the purchaser of a property where the purchaser, after the closing, agrees to lease the property back to the seller for a short-term period of time before taking occupancy. The agreement allows the purchaser to close and the seller to obtain proceeds from the sale of the property while simultaneously allowing the seller more time to vacate the property.”
Negotiation
The negotiation process is very important when figuring out the terms of the lease agreement for the previous owner, who will now become the tenant of the property. For example, the new owner will want to come up with rental payments that are at least enough to cover the monthly mortgage payments, including real estate taxes, mortgage insurance, and other expenses the new owner is now responsible for, says Katz.
The seller then begins to make leaseback payments to the new owner/purchaser for the term of the leaseback, typically amounting to a payment that at least matches the purchaser's daily carry for the property in terms of mortgage principal, interest, taxes, insurance, etc. - Ian KatzClick to Tweet
Termination
It’s also important, when negotiating the purchase agreement, to decide how the termination of the leaseback agreement will go. Items to consider include the date when the previous owner moves out and the inspection of the property’s condition upon vacating the premises, for example.
“The seller vacates on or before the end of the leaseback term,” Katz says. “The purchaser inspects the property to ensure no new issues have arisen since closing, then takes ultimate occupancy and refunds the seller the security deposit if applicable.
Pro Tip
For a buyer hoping to acquire a new property (maybe even their dream home!), agreeing to a sale-leaseback transaction can be a strong negotiating tool, particularly in a competitive market, says Katz. “The buyer is giving the seller some added flexibility on timing that, if needed by the seller, increases the attractiveness of their offer to the seller, which is especially beneficial in a seller’s market.”
Other residential sale-leaseback agreements
Not all residential sale-leaseback agreements are short-term, however. For example, sometimes the buyer of a property is purchasing it to use it as an investment property to bring in rental income.
In that case, the leaseback transaction is meant to last for a longer period of time. So a long-term lease is negotiated between both the buyers and sellers to agree on issues such as monthly rent, lease duration, home insurance, and other factors.
Sale-leaseback agreements in business
You may hear more about residential real estate sale-leasebacks, but businesses often utilize these types of arrangements as well. In commercial cases, the point of a sale-leaseback agreement is often to allow the company or business owner to free up some cash by selling an asset but still getting to make use of it.
“The basic premise of a leaseback agreement is that a company sells a property to an investor and then leases it back from them for a set period of time. This allows the company to free up capital while still maintaining use of the property,” explains Adie Kriegstein, a licensed real estate salesperson and founder of the NYC Experience Team at Compass Real Estate.
For example, a company may sell their equipment to an investor and then lease it back in order to generate cash flow. This is particularly common in the transportation and manufacturing industries. - Adie KriegsteinClick to Tweet
And the investor who’s buying the asset now owns the property that also comes with the added financial benefit of a guaranteed lease agreement and revenue stream, often for a long period of time. The key to making these agreements successful is negotiating the terms of the company lease before closing on the deal, Kriegstein points out.
“Leaseback agreements can be complex and require careful negotiation to ensure that both parties are satisfied with the terms. Ultimately, whether a leaseback agreement is beneficial or not depends on the individual circumstances and goals of both parties involved.”
Benefits and risks of sale-leaseback agreements
As with any complex transaction, there are risks and potential benefits that should be weighed before entering into a sale-leaseback agreement.
Potential benefits of sale-leasebacks
As previously explained, the most immediate benefit to buyers in a sale-leaseback agreement is the opportunity to buy a property and collect lease payments for a period of time. And the seller/tenant doesn’t have to vacate the premises or stop using the property but still gets access to the cash from the sale.
“The benefits to the seller are that they are able to get access to equity that they had in the property. This equity can then be used for other investments or immediate cash needs of the seller,” says Sebastian Jania, director at Ontario Property Buyers.
The benefits to the seller are that they are able to get access to equity that they had in the property. This equity can then be used for other investments or immediate cash needs of the seller. - Sebastian JaniaClick to Tweet
There are also tax implications that can benefit both buyers and sellers engaged in a sale-leaseback. The buyer/landlord may be able to take a depreciation deduction, depending on the type of property, and a deduction for property taxes. Also, if the new owner is financing the property, they may also get a deduction for interest paid on the loan.
If the seller/tenant is using the sale-leaseback agreement for business purposes, then the business owner should be able to deduct lease payments and other expenses incurred from carrying on a business using property in which they don’t hold title or have equity, according to the IRS. If you’re unsure of which deductions you can take, you may want to seek the help of a tax professional.
Risks of a sale-leaseback agreement
Despite having a legally-binding document (highly recommended even if the parties are related), a leaseback arrangement can still have some risks. After all, not everyone makes their lease payments on time or adheres to the terms of the agreement.
“The buyer assumes the risks associated with being a landlord, such as property damage and tenant disputes. For example, if the owner/tenant defaults on their rental payments, the buyer may be left with an empty property that they need to find a new tenant for,” Kriegstein points out.
It can also be a difficult transition for the seller/previous owner who now becomes a tenant that no longer has any ownership rights to the property, says Jania. “The downsides (for) the seller are that they now have to abide by a landlord’s rules. This can be very challenging for some as they can no longer say the property is theirs. (And) there is the risk of the seller not making payments for rent or treating the property the same way as if it were their own.”
Pro Tip
Especially in cases of a residential short-term leaseback option, both the seller and buyer may think a verbal agreement will suffice. But it’s always important to put a binding contract in place to make sure the tenant and landlord responsibilities are clearly spelled out.
FAQ
How long do leaseback agreements typically last?
The leaseback period for a sale-leaseback agreement can vary anywhere from a couple of weeks or months to years, depending on the specifics of the leaseback transaction. As mentioned, residential lease agreements are often very short in duration, typically to give the seller more time to move out.
But when the sale-leaseback involves an investment property or a company lease, for example, the leaseback period is most often at least a year or more. In the case of a sale-leaseback agreement for expensive equipment or intellectual property, for instance, a leaseback period could extend for many years.
“A company may sell their intellectual property to an investor and then license it back in order to continue using it. This allows the company to generate revenue from their intellectual property while still maintaining control over it,” says Kriegstein.
Can a leaseback agreement be beneficial for a property owner who needs immediate cash?
A sale-leaseback is commonly used by a property owner or business owner who needs cash right away, perhaps to reinvest in their business or buy a vacation home or investment property. But a business owner may also seek a sale-leaseback to decrease their debt load or to raise capital to pay back investors.
What happens if the property owner wants to terminate the leaseback agreement before its agreed-upon duration?
It’s pretty tough for the new owner of the property to terminate a sale-leaseback before the agreed-upon leaseback period is up. For example, the buyer can’t just decide on a whim to randomly evict the tenant and take possession of the property early.
Presumably, there is a binding contract in place which prevents that. But, the owner could seek to terminate the sale-leaseback if the tenant has breached the terms of the contract, which can be a complicated legal process.
If, on the other hand, “the tenant decides they want to move out before the end of the lease term, they may be responsible for paying penalties or other fees,” says Kriegstein.
Key takeaways
- A leaseback agreement, or sale and leaseback agreement, is a transaction in which a seller sells off an asset but still retains use of the asset for a specified leaseback period.
- The buyer takes ownership rights in a sale-leaseback agreement but agrees to allow the previous owner to maintain use of the asset in exchange for lease payments.
- Sale-leaseback agreements are often utilized in the real estate, transportation, aviation, healthcare, manufacturing, and other industries.
- There are additional benefits for both the buyer and seller in a sale-leaseback transaction, such as certain tax advantages.
- There are risks involved as well. For example, in a real estate leaseback agreement, the buyer has to assume the responsibilities of a landlord while the seller has to abide by the landlord’s rules on their former property.
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