Thinking | 23 July 2020
Sale and leaseback options for the health and community sectors
Sale and leaseback is an option for the health and community sectors, in particular, the private hospital sector, medical centres and specialist disability accommodation. However, appropriate regulatory and financial advice – including financial modelling in the changing funding environment – should be sought.
What is a sale and leaseback arrangement?
Effectively, a sale and leaseback arrangement involves the owner of a property who runs a business from the premises (the vendor) selling the property to a purchaser (an investor) on the condition that the purchaser must grant the vendor a lease of the premises once the sale is completed.
Benefits to the vendors
Sale and leaseback arrangements allow vendors to unlock the capital in their landholdings that may be better utilised and invested elsewhere in their business (for example, business expansion or acquisitions, investment in high-yielding investments, or reducing debt), while continuing to secure the location and ongoing use of the property for their business operations (and generally on long-term and more commercially favourable lease terms).
It can also be attractive as it allows the vendor to monetise the value of the property, whereas traditional financing facilities may only allow the vendor to borrow a portion of the value of the property (65-75% of the value of the property, being the loan-to-value ratio). This may present an opportunity in the current economic climate for vendors exploring alternative methods of raising capital and increasing liquidity.
Benefits to purchasers
Sale and leaseback arrangements allow investors to acquire capital assets with long-term lease agreements that generally provide secure and predicable rental returns, while also allowing the investor to benefit from any potential capital appreciation in the property.
With borrowing costs at record lows and many vendors seeking to raise capital and increase liquidity in the current economic climate, this may present opportunities for investment in the health and community sectors.
However, appropriate regulatory advice should be sought. For example, in residential aged care, the Aged Care Act 1997 (Cth) restricts the use of refundable accommodation deposits (RADs) (which are commonly used to purchase the real property). Approved providers must comply with prudential standards and liquidity standards and ensure sufficient assets are available to meet bank covenants and operational requirements.
Further, the funding of residential aged care is likely to significantly change due to:
- moving towards a consumer-directed care model for residential aged care;
- residential aged care being less desirable due to COVID-19 and therefore vacancies are to be expected; and
- recommendations by the Royal Commission into Aged Care Quality and Safety on funding are likely to result in changes as to how aged care services are funded and tighter prudential requirements.
This is likely to materially impact upon the ability of approved providers to pay rental under long- term leases.
In determining whether to enter into a sale and leaseback arrangement, vendors and investors should consider the following key issues:
- Due diligence: The parties should undertake appropriate legal, regulatory and financial due diligence to assess whether a sale and leaseback arrangement is suitable for their objectives and needs.
- Contract terms: The parties need to consider both the terms of the contract of sale and the lease and understand how the terms negotiated may impact the sale price of the property. For example, the sale price will likely be negatively impacted if the rent payable under the lease is below market rates or if the term of the lease is too short, as this is less attractive to an investor. The vendor/tenant may also need to consider whether express provisions should be included in the contracts to prevent the investor from later selling or leasing the property to a competitor of the vendor/tenant.
- Tax and financial implications: The parties should obtain appropriate tax and financial advice in relation to the GST and stamp duty consequences of the transaction.
Seeking the right advice
A sale and leaseback arrangement requires significant planning, consideration, and the right advice in order to be successfully implemented. Hall & Wilcox has significant experience advising both vendors and investors in structuring, negotiating, documenting, and implementing sale and leaseback arrangements.
If you are a vendor or investor considering entering into a sale and leaseback arrangement, please contact us if you require any information or assistance.
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