From Site Selection magazine, May 2003
SPECIAL ADVERTISING SECTION
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From Site Selection magazine, May 2003
SPECIAL ADVERTISING SECTION
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Synthetic Leases Vs. Sale-Leasebacks
ill new rules for synthetic leases boost corporate interest in sale-leasebacks? Four months after the arrival of the Financial Accounting Standards Board (FASB) rules, the issue remains unclear. In January, the FASB issued long-awaited rules that affect the accounting treatment of synthetic leases. The spirit of the new rules requires special purpose entities (SPEs), which hold synthetic leases, to be more than financial shells created to protect transactions from full disclosure. Instead, SPEs must be capitalized sufficiently to pay for business losses. Generally but not always, the new SPE rules mean that either a lessor or lessee must include synthetic lease transactions on its balance sheet. There are exceptions. Synthetics held by SPEs to which third party investors have contributed a minimum of 10 percent in equity -- more if the risk of loss is higher than 10 percent -- need not be consolidated in financial statements. The old rules required SPE equity of only 3 percent to earn the benefit. Despite exceptions in the FASB rules, other factors are pushing synthetic leases toward balance sheet disclosure, notes David Cobb, executive vice president of Commercial Net Lease Realty. The Sarbanes-Oxley Act of 2002, for example, requires top executives to sign full-disclosure statements in connection with their financial reports. "You may not have to put such a synthetic lease on the balance sheet, but you still have to disclose it," Cobb says. "To me, the most important point is that the capital markets want full disclosure. The incremental benefit you might get from an off-balance-sheet transaction like a synthetic lease isn't worth the potential brain damage and legal liability." For much of last year, while FASB was developing the new rules, sale-leaseback providers speculated wildly about the effect the new rules might have on the sale-leaseback business. Some looked forward to an expansive new market. Others predicted that the changes would have little or no effect on the market for sale-leasebacks. Five months after the FASB rulemaking, the market effect remains foggy. One thing is clear. The synthetic lease market is huge. Commercial Net Lease Realty's Cobb says the market is generally estimated at $100 billion. Some of those leases will certainly end up unwinding into sale-leasebacks. About a dozen corporations with synthetic leases have already re-quested sale-leaseback proposals from Miami-based United Trust Funds, according to Fred Berliner, a senior vice president with the firm. None of those deals had closed by the middle of March, but the corporations exploring sale-leaseback alternatives seem committed to moving their synthetic leases toward more conservative accounting treatment. "Some are talking to us about balance sheet treatment for their sale-leasebacks," Berliner says. "That could mean showing the transactions as capitalized leases instead of operating leases." Not all synthetic leases appeal to sale-leaseback providers, however. "In the heyday of the real estate market, corporations were structuring synthetic leases at $500 per sq. ft. for real estate which today is worth $200 per sq. ft.," says Howard Sands, a partner with Corporate Partners Capital Group, Inc., in Los Angeles. "That's a problem. A sale-leaseback company will bid on the value of the real estate, not the synthetic lease, and many corporations won't want to take a hit for $300 per sq. ft." Moreover, not all corporations want to move their synthetic leases into sale-leasebacks. Corporations with synthetic leases fall into three camps, says Ethan Nessen, a principal with CRIC Capital, LLC. Only one of these will likely pursue sale-leasebacks. "The first camp figures the heck with it," says Nessen. "Let's put these synthetic leases on our books and not worry about them." Second, continues Nessen, lenders are creating structures called Voting Interest Entities, to hold synthetic leases under FASB rules. Disclosed on lenders' balance sheets, these structures will allow corporations to continue using synthetic leases.  Finally, companies not comfortable with either of the first two alternatives will likely look to sale-leaseback and net leasing alternatives, says Nessen. Which option will most corporations pursue? "No one knows yet," Nessen says.
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