Strategic Alternatives to Synthetic Leasing

T
he emergence of the synthetic lease has, perhaps more than any other development in the last 10 years, allowed Corporate America to maximize the value of its real estate assets. A synthetic lease is a financing vehicle that enables companies to move such real estate assets as factories, headquarters and distribution facilities off the balance sheet while retaining the tax benefits of real estate ownership.

Recently, economic changes have brought the issue of strategic alternatives to synthetic leasing to the forefront of many corporate real estate directors’ minds. The downward trend in interest rates has done more than any other single event to bring this issue to a head. Another major development that has an impact on corporate opportunities to use and benefit from synthetic leases is the continued phenomenal growth of the real estate investment trust (REIT) market. REITs have changed the landscape of real estate ownership, converting a predominantly private sector of the market to public ownership. REITs’ appetite for assets, combined with a dwindling supply of real estate portfolios for purchase, has led more REITs to focus on corporate real estate assets. Typically, corporations can move assets from the balance sheet by selling and then leasing back facilities from REITs. REITs such as TriNet, Corporate Property Investors (CPI), Meditrust and Crescent are among those that have acquired corporate assets. These sale-leasebacks also can be executed with other non-REIT investors. However, sale-leaseback transactions do not allow lessees to retain the tax benefits of real estate ownership. Rather, the tax benefits are transferred to the lessor, unlike synthetic leasing, which allows the lessee to retain these valuable benefits.

The REIT market also provides another financing alternative for companies in the form of structuring corporate REITs. These are REITs structured and sponsored by the corporation itself. AMC movie theaters recently blazed a trail in the corporate REIT sector by securitizing a group of AMC screens in a New York Stock Exchange-listed REIT known as AMC Entertainment. The opportunity exists for corporations in other sectors to structure similar REITs to hold all or a portion of the corporation’s real estate assets, thus providing the tax benefits of the REIT structure to corporations as well as to commercial real estate developers. This is an avenue that many other companies are likely to pursue in the coming years, including retailers, health care providers, telecommunications companies, public utilities, entertainment companies and others.

The logical extension of the corporate REIT vehicle could include companies set up to own bank branches leased back to major banks, wafer fabrication plants leased to high-tech firms and myriad other such facilities. The potential for two forms of corporate REIT exists — one set up solely to own the real estate assets of a specific company, and one structured to own a diversified collection of corporate assets spread across industries.

The recent growth in capital availability spurred by the renaissance of mortgage REITs also poses another alternative to synthetic leasing.

While much of the jury is still out on the mortgage REITs and their ability to provide a steady supply of cheap capital, they obviously are reinforcing the conventional mortgage market’s appeal for many corporations.   SS

Michael L. Evans is National Director of the Ernst & Young Kenneth Levanthal Real Estate Group. James Ryan is a tax partner at Ernst & Young LLP. Both are based in San Francisco.