Reviewing Sale and Leaseback
Transactions:
Mechanism for Raising Productive Potential
Noriko Ashiya
Meikai University, Faculty of Real Estate
1. Introduction
• In modern literature on real estate finance, it is
accepted as fact that the current development of
international accounting standards is leading
towards a situation, in which the use of offbalance sheet finance through financial leases is
becoming more difficult.
• Observing this, Grönlund, Louko and Vaihekoski
(2008) examined other motives for sale and
leaseback transactions;
• they studied more recent data using a sample of
more than one hundred companies in the panEuropean market, and empirically concluded
that sale and leaseback could also be seen as a
mechanism for revealing the hidden value of
company’s asset to the market.
• They also examined whether the sale-andleaseback effect varies across property types;
• they collected information about the property
types for the same sample;
• they empirically found that the said mechanism
of the sale and leaseback transaction, or positive
valuation effect of the transaction that will reveal
the hidden value of the company’s asset, differs
on the basis of the property types.
• However, as they pointed out, not all the data
included information about the property types
that were sold.
• So, to counter this problem, they handpicked the
corresponding information to complete the
sample.
• In this study, in stead of enriching the data set, I
will adopt a theoretical approach;
• with a model setting that indicates the rate of
capital depreciation to clearly reflect the property
types, I intend to fill the gap between the
literature and details of recent sale and
leaseback transactions.
• In contrast with Grönlund et al. (2008)’s six
different categories such as hotel, logistic, and
so on, my classification will not have a definite
category;
• in the model for this study, rates of capital
depreciation, which will be supposed to have a
wide range from low to high, will also be
supposed to reflect various kinds of categories.
• The rate of capital depreciation, as studied in the
following, will be shown to be a key factor that
may determine the advantages in the use of
corporate real estate sale and leaseback
transactions.
• In short, this study has two objectives.
• The first is to formulate the advantages in the
use of off-balance sheet financing through
corporate real estate sale and leaseback
transactions.
• The other, based on the above derived formulae,
is to obtain criteria that make it possible for the
company to choose the best property for such
selling and leasing of corporate real estate.
• Note that, only through operational leases, will a
company be able to guarantee such
advantages;
• as described at the beginning, the use of offbalance sheet finance through financial leases is
becoming more difficult.
• Therefore, for the purpose of the study,
• I will suppose that the company in the model
executes an operational-type lease.
• It will be shown that the relative ratio of the chosen
property’s rate of capital depreciation and real interest
rate would determine such advantages in the sale and
leaseback transactions;
• Table 1 presents a numerical example;
• it shows the combination of the two factors, the rate of
capital depreciation and the nominal interest rate, which
makes it possible for the seller-lessee company to
decrease the capital cost;
• from the point of view of the company, such a decrease
meets the higher level of the optimal quantity of capital,
and, therefore, new investments will be encouraged.
• Based on general economic theory, a company
produces on the principle of profit maximization;
• it chooses an amount of Optimal Capital Stock,
with which the amount of production will also be
optimal, and so the profit will be maximized.
• From a long-term perspective, the amount of
capital stock will be adjusted in a positive
direction, and so, the company, with more
Optimal Capital Stock, could produce more, i.e.,
increase the output.
• These findings suggest a role for corporate real
estate sale and leaseback as a mechanism for
raising a company’s productive potential.
• Subsequent to the transaction, the seller-lessee
company would have another way to increase
the efficiency of the use of its corporate capital
(corporate real estate),
• even though the current amount of capital stock
is seen as optimal in view of the company’s
principle to maximize its long-term profit.
• Moreover, these findings will be applied to an analysis
for Europe.
• Since the model in this paper sets the nominal interest
rate as given and exogenous, the model can also be
seen to suppose an economy that simply reflects the key
characteristics of the economy in the Euro zone.
• For the model, this study assumes a given and
exogenous type of nominal interest rate, which, from the
seller-lessee company’s point of view, is uncontrollable
by itself, and tends to be unfit for its favorable business
surroundings.
• In addition, recall that this study will adopt a theoretical
approach and intends to complement the missing
information prior to the Grönlund et al. (2008)’s panEuropean sample of sale and leaseback transactions,
i.e., information about the property types.
• This is why the findings of this paper contrast
with those in the study of Grönlund et al.
(2008)’s.
• They used pan-European data and empirically
presented an aspect of a “value revealing
mechanism” in the corporate real estate sale
and leaseback transaction;
• this study extends the traditional theory of firms
in the Euro-zone-like setting and theoretically
presents an aspect of a “value creating
mechanism” in the same sale and leaseback
transaction.
• As for the analytical aspect, in this study, I will adopt an
accounting point of view; I will focus on a case in which
the company can use the off-balance sheet finance and
abstract such advantages from a system of taxation.
• The setting is in line with the findings of Grönlund et al.
(2008) that the tax savings were not the only motivation
for sale and leaseback transaction;
• it makes it possible to highlight the seller company’s
status of the capital held, and so the roles of the capital
cost, capital accumulation, and corresponding motive for
new investments will also be highlighted.
2. Formula that Calculates the
Off-balance Sheet Advantages
2.1. Economic framework, terms
and expressions
• To formulate the advantages in the use of offbalance sheet finance through corporate real
estate sale and leaseback transactions, I use a
general economic framework.
• I assume the representative company engages
in the production of Y (output) using its
production technology comprised of K (capital)
and L (labor);
• the company’s objective is to maximize its 
(profit).
• Note that the term capital, in the model,
possesses a meaning equivalent to real
estate.
• This simple assumption makes it possible
to extend the said general model in the
more specific context of a corporate real
estate sale and leaseback transaction.
• To evaluate the corporate real estate sale
and leaseback advantages, I need a
setting that clearly presents the link
between the current business areas of the
seller-lessee company and amounts of
capital being utilized in corresponding
areas.
• For this, firstly, I assume that the company has
two types of capital, Core Capital Kf and NonCore Capital K0, in the ratio of (1–α) : α.
• Core Capital is the capital that is being utilized
for the core business of the company, such as
plants or factories.
• Non-Core Capital is for the company’s non-core
business, such as the operation of administrative
offices.
• Secondly, I assume that the company has
already maximized its profit , not only from the
short term perspective but also from the long
term perspective.
• This assumption implicitly supposes a situation
in which the company already holds the most
desirable quantity of capital stock (Optimal
Capital Stock);
• and therefore, the company does not have an
incentive to make new investments or make new
capital accumulations.
• That is, the Optimal Capital Stock K*
equals the total of Kf and Ko, denoted by
K.
• Core Capital is defined as Kf = (1–α) K*
and
• Non-Core Capital is defined as Ko = α K*.
• To get clear and plausible results, I select
two other factors to model the corporate
real estate sale and leaseback transaction:
• the risk burden rate of the seller-lessee
company, denoted by β,
• and the rate of increase in the payment for
the capital after the sale and leaseback
transaction, denoted by γ.
• In addition, according to the general theory,
I need the nominal interest rate, denoted
by i, and real interest rate, denoted by r.
• To substitute the nominal interest rate into
the real interest rate, I use the Fisher
Equation, i = r + πe, where the symbol πe
denotes the inflationary rate.
• Note that the model distinguishes the
general price, denoted by P, and the unit
capital price, denoted by Pk.
• Another expression for πe is ΔP/P, where
∆P represents the change in the general
price.
• In contrast, with the expression of ∆Pk/Pk,
where ∆Pk represents the capital gain, I
express the change in the unit capital price.
• As for the capital depreciation, the model
assumes that the capital depletes at a rate δ
(the rate of capital depreciation).
• Thus, δ PK expresses the amount of capital
depletion.
• The expression iPk represents the company’s
opportunity cost, which is equivalent to the
interest income that would have been earned if
the company had not acquired any new capital,
but, instead, had invested the same amount.
• Note that the model denotes two kinds of
capital costs.
• The company must pay the cost per unit of
utilizing capital (Unit Capital Cost),
denoted by R, prior to the undertaking of
the sale and leaseback transaction;
• the company must pay R^, subsequent to
the same transaction.
• Based on the discussions in the introduction, the
model in this study sets the nominal interest rate
as given and exogenous, which implicitly
assumes that the nominal interest rate in the
model works as the unit policy interest rate
applied in the Euro zone.
• It also assumes the Fisher equation, which
provides the method of substitution between the
nominal interest rate and the real interest rate, to
be valid.
• To get an accurate and plausible conclusion, it is
important to select a right variable that measures
the diversity of the properties sold and leased.
• In contrast with Grönlund et al. (2008)’s study,
which classified the transactions into six different
categories on the basis of the property type sold
and leased, I use the rate of capital depreciation
as a representative factor.
• As explained in the introduction, the range of the
rate of capital depreciation will be a clear
reflection of such property types.
2.2. Scheme for sale and
leaseback transaction
(Insert Figure 1 around here)
2.3. Off-balance sheet advantages
• The Unit Capital Cost prior to the undertaking of the sale and
leaseback transaction, denoted by R, is calculated using equation
(1) below.
• R = iPK - ∆PK + δ PK
(1)
• The Unit Capital Cost subsequent to the undertaking of the sale and
leaseback transaction, denoted by , is calculated using equation (2)
below.
• R^ = (1–α)(iPK-∆PK+δPK) –
α{[iPK-(1–β)∆PK+δPK]–(1+γ)PK} (2)
• Then, the difference between equations (1) and (2), which equals
the amount of the unit-capital-cost-advantage in the use of offbalance sheet finance, is determined as:
• – α [2(iPK - ∆PK + δ PK) +
β∆PK – (1+γ) PK]
(3)
• Note that, when the sale and leaseback causes cost deduction, a
sign in (3) is negative. So, to represent such an advantage in sale
and leaseback transactions more intuitively, I removed a minus sign
from (3) and call it the “Off-Balance Sheet Advantage.”
3. Criteria to Choose Properties
for Sale and Leaseback
3.1. Off-balance sheet advantage
condition
• Based on the discussions in the introduction, with the analytical
framework presented in the former section, one of the criteria that
makes it possible for the seller-lessee company to choose the best
property for corporate real estate sale and leaseback transactions is
obtained as follows:
• Theorem 1 (Positive Off-Balance Sheet
Advantage Condition):
[2(i δ)  (1  γ)] ΔPK

2 β
PK
(4)
• Proof:
• Since a negative sign in (3) implies that
the seller-lessee company could achieve a
decrease in the capital cost, put a sign of
inequality, <, on to (3).
• By rearranging the condition, (4) can be
obtained simultaneously. Q.E.D.
• Theorem 1 implies that the rate of increase in the capital
price must be kept within a certain range so that the
seller-lessee company expects cost reduction and fund
raising via off-balance sheet financing.
• From the point of view of the company, an increase in
the capital price has two implications: negative and
positive.
• While the cost of leaseback rises, the capital gain, which,
in the present model, is supposed to be earned in
proportion to the company’s risk burden rate of
β(×100)%, will also rise.
• Theorem 1 shows that the change in the lease payment
and change in the capital price should have certain
values and relations.
3.2. Condition in real terms
• To study the findings of Theorem 1 (Positive Off-Balance
Sheet Advantage Condition) further, I use the Fisher
Equation to transform (4), written with the nominal
interest rate, into an equation with the real interest rate.
• Theoretically, a condition in real terms has a direct
impact on the possible alternative strategies of the
modeled company.
• Thus, such a transformation allows me to detect key
factors that the company should consult in order to
obtain the advantages in the use of off-balance sheet
finance through the sale and leaseback transactions.
• As explained in Section 2, this study assumes the
validity of the Fisher Equation.
• To highlight the key factors, I set the following two
assumptions: γ = 0 and β = 0.
• The condition γ = 0 applies to the case where there are
no increases in rent, and conveys the fact that the lease
payment incurred from a leaseback transaction is
equivalent to the opportunity cost arising from using the
same quantity of capital.
• The condition β = 0 applies to the case in which the
seller-lessee company bears a zero risk burden rate.
• In addition, to simplify the model, I assume ∆Pk/Pk =
ΔP/P ,
• i.e., the rate of increase in the price of capital equals the
rate of increase in general prices.
• Recall that the present model starts with an assumption
that the seller-lessee company has already maximized
its long-run profit. In other words, the model takes a
long-term perspective.
• Since, in the long run, the condition ∆Pk/Pk = ΔP/P
generally holds, even though the present model sets the
same assumption of ∆Pk/Pk = ΔP/P , the generality of
the findings will be maintained.
• Under these assumptions, the Positive Off-Balance Sheet
Advantage Condition, presented in Theorem 1, is transformed into:
• Theorem 2 (Positive Off-Balance Sheet
Advantage Condition in Real Terms):
2r  2 δ  1
(5)
• Proof:
• Substitute the following conditions, γ = 0,
β = 0 and ∆Pk/Pk = ΔP/P in (4), and use
the Fisher Equation. Then, with a slight
rearrangement, (5) can be obtained
simultaneously. Q.E.D.
• Theorem 2 implies that when the sum of the two factors,
the nominal interest rate and the rate of capital
depreciation, rises above a certain level, the sellerlessee company could achieve a decrease in the capital
cost.
• From the point of view of the seller company, such a
decrease meets the higher level of the optimal quantity
of capital, and, therefore, new investments will be
encouraged.
• Note that (5) can also be transformed into
1  δ/ r  0.5 / r .
• And, to interpret this condition, recall that the present
model sets the nominal interest rate as given.
• Since the model assumes the validity of the Fisher
Equation, under those settings, the real interest rate will
also be a given variable.
• This is why this study can take the right hand side
of , 1  δ/ r  0.5 / r , as given, and can re-interpret the
formula as follows.
• The formula shows that the relative ratio of the chosen
property’s rate of capital depreciation and real interest
rate, expressed by δ/ r , would determine the offbalance sheet advantages in the corporate real estate
sale and leaseback transactions.
3.3. Criteria for choosing the best
property
• As a final study, I examine further the insights of
Theorem 2.
• Since Theorem 2 is expressed in real terms, as
explained above, it has a direct impact on the
economic activity of each unit.
• It highlights two factors, the rate of capital
depreciation, denoted by δ , and the real interest
rate, denoted by r , and so, I can present Figure
2 (strategies of the seller-lessee company)
which also highlights the said two factors.
• As explained in Section 2, with the setting of
given nominal interest rates, the real interest
rate r is determined by πe.
• So, to depict Figure 2, I converted the conditions
expressed with r, into those with πe.
• In so doing, note that, πe can generally be seen
as the most important economic indicator. In the
model of this study, also in Figure 2, πe
indicates the business environment given to the
company.
(Insert Figure 2 around here)
Theorem 3 (Criteria for choosing
the best property):
• 1st criterion: δ (rate of capital depletion) is high.
• 2nd criterion: sign of πe (rate of increase in
general prices) is negative, i.e., deflation.
• 3rd criterion: inflation, but positive sign of πe is
low, i.e., low inflation with high r (real interest
rate).
• Theorem 3 makes clear the link between the company’s
possible strategies and its business surroundings.
• It shows which kind of property the company should
choose for sale and leaseback transactions, according to
the move on the general price.
• And not that, as presented in Figure 2, higher/lower πe
implies lower/higher r, which implicitly determines the
seller-lessee company’s business environment in the
Euro-zone-like economy.
3.4. Numerical example
• To clearly show the insights of Theorem 3,
I take the following example presented in
Table 1. Table 1 calculates r  δ , which
corresponds to 2r  2 δ , the expression
on the left-hand side of (5), presented in
Theorem 2.
(Insert Table 1 around here)
•
4. Summary
• In this study, I have examined the advantages in the use of offbalance sheet financing through the sale and leaseback
transactions.
• My theoretical findings indicate that the impact of off-balance sheet
finance will be realized as a stimulus for investments, even though
the seller-lessee company has already achieved its objective of
maximizing profit from a long term perspective.
• This result was obtained in a model that reflects the economy in
Euro-zone, i.e., the economy that sets a common and unique policy
interest rate for various member countries. For the model, this study
assumed a given and exogenous type of nominal interest rate,
which, from the seller-lessee company’s point of view, is
uncontrollable by itself, and tends to be unfit for its favorable
business surroundings.
• Recall that this study adopted a theoretical approach and intended
to complement the missing information prior to the Grönlund et al.
(2008)’s pan-European sample of sale and leaseback transactions,
i.e., information about the property types.
• That is, I took a different approach to link the information of the
property types sold and leased to the actual sale and leaseback
transactions.
• This is why I called the findings of this study a mechanism for raising
the company’s productive potential, in contrast with Grönlund et al.
(2008)’s finding of the sale and leaseback’s mechanism for
revealing the hidden value of a company’s assets to the market.
• As for the analytical aspect, I adopted an accounting point of view; I
focused on a case in which the company can use the off-balance
sheet finance and abstract such advantages from a system of
taxation. It should also be noted that former studies such as Slovin
et al. (1990) and Alvayay et al. (1995) empirically found the
advantages from the system of taxation.
My main findings are summarized
as follows.
• First, for the seller-lessee company to
expect the off-balance sheet advantages
in the use of the corporate real estate sale
and leaseback transactions,
• the rate of increase in the capital cost,
∆Pk/Pk, must be kept within a certain
range, [2(i δ)  (1 γ)] .
2β
• Second, the relative ratio of the sold and
leased property’s rate of capital
depreciation and real interest rate would
determine the capital cost advantage in
the sale and leaseback transactions;
• when the sum of the two rises above a
certain level, a company could achieve a
decrease in the capital cost.
• Finally, based on the criteria presented in
Theorem 3, the company could choose the
best property to be sold and leased.
• Simply put, Theorem 3 suggests the following criteria:
• for the company to choose properties with high δ for sale
and leaseback transactions;
• for the company to check the sign of πe so that it could
estimate r and the corresponding business environment;
• if the sign is positive, low inflation would be preferable for
the company to obtain off-balance sheet advantages.
The limitation of this study could
also be summarized as follows.
• As Table 1 showed, the possible
combination of δ and r does not always
satisfy (Theorem 2).
• Or, for the company to always expect the
off-balance sheet advantages, r might be
above, for example, 50%;
• only within the limited range of r , the
condition will be valid.
Why did such a gap between
theory and practice emerge?
• The possible explanation is that this gap came
from the setting of the present model, which
focused on the roles of δ and r in the
advantageous sale and leaseback transactions.
• As explained above, my simple model made the
present analysis tractable and made it possible
to clearly show the criteria for the company to
choose the best property for the sale and
leaseback transactions.
• Thus, it would be of interest to detect the other key
factors that may fill the said gap between theory and
practice.
• For this, one possible extension is the inclusion of the
said tax saving effect, sale and leaseback advantages
from the system of taxation.
• In this study, as shown in Section 3, I could present the
suggestive finding:
• when the sum of the rate of capital depreciation and the
real interest rate rises above a certain level, a company
could achieve a decrease in the capital cost;
• intuitively, the greater each of the two factors, the more
probable the company could obtain the off-balance sheet
advantages.
• For further research, a simulation would play an
important role.
Thank you very much indeed.
Reviewing Sale and Leaseback
Transactions:
Mechanism for Raising Productive Potential
by
Noriko Ashiya
Meikai University, Faculty of Real Estate