Academic journal article Real Estate Economics

The Wealth Effects of Sale and Leasebacks: New Evidence

Academic journal article Real Estate Economics

The Wealth Effects of Sale and Leasebacks: New Evidence

Article excerpt

This paper investigates the phenomenon of sale and leasebacks as one way in which firms may use financial contracts to rearrange their organizational architecture. A theoretic model links the length of initial leaseback period to incentives to make noncontractible future investments in the lease relationship and predicts that firms choose shorter leases when landlords make relatively important investments. Using a sample of 71 sale and leaseback events from the 1990s, we document a significant mean abnormal return of 1.3% for shareholders of seller/lessee firms announcing relatively short leasebacks. The evidence suggests that firms may use sale and leasebacks to optimize their claims to real estate.

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In this study, we investigate integration decisions by firms who engage in the sale and leaseback of commercial real estate. In a sale and leaseback, the firm sells an asset but simultaneously enters into a lease for its continued use. Sale and leasebacks have historically been considered financial contracts. This study differs from prior research, however, because we dispense with the assumption that leasebacks are all long-term financial leases. (1) In particular, we hypothesize that contractual hazards first proposed by Coase (1937) influence the firm's decision to use long-term leasebacks (continued integration of the real estate within the firm) versus short-term leasebacks (nonintegration). As applied to commercial real estate markets, this work suggests that in certain cases it is efficient for investors other than the user of an asset to own commercial real estate.

Prior studies have found that announcements of sale and leasebacks are associated with positive wealth effects for seller/lessee firms and that these wealth gains are attributable to the reallocation of tax benefits from the ownership of a durable asset to a firm who values the benefits more highly than the seller (Slovin, Sushka and Polonchek 1990, Rutherford 1990, 1992, Alvayay, Rutherford and Smith 1995, Ezzell and Vora 2001). Alvayay, Rutherford and Smith (1995), however, provide evidence that the value of taxes expropriated from the government through sale and leasebacks was reduced by the Tax Reform Act of 1986. Absent significant tax consequences, the extant financial theory suggests that announcements of sale and leasebacks should be similar to other announcements of debt.

We develop a model of the sale and leaseback in which the length of the initial leaseback influences the incentives of both the seller/lessee and the buyer/lessor to make future noncontractible investments in activities related to the real estate. Lease length matters when the returns to investment are dependent on the continuation of the leasing relationship and the investors anticipate that some of the returns may be appropriated by their contracting partner at the end of the lease. We show both that the choice of a leaseback period is endogenous to the decision to enter into a sale and leaseback and that the optimal choice depends on the relative importance of one party versus the other in producing joint wealth. The model predicts that firms optimally choose shorter lease lengths when there are positive wealth gains to be captured relative to continued ownership of the asset.

Using a sample of 71 sale and leaseback events involving commercial real estate between 1990 and 2000, we use standard event study methodology to document that there were no abnormal returns to the shareholders of seller/lessee firms for our full sample on the day of a sale and leaseback announcement (day 0). When we divide the sample into short (less than or equal to 15-year) or long (greater than 15-year) leasebacks, we document a mean abnormal return of 1.3% for shareholders of seller/lessee firms in the short subsample. The mean abnormal return associated with short leasebacks is significantly different from zero at the 5% level of significance and is also different from the mean abnormal return to lessee firms announcing long leasebacks at the 1% level. …

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