Commercial property purchases with full or partial lease backs are relatively common. But what happens when a not-for-profit (NFP)entity purchases a bank headquarters building, and the selling bank seeks to lease back small portions of the property for a specific term? Such a scenario is being handled by your co-authors and has presented us with numerous challenges on behalf of our NFP client. Here are some tips to navigate these choppy waters and facilitate a favorable outcome for both parties.
In this case, the property is a free-standing, three-story 35,000 square foot office building. The selling bank needed time to continue branch operations, slowly transition operations, and relocate services to its suburban headquarters. Additionally, the bank’s leaseback included a relatively small portion (approximately 10%) of the property, plus a lower-level IT/Server room, two of the existing five outside drive-through lanes, and two existing outdoor ATM machines. At the time of lease inception, the purchaser intends to commence substantial modifications to the remainder of the property but without interference with the branch bank activities.
The special arrangements to accommodate the foregoing requirements provide benefits to both parties. They also introduced unique considerations that had to be carefully addressed to ensure a successful transaction.
Key Considerations For Leaseback Transactions:
1. Regulatory and Tax Implications: NFP organizations benefit from tax-exempt status. In this case, the portion of the property being leased back to the for-profit bank entity remains taxable at local and county levels. Therefore, the NFP purchaser was tasked with creating a taxable carveout in the otherwise non-taxable property! What’s more, legal counsel for the NFP had to assess whether the lease back affected the entity’s tax-exempt status or resulted in any unintended tax consequences.
2. Zoning and Land Use Restrictions: In this case, the NFP intends to use the property for its own purposes that are totally different from the bank's existing use. Accordingly, zoning laws and land use regulations were analyzed. The end result: NFP was required to file a zoning change to designate the branch bank’s leased portion as fully taxable, while the remaining + 90% of the acquired property would be tax exempt. The city required that these changes be filed and approved by the city council before closing the transaction.
Structuring the Lease Terms
In this case, there were multiple challenges for lease drafting to safeguard the interests of both parties.
1. Lease Back Terms: The lease term is 10 years, providing the bank with sufficient time to transition, while ensuring the NFP has access to the remaining building when needed and is rewarded with rental income for some time.
2. Rental Rate and Financial Terms: This became one of the most challenging aspects. Banks are highly regulated and keep their operational information confidential. Comparable rental rates for banks and their branches are very hard to find. Thus, designating a fair lease back rate was most challenging. Ultimately, through consultation with outside brokers experienced with branch bank leases, sufficient information was provided to establish a fair market value that was agreeable to both parties, would avoid regulatory scrutiny, and ensure compliance with GAAP tax and accounting principles.
3. Maintenance and Operational Responsibilities: Clearly defining who is responsible for maintenance, utilities, insurance, and security is crucial to prevent disputes. Since the bank desired to lease back very discrete portions of the interior and exterior of the property, the parties allocated CAM & other operational costs accordingly in the lease document.
Role of Brokers and Attorneys Facilitating the Transaction:
The parties’ brokers and attorneys played a critical role in navigating the complexities of the property sale and partial leaseback transaction. The brokers helped to identify comparable lease transactions and sources and negotiate the purchase and sale agreement and lease document business terms. They also facilitated communication between the parties, making sure expectations were met on both sides.
The parties’ attorneys drafted, redrafted, and reviewed the purchase agreement and lease contract to ensure compliance with the parties’ specific wishes, as well as local, state, and federal regulations. They also assessed potential liabilities, including the real estate tax implications and zoning restrictions previously discussed to prevent complications down the road.
A property purchase involving a partial leaseback from a branch bank to a NFP entity presents distinct challenges that require careful planning, expert guidance and A LOT of patience. By addressing these considerations, structuring a fair lease back agreement, and leveraging the expertise of brokers and attorneys, both parties can achieve a successful and mutually beneficial outcome. Through careful due diligence and strategic negotiation, the advisors can ensure that the property purchase and sale plus the lease back arrangement align with the operational and financial goals of both parties while mitigating risks and preserving long-term relations between the parties.