A single-tenant building is worth its lease until the lease ends. The lender's question is what the loan balance is when the building is empty.
A sale and leaseback property supports the lowest of three loans: a share of the price, a multiple of rent cover, and the loan that the rent can repay down to a safe share of the building's vacant, or dark, value by the time the lease ends. On an illustrative 50 million leaseback with a 26 million dark value, that third test limits an interest-only loan to 15.6 million, 31.2 per cent of the price, but allows the full 30.0 million if the loan amortises with the rent.
Worked in full in Sale and Leaseback by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A manufacturer sells its main plant to an investor and leases it back for fifteen years. The building is specialised: empty, re-let to someone else after a void and works, it would be worth about half the price. The buyer wants to finance the purchase. Every figure is illustrative.
| Input | Value |
|---|---|
| Price | 50,000,000 |
| Rent in year 1 (6.0% initial yield) | 3,000,000 |
| Lease term, years | 15 |
| Annual indexation | 2% |
| Dark value, today and at expiry | 26,000,000 |
| Maximum LTV on price | 60% |
| Interest rate, fixed | 5.5% |
| Minimum interest cover, interest-only | 1.50x |
| Minimum debt service cover, amortising | 1.25x |
| Maximum balance at lease expiry, share of dark value | 60% |
1. The two familiar limits.
LTV loan = 60% × 50,000,000 = 30,000,000
Interest cover loan = rent ÷ ICR ÷ rate = 3,000,000 ÷ 1.50 ÷ 5.5% = 36,363,636
On these two alone the loan is 30,000,000. Both treat the rent as permanent. It is not: it lasts fifteen years and depends on one company paying it.
2. The dark-value test. At lease expiry the tenant may leave. The lender then holds a loan against an empty building worth 26,000,000, and wants the balance to be no more than 60 per cent of that: 15,600,000.
An interest-only loan still owes its full amount at expiry, so it cannot exceed 15,600,000. That is 31.2 per cent of the price.
3. Let the rent repay the loan. With a level annual payment P at rate r over T years, the balance at expiry is:
BT = L × (1 + r)T − P × ((1 + r)T − 1) ÷ r
(1.055)15 = 2.2325; the annuity factor is 22.41
Largest payment the cover test allows: 3,000,000 ÷ 1.25 = 2,400,000
Largest loan with B15 = 15,600,000: (15,600,000 + 2,400,000 × 22.41) ÷ 2.2325 = 31,077,950
Excel: =PV(5.5%, 15, -2400000, -15600000)
That exceeds the LTV limit, so LTV binds at 30,000,000. The payment needed to bring 30,000,000 down to 15,600,000 in fifteen years is 2,292,609: interest of 1,650,000 and amortisation of 642,609 in year 1, a year-1 DSCR of 1.31x.
| Year | Balance | Rent that year | Balance / dark value |
|---|---|---|---|
| Start | 30,000,000 | 3,000,000 | 115.4% |
| 5 | 26,413,543 | 3,247,296 | 101.6% |
| 10 | 21,726,187 | 3,585,278 | 83.6% |
| 15 | 15,600,000 | 3,958,436 | 60.0% |
The amortising loan is 1.92 times the interest-only one. Note what the first rows say: for the first five years the loan is larger than the empty building is worth. Over that period the lender is relying on the tenant, not on the property, which is exactly how the investor's own price should be read. By year 15 the indexed rent of 3,958,436 covers the payment 1.73 times.
| Case | Interest-only | Amortising | Amortising LTV |
|---|---|---|---|
| Dark value 20,000,000 | 12,000,000 | 29,465,391 | 58.9% |
| Dark value 26,000,000 | 15,600,000 | 30,000,000 | 60.0% |
| Dark value 32,000,000 | 19,200,000 | 30,000,000 | 60.0% |
| Lease 8 years | 15,600,000 | 25,367,901 | 50.7% |
| Lease 10 years | 15,600,000 | 27,223,019 | 54.4% |
| Lease 20 years | 15,600,000 | 30,000,000 | 60.0% |
The interest-only loan moves one for one with the dark value and ignores the lease; the amortising loan barely notices the dark value and depends on the lease length. Below 14 years remaining, the dark-value test rather than the LTV sets the loan. That is the financing side of how lease length changes a sale and leaseback price: a shorter lease lowers both the price and the share of it a lender will fund.
Sizing the loan at 60 per cent of the price, interest-only, and assuming it will refinance at expiry. If the tenant leaves at the end of year 15, the lender holds 30,000,000 against a 26,000,000 building and is short 4,000,000 before any sale costs. The price of a leaseback is mostly the tenant's covenant, and a loan sized on the price inherits that exposure without being paid for it. The second mistake is judging the tenant on the group's profits rather than on the earnings of the subsidiary that signs the lease, a separate test set out in how to calculate rent cover in a sale and leaseback.
The book decomposes a leaseback price into its property and its covenant, and the free workbooks for this case include the lender's arithmetic on the same portfolio.
The value of the building vacant, with no tenant and no lease, after the costs and void of re-letting it. For a specialised building sold and leased back it can be far below the let value: 26 million against a 50 million price in the illustrative case. A lender who will still hold the loan when the lease ends sizes against it.
Because the security changes over the lease. The let value relies on the tenant paying rent; at expiry only the dark value is left. In the illustrative case an interest-only loan is limited to 15.6 million, while a loan amortising with the rent to 60 per cent of dark value by year 15 can be 30.0 million, 1.92 times as much.
Yes, because there are fewer years of rent to repay the loan down to the dark-value limit. On the illustrative building the amortising loan is 30,000,000 with 15 or 20 years left, 27,223,019 with 10 and 25,367,901 with 8. Below 14 years the dark-value test, not the LTV, sets the loan.
This article is one calculation from Sale and Leaseback. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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