An accounting change on the horizon could have profound implications for healthcare entities of all sizes.
When the implementation of new lease accounting standards begin in January of 2019, the revised "FAS 13" will constitute a major change in how companies account for leases, requiring lessees to carry most long-term leases on rents, equipment and other assets as a liability – as opposed to an operating expense. This will make otherwise healthy balance sheets appear riskier, with more debt than they would have had before the implementation of FAS 13's new standard. And, of course, the mere appearance of more debt will make it harder for health care companies to borrow from their banks or issue corporate bonds and, in general, will raise the cost of capital.
Importantly, there's a 2-year implementation window that provides unique opportunity for health care organizations to mitigate the adverse impact of the revised FAS 13 through sale/leaseback transactions. Such a transaction enables a company to reduce its investment in a non-core asset such as property, and raise cash in exchange for executing a lease and paying rent to an external capital provider in exchange for upfront liquidity. Ownership-like controls can be structured during the sale to ensure the lessee maintains control of the asset post-transaction.
Healthcare companies contemplating the implications and benefits of such a transaction should be mindful of the following:
• First, the most obvious benefit of a sale/leaseback transaction during the two-year implementation window is that it will shore-up up your balance sheet and liquidity before long- term leases must be carried as a balance sheet liability. It's a win-win: a stronger, healthier balance sheet driven by proceeds of the sale without the burden of carrying the lease terms on your balance sheet as a liability. In turn, this carries clear benefits in terms of securing financing on optimal terms and facilitating growth initiatives with fresh capital. It is worth noting, as well, that the current market for healthcare properties is quite strong, so any potential sale/leaseback could generate substantial cash.
• As noted, one of the implications of executing a sale/leaseback transaction is that the selling entity would then enter into a long-term lease. Again, there is a market timing component, as the leasing environment is highly favorable for lessees - the low interest rate environment translates to investors willing to accept a lower rent yield in exchange for a high upfront purchase price. With favorable lease terms locked-in, the balance sheet impact after the revised FAS 13 implementation will be mitigated.
• Another important consideration is ensuring ongoing and transparent communication with rating agencies and creditors in advance of FAS 13's new standard implementation to prevent an unforeseen downgrade.
The implementation of FAS 13's new standards is inevitable (over 85% of $33 trillion of leases are currently "off" balance sheet) and, if not managed correctly, could have significantly negative balance sheet implications. Over the last decade, Duff & Phelps has successfully advised clients to help them achieve hundreds of millions of operating leases in the form of sale/leasebacks. But, executing a sale/leaseback transaction prior to the 2019 FAS 13 new standard compliance date will help create a virtuous cycle: access to additional corporate financing while long-term leases are still treated as an operating expense, not debt.
Laca Wong-Hammond is a managing director in the firm's Corporate Finance M&A Practice, specializing in real estate transactions. Laca has more than 15 years of real estate transactions advisory experience including acquisition and divestiture of assets, sale/leasebacks, developer selection, strategic planning and capital placement of debt and equity across property types. Her clients include owner-operators, developers, not-for-profit organizations, private equity funds and publicly-traded companies. Prior to joining Duff & Phelps, Laca was the leader of the healthcare real estate practice at Raymond James and joined through its predecessor companies Shattuck Hammond Partners and Morgan Keegan.
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