This article was written by Emily Masters and Andrew Erikson.
Sale and leaseback transactions have been a feature of the agricultural sector for some time and will become more frequent as more passive investors seek exposure to the agricultural sector.
The transactions, where a seller pays a rental to an investor purchasing the land and continues to carry on the farming operations as a tenant of the land, are a way to create and monetise a steady income stream that is isolated to an extent from the business risks of farming.
Both corporates and families have implemented sale and leaseback transactions as a means to realise value from their agricultural landholdings, while retaining control of the business operated on the land.
Sale and leaseback deals are a very attractive way for institutional investors to obtain some exposure to the agricultural sector, without needing to be directly involved in management of agribusiness which requires specialist skills. We are increasingly seeing wider categories of investors keen to invest in this space, such as super funds, REITs and syndicates of high net worth individuals.
There are a number of common issues that need to be carefully considered in structuring any sale and leaseback transaction to maximise the sale value of the land, while ensuring the future business operations of the seller on the land are not compromised.
What are the right commercial terms to set for the deal?
Setting an appropriate rent and lease term will be critical to a successful sale process. An appropriate balance needs to be maintained to ensure the rent is sustainable and in keeping with market and the term is sufficiently long to attract investors and allow the tenant sufficient tenure to operate and develop the business being run on the land.
The sale price will be negatively impacted by a term that is too short or a rent that is too high.
The quality of the tenant covenant is also a primary consideration for investors. For a long term lease investors will want to know - will the tenant be around and be capable of paying the rent?
It is not as simple as identifying the relevant operating entity and nominating that entity as the tenant. Any investor will be critically assessing the financial strength of the tenant in determining its pricing of the risk. In some circumstances, it might be appropriate for another entity within the same group with substantial assets to provide a guarantee of the tenant’s obligations, to ensure the tenant risk is minimised and the price is maximised.
Does GST apply?
Many sale and leaseback transactions will be exempt from GST on the basis of the farming business exemption.
However, this might not always be the case. For example, where the property is used for processing or another part of the supply chain that is not primary production, the farming exemption will not apply. In those cases, the sale and leaseback can be structured to attract the going concern exemption. This requires the lease to be in place prior to completion of the sale, which means that the group member selling the land needs to be different from the group member taking the lease. Careful consideration needs to be employed prior to sale to ensure that the appropriate holding structure is in place.
Who will own plant and equipment and crop?
Most agricultural properties will have expensive plant and equipment and/or plant and equipment that is vital to the agricultural operation.
Consideration needs to be given to what plant and equipment will be sold to the investor and leased as part of the tenancy and what will be retained in the ownership of the seller as tenant. When the tenant ultimately departs from the land will it want to take the plant and equipment with it? Is it vital to the seller’s continued operations elsewhere? Will the tenant want to prevent a competitor from coming in and assume the plant and equipment? What are the tax consequences of the allocation, such as the ability for each party to depreciate these items?
Once a decision has been made, the sale documentation should clearly set out which items are being sold to the investor and leased back and which items are being retained by the seller.
For horticultural properties, the sale documentation will need to provide for who owns the biological assets. The lease will also need to contemplate what happens to hanging crop at the end of the term. The lease might allow the seller to continue to occupy for an extended period to harvest the hanging crop.
Repair & maintenance and the triple net lease
Unlike most commercial tenants in Australia, agricultural tenants generally carry out all repair and maintenance for the premises including capital repairs and replacements. Where this is the case, and the tenant is responsible for cost, the lease is called a “triple net lease”. The advantage of a triple net lease in an agricultural sale and leaseback is that the seller maintains full operational control of the property, allowing the seller to choose how to manage maintenance and biosecurity concerns. For the investor, it makes the investment as passive as possible and the rent is a net rent.
However, this may result in the seller incurring significant ongoing capital costs, producing inefficient cashflow and tax outcomes. To mitigate this, sellers may want to incorporate a mechanism in the lease requiring investors to fund capital expenditure, with the funds recouped by an increase in rent for the balance of the term. These types of provisions can be contentious, and investors are very likely to seek controls over the amounts of funds that can be sought and a minimum lease term after funds are provided.
In NSW, under the Agricultural Tenancies Act 1990, agricultural tenants have a statutory right to compensation at the end of the lease for certain types of improvements, such as drainage or subdivisional fencing works.
Investors acquiring agricultural land subject to a leaseback to the seller should require the preparation of and compliance with annual R&M programs to ensure the property is being appropriately maintained and value is not adversely impacted.
Should sellers seek buyback rights?
Typically commercial tenants in Australia have no rights in relation to a sale by their landlord. If the identity of the landlord is important to a seller in a sale and leaseback transaction, the seller might seek an ability to prevent sales to competitors or to buyers who cannot demonstrate an ability to comply with capex funding requirements. Alternatively, a right of first refusal will provide some oversight into the sale process and an ability to gain back control over the land if that is the preferred outcome at that point.
Similarly the seller might want a buyback right that applies at the end of the lease so that the seller can ensure that it can continue to operate its business on the land.
If these rights are included, the lease will need to clearly articulate the financial parameters, valuation process (if applicable) and timeframes that apply to ensure these rights are enforceable.