Off balance sheet financing refers to a transaction in which a corporation uses its assets or its credit to raise cash without adding debt to its balance sheet. For accounting purposes, the transaction is structured as a lease or a sale-leaseback, but for tax and other purposes the transaction may or may not be considered a lease; instead, it may be considered a financing. The landlord under the “lease” obtains a mortgage loan based on the corporate tenant’s lease payments and uses the loan proceeds to finance the acquisition of the property.   

The rules governing off balance sheet financing of real estate and the way in which the transaction is structured depend upon whether the property to be leased is already owned by the corporation or needs to be acquired and possibly developed.

Sale-Leasebacks: When the corporation already owns the target property.

A corporation that owns its factories, retail outlets or other facilities often finds that the capital tied up in these assets would yield a higher return if reinvested in its core business. To unlock this capital while maintaining the right to continue to use the real estate, the corporation could either mortgage the property - in which case it could raise cash of no more than 65-75% of the value of the property (without increasing its unsecured credit balances) - or it could engage in a sale-leaseback - in which case it would cash out 100% of the value of the property. Because they can raise more cash from a sale-leaseback (and for other reasons), corporations often opt for a sale-leaseback over conventional financing.

To qualify for off-balance sheet treatment, sale-leasebacks are subject to stricter accounting rules than are other leases. (See FAS 98) These stricter rules preclude the use of a synthetic lease.

Build-to-Suit and other Long-Term Leases: When the corporation does not own the target property.

A corporation that wishes to move or expand its real estate facilities could finance the construction and acquisition of the new facilities in one of two ways: it could pay the cost with some combination of cash and mortgage financing or it could avoid investing any cash or adding any debt to its balance sheet by having another entity build the facilities and then lease them to the corporation. Properly structured build-to-suit leases are not subject to the strict accounting rules applicable to sale-leasebacks. As a result, build-to-suit leases are often structured as synthetic leases.

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