Obtaining financing for investment deals is all but impossible in today's lending environment, however we are finding a few creative ways around that. Five weeks ago we closed on an investment property that was effectively a Sale / Leaseback.

The Seller of the building wished to Sell the property and then lease back the property for a five year term (with options for additional terms). This would allow the seller to take the equity out of the building and invest it in a more lucrative business opportunity and provide a solid investment for the potential buyer.

Effectively, the Seller owned the building free and clear (The mortgage for the building was held in a  trust controlled by the seller). And the Seller was smart enough to put this equity to good use in the transaction.

The Seller offered to lease the property back from the Buyer for a three year term (which was quickly negotiated to five years) and prepay the full term of the lease. At first this sounds a little crazy, why would someone prepay five years of a lease? The expense to the Seller was the opportunity cost of the potential interest earned (Lets assume 4% in this lousy economy) - The upside was that it enabled him to access the equity in the building and exit the ownership role. The upside far outweighed the downside with this logic.

The offering price was $1M. The Offered cap rate was 10%. So the lease amount was $100,000 per year or $500,000 prepaid.

Initially when buyers looked at the deal they were analyzing it as a $500,000 purchase (the $1M purchase price minus the $500,000 prepaid rent)  that paid them nothing for the first five years, after which the tenant may vacate. This frame of perception proved unappealing to buyers and we altered tactics.

Generally, on a lease, the potential Tenant writes a Letter of Intent (LOI) to the Landlord outlining the terms and conditions of a lease arrangement. As an agent, I facilitate this using a combination of templates and experience. We then negotiate this into a workable deal and have an attorney reduce it to a written lease.

On this deal we had the addition of a Purchase and Sale Contract and some language making the purchase contingent on the Lease and vice versa, but the Purchase contracts are generally much simpler than leases and so it was on this deal.

The new tactic was to develop a Letter of Intent from the Seller (and tenant to be) to the Buyer (opposite the normal pattern) outlining the terms and conditions of the deal in very clear language. The Seller and I spent a significant amount of time on the writing and editing of this to be sure it was as simple as possible (but not simpler) and then began presenting it to potential buyers.

The key to this deal was to look at it in the proper perceptual frame. The first five years of building ownership generate no cash flow (neither positive nor negative), but at year six, a significant amount of equity in the building has been purchased (with a pay down of the principal portion of the loan) and, when refinanced, the new, low debt service payments will allow the new owners to lease at below market rates and still have a healthy cash flow. It is at year 6 that this becomes a very good deal for the Buyer.

The key to this deal was to take the money from the pre-payed rent and with it, pre-pay the first five years of the mortgage. This approach gave us the following benefits:

• The Seller (and now tenant) was protected from mortgage default by the new owners.
• The Bank now became comfortable writing the mortgage (they would have been foolish to turn it down)
• By prepaying the mortgage the Buyers were eligible for discounts in their interest rate to the bank.
• The pre-paid five years of mortgage payments coincided with the 5 year balloon of the mortgage.
• By pre-paying the mortgage with the prepaid rent money, the buyers had a total cash outlay of less than $100K (The $500K pre-paid rent covered the downpayment and most of the pre-paid mortgage).

However, in prepaying the lease and the mortgage we were presented other issues. Typical commercial leases have language to accommodate partial or complete destruction of the building (by fire, or hurricane, etc) and these clauses typically call for an abatement of rent for the portion of the building that is unusable, or call for an exit from the lease if the building is not repairable. In our case, the rent was prepaid, so we needed a rebate, as opposed to an abatement, and therefore needed adequate insurance to cover this risk with language in the lease to accommodate this issue.

Once we got the structure of the deal worked out (which took about a month of negotiation and dialog) then we put together a contract and closed two weeks later.

Times are tough, but there are still some excellent deals out there for the creative among us.