By Martin S. Katz

As published in Shopping Center World, November 1997


Because they provide a readily available source of capital, sale-leaseback transactions have become a popular alternative for corporate real estate. Likewise, pension funds, insurance companies and other institutional investors are willing to invest in portfolios and large individual properties through sale-leaseback transactions. However, when analyzing the potential benefits of this acquisition structure, careful consideration must be given to determining the fair market value of the property for ad valorem tax purposes.

Under the laws of most states, the best indicator of a property’s full fair cash value is generally considered to be a recent purchase between an unrelated buyer and seller. This does not hold true in sale-leasebacks, however, because they are financing arrangements rather than pure real estate transactions. A more appropriate determination of the property’s value, therefore, is derived from an appraisal based on recent sales of comparable properties.

For example, a major international client of Fisk Kart and Katz, Ltd. had engaged in a sale and leaseback transaction relating to an office-research-industrial complex consisting of six buildings and located in a suburb of Chicago. The property was assessed based upon a fair market value of approximately $15.5 million, but sold for $18 million.


By way of background, when it was unable to service an enormous debt, the client had been forced to seek bankruptcy protection from its creditors. The client emerged from bankruptcy in 1993. Under the reorganization plan, the prior creditors became shareholders of the reorganized company. However, the client still had a dire need for a quick infusion of capital. Because it could not incur additional debt without affecting the situation with those creditors, the client had limited options available to raise the capital it required.

Given its borrowing constraints, the client sought to acquire the needed capital under the most favorable circumstances available at that time. The financing device identified was via a sale and leaseback of the property. Post-bankruptcy procedures and regulations issued under the Internal Revenue Code would allow the capital gains from the sale to be fully offset by the client’s net operating losses. However, to take advantage of the favorable tax provisions, the transaction had to be fully consummated prior to the end of the year in which the client emerged from bankruptcy. Therefore, the property was sold in late December to an unrelated partnership (“lessor”) which agreed to immediately lease it back to the seller (“lessee”) for an initial term of fifteen years.

The assessing authorities proposed that the amount of the sale price from the sale-leaseback transaction should be used for purposes of valuation for property tax purposes. A consulting firm had filed an appeal with the County Board of Review without any indication of market value other than the $18 million sale price. Fisk Kart and Katz, Ltd., on the other hand, sought to have the transaction treated strictly as a financing arrangement.

In order to accomplish this, Fisk Kart and Katz filed an appeal with the State of Illinois Property Tax Appeal Board, presenting evidence revealing that, under the financing arrangement, even though it now technically lacks legal title (as the lessee), the seller maintains interests consistent with ownership. Among the factors shown indicating substantial control over the property’s use and disposition were:

1. The terms of the transaction provided for annual rental rates which exactly equaled the payments that would be needed to amortize a loan at a current market rate of interest;

2. The lease is triple net, whereby the client is liable for all expenses, including real estate taxes, insurance and maintenance costs;

3. The lessee was given absolute options to purchase the property at various times throughout the lease term, (i.e., the lessor would not benefit if the property were to appreciate in value); and

4. The lessee had the ability to make alterations and lease the property without the consent of the lessor.

The evidence presented by Fisk Kart and Katz focused on the concept of sale and leaseback transactions and, in particular, the fact that the seller retained substantially all of the benefits and burdens of ownership. Fisk Kart and Katz argued that the lessee’s interests were so substantial that the transaction could only be considered a financing agreement with the purchaser. The evidence demonstrated that the purpose of the lease/financing plan was to generate additional cash to pay down short to medium term debt and that the effect of the transaction was to provide the client with additional capital flexibility.

Ultimately, the State Property Tax Appeal Board agreed that the transaction should be viewed as a financing and not as a sale transaction indicative of value for property tax purposes. The result of the appeal was a valuation for assessment purposes representing the market value of approximately $10 million indicated by the appraisal and presented by Fisk Kart and Katz.