New Life for Synthetic Leases

The synthetic lease, a form of off-balance-sheet financing, boasts a relatively long history of use by companies for acquiring such items as heavy equipment, or such assets as vehicles with a shorter economic life.

The synthetic lease, a form of off-balance-sheet financing, boasts a relatively long history of use by companies for acquiring such items as heavy equipment, or such assets as vehicles with a shorter economic life. After a period of rapid growth, the use of synthetic leases slowed in the mid-1990s, when it looked as if the regulators would close the scheme down. They did put more constraints on the synthetic lease, but nowhere near as many as people expected, and in the late 1990s it became increasingly popular.

Ryder System Inc., of Miami, for example, has done about four of these deals as a way of acquiring trucks to be used for rentals. The $5 billion company closed its last synthetic-lease deal in September for about $200 million.

“We look at it as a funding source,” says C. J. Nelson, Ryder’s CFO and senior executive vice president of finance. “It gets the vehicles off balance sheet and helps reduce the overall debt of the company, allowing us to use that debt for other things.”

With a synthetic lease, a capital source directly finances or acquires the real estate and leases it to the corporate user. “The synthetic lease is financed predominantly by the credit of the tenant that bears the majority of the asset risk,” reports Brant Bryan, president of Staubach Financial Services, in Dallas. “It’s also shorter-term, typically about five years, and off balance sheet for financial reporting but not for tax purposes. The tenant is treated as if it owns the property, so it gets the deduction not only for rent payment, but also for depreciation.”

Michael Evans, a partner specializing in real estate with Ernst & Young LLP’s Consulting Services Group, says there’s another potential benefit to synthetic leases: Through a fixed-purchase option, future appreciation on the property can be realized by the corporate user.

The Novell Corp., in Provo, Utah, has done synthetic leases on a few key buildings. The $1.3 billion technology company did a $157 million transaction on its campus in San Jose, Calif., in 1997, and then a $115 million deal on a couple of buildings in Provo.

“It fits into our corporate strategy by giving us, the lessee, the ability to use our cash as we determine,” says Dan Baker, director and assistant treasurer at Novell. “Although we are a cash-rich company, if we had paid cash for these buildings, it would have shown up as a nonperforming asset on our balance sheet.”

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