Many corporations and individuals earn a significant portion of their income from rents that they derive from their immovable properties. The financing needs of these people are different from the vast majority of the population. It is for this reason that special products like lease rental discounting have been created to meet their needs. In this article, we will understand the features, benefits and applications of this unique financial produce viz. lease rental discounting.
What is Lease Rental Discounting ?
Lease rental discounting works like factoring. Lease rentals are considered to be the bills that are owed by other corporations to the lessor. These amounts are considered to be payments that will be received in the future. Hence, banks deduct time value of money from these payments and pay the balance to the lessor if lease rental discounting is availed.
This means that a rental which is due just next month will have to take a relatively small loss in value as compared to rentals which are far off in the future. Standard concepts related to time value of money apply to such calculations.
Also, lease rentals are not secured by the property but by the rental cash flow that the property is expected to generate. It is for this reason that lease rental discounting agreements have to be signed between three parties. The borrower and the lender sign the usual agreement. The tenant also signs an agreement with the bank and is required to make rental payments to the bank and not to the lessor once such an agreement is in force.
Pre-Requisites to Lease Rental Discounting
Not everyone who has given their property on rent can enter into a lease rental discounting agreement. These agreements can only be entered into if the following pre-requisites are met.
- Corporate Tenants: Banks are using future cash flow as collateral to make lump sum loans now. Hence, the lease rental discounting loan is only as valuable as the future cash flows are certain. It is therefore the banks responsibility to ensure that the tenant is financially fit to meet the obligations of the bank. Since corporations are publicly traded entities, information pertaining to them is easily available. This allows banks to ascertain whether or not future payments are likely to come. It is for this reason that banks only discount lease rentals belonging to renowned corporations with a good credit rating. If person “A” signs an agreement with “person B” and goes to the bank to discount these receivables, the bank will refuse to do so given that the credibility of “person B” is unknown and difficult to ascertain when compared with a corporation.
- Long Term Lease: Secondly, the tenure of the banks loan is usually between five to seven years. Banks do not make short term lease rental discounting loans. It is for this reason that banks want the agreement to be of about the same tenure as well. Also, to ensure the continuity of the monthly payments, banks ensure that tenants are made to sign agreements which are difficult to get out of. Agreements, based on which, lease rental discounting agreements are made must have lock-in periods wherein the tenant cannot vacate the property. In fact the bank provides finances only up to the extent of the lock in period.
Dual Use of Property
Lease rental discounting allows owners to use their properties more effectively. This is because owners can take one loan against the capital value of the property. At the same time, they can take another loan which is secured by the cash flow that the property in question will produce. Therefore, lease rental discounting offers much needed liquidity which is not present in immovable properties.
Commonly Used By
The following borrowers regularly use lease rental discounting to meet their financial needs.
- Developers: Developers of commercial shopping areas and industrial complexes commonly resort to lease rental discounting. Since builders develop the property at cost price and discount rentals based on market value, they can almost recoup the entire investment that they made in the project. The builder can therefore recover the money and also have a title to the property!
- REITs: The rentals that are fetched by commercial buildings and shopping complexes are way higher than regular residential rentals. It is for this reason that Real Estate Investment Trusts (REITs) have an interest in such properties. Once they acquire these properties and discount their lease rentals, they can use the proceeds to magnify their returns by investing in similar properties.
- High Net worth Investors: The common man cannot afford the kind of properties that are usually involved in lease rental agreements. Also, they do not have the wherewithal required to find corporate tenants and sign long term leases with lock in periods. However, this can be done by high net worth individuals. They use lease rental discounting loans to leverage their investments.
