A synthetic lease is a lease which allows the entity that is taking advantage of the lease, also known as the lessee, certain tax benefits and balance sheet considerations. The structure is set up so that the owner of the property, or lessor, allows the renter of the property, or lessee, the right to operate on the property in exchange for rental payments. Even though the lessee generally uses financing to pay the rent, a synthetic lease does not show up as a liability on the lessee company's balance sheet. In addition, the lessee is able to get beneficial tax treatment for interest payments made on the loan and any depreciation the property might suffer.
Companies are very concerned at all times with making deals which improve their overall financial standing. In many cases, deals may be structured in ways that allow a company to keep its balance sheet looking pristine even while it is undertaking a significant financial obligation. One such arrangement is known as a synthetic lease, which allows a company to rent property without having it show up as a negative on the balance sheet.
The two main parties to a synthetic lease are the lessor, which is usually a bank or a special company set up just for the purpose of the arrangement, and the lessee, which agrees to rent the property and operate on it. That is why this type of lease is also known sometimes as an operating lease. In many cases, the lessor also lends money to the lessee to complete the arrangement, allowing for financing to be in place.
While the lease is in operation, the particulars of a synthetic lease allow the lessee to keep it off the balance sheet. Such a consideration is extremely important for companies that are interested in showing strong financial fundamentals to potential investors. Another positive for the lessee is that the company also receives tax benefits for any depreciation of the property or any interest paid to the lender on the loan.
It is important to note that there are certain restrictions placed on a synthetic lease. For example, it must be structured in such a way that the lessee is not required to buy the property at the completion of the lease, although it may do so if it wishes. In addition, rent levels must be kept low enough so that the total amount of payments throughout the life of the lease don't go past 90 percent of the property's market value.