Why are major companies exploring a Sale-Leaseback?

Why are many major companies exploring a Sale-Leaseback?

First lets start with a basic explanation of a Sale Leaseback : A sale-leaseback constitutes an arrangement where the seller of an asset leases back the same asset from the purchaser.

The lease arrangement is made immediately after the sale of the asset with the amount of the payments and the time period specified. Essentially, the seller of the asset becomes the lessee and the purchaser becomes the lessor in this arrangement.

Who stands to benefit from a Sale-Leaseback?

Property owners who want to unlock the full financial equity they have in there property with out relinquishing the location and infrastructure in-place. Likewise companies who require cash to undertake capital investments but are illiquid due to holdings being invested in real estate yet also it is imperative for the successful operation of the business to stay at the current property. The caveat that a property owner gets to cash out and still maintain a high level of control over his property is what has made the sale-leaseback so popular.

Some of the top reasons reported for wanting a sale-leaseback:

  1. Strategic location that can not be replicated

  2. Infrastructure / design was tailored to the companies specific use.

  3. Cost of relocation is to great

Both the buyer and the Seller benefit. The Seller who becomes the lessee acquires capital and retains use of the property via a long term lease. The buyer acquires the real estate and has a long term worry free tenant, enabling him to collect passive income.

A major factor in the emergence of the sale-leaseback is the steady increase in real estate prices. Taking note of this trend have been a slew of industry leaders like Wendys and CVS (Forbes Article) who are offering investors and opportunity to execute a sale-leaseback offering strong returns and allowing the companies to focus on revamping stores and reinvesting capital into the company. The research has shown that they are better able to make use of the capital by reinvesting in the company than by owning the property outright.

The trend has caught in several sectors, as more and more case studies have proven successful. Large portfolios comprised of Hospitals, Medical practices, and Supermarkets are being sold to investors who are now competing to have these “anchors tenants” in place providing a strong creditworthy tenant who lowere the risk for the the buyer.

Companies have taken advantage of investors willing to buy and leaseback the real-estate, monetizing on its underlying value while keeping control of the property through a long-term lease. The influx of capital intern can be reinvested into the company directly or can be used to acquire new real estate holdings that may present a higher return on investment.

To reinvest the procedes received from the sale into a new real estate holding the seller who now has an influx of capital may take advantage of the ability to differ having to pay capital gains tax via a 1031 exchange. The 1031 Exchange must be filed properly taking into account all local and state tax laws. When used correctly by an investor a 1031 exchange can facilitate sizable gains by flipping into new properties all the while differing capital gains.

In essence it is the the ability for a property owner to differ paying capital gains by holding his funds with a qualified intermediary and reinvesting in a higher valued like kind property thus exchanging his old property for a new one. Time frames and reporting structures can vary state by state. This is not a new concept but it has created a pool of buyers who are competing to acquire properties.

Capital Acquisition

Conventional Financing vs. Sale leaseback

Some of the economic benefits to consider when considering Sale Lease back vs Conventional financing.

1)Terms: A key differentiator when comparing the two ways of acquiring capital is the fact that when looking into traditional loans or financing for a commercial property loan terms are typically between 10 - 15 years with a ballon payment at the end of the term. As opposed to a leasing structure that can be negotiated to have an initial term of 20 years or more. There is the ability to add on multiple options to extend the lease.

2) Rental payments: The ability to have one fixed payment. That is not variable or tied to any conditions of traditional financing is advantageous. Thus allowing the lessee to have a fixed operating cost for 15-20-25 years or as negotiated in the terms of the lease. Every deal is independent of the next but in some cases these locked rental payments are structured as net-zero deals where the rent is equal to the amount of debt service paid by the buyer.

3) LTV ratio 100%: When applying for conventional financing with banks there are set standards for loan to value ratios. The most common LTV ratio is in the range of 70-80%. When selling a property the owner is able to recover 100% of his expenses, this includes recovering all cash invested into the property.

4) Balance Sheet: Sales-Leasebacks can convert a depreciating asset into cash in hand. The sale-leaseback can be structured in a way that the seller can take advantage of rent payments being deductible instead of only being able to deduct the interest paid in a conventional debt service.

5) 1031 Exchange: The benefit is not existent with Conventional financing and allows the owner to reinvest the money from the sale in a like kind property of greater value and differ capital gains tax.

6) High Cost of Financing:  A sale-leaseback transaction can be a quick economical way to raise capital compared to the process of originating a new stock issue. Issuing new stock may result in an ownership dilution at unfavorable prices or unwanted investors. The leaseback is a low-cost tool that avoids these consequences. As a rule, a sale-leaseback transaction should provide capital at an effective cost of 100 to 150 basis points less than that of long-term mortgage financing. It should have no restricted covenants and no principal repayment after all lease payments.

Will you retain control?

YES. In the case of a sale lease back the the biggest obstacle can be the perception that the seller is loosing control over his companies future by selling there place of business to an outside investor. When a sale-leaseback is done properly it is structured in a way that (the seller) once a tenant will have benefits of ownership through the lease agreement. One of the ways to capture control is to structure the lease as a NNN lease. “A triple net lease is a lease agreement that designates the lessee, which is the tenant, as being solely responsible for all the costs relating to the asset being leased, in addition to the rent fee applied under the lease. The structure of this type of lease requires the lessee to pay the net amount for three types of costs, including net real estate taxes on the leased asset, net building insurance and net common area maintenance.”

To retain control of the location the lease will have options to extend wich would be enforceable by the lessee. Considering that a typical lease is 15-20 years with an option to renew every 5 years the business is in control of the real estate for most of the normal life of a commercial property.

Things to consider when evaluating if a Sale-Leaseback is right for you.

  1. Is the potential tenant creditworthy?

  2. What are the terms available?

  3. What is the current state of the property?

  4. Estimating repair costs for the property?

  5. Environmental concerns surrounding the property.

  6. Is the location strategic to the existence of the business?

So why are companies exploring a Sale-Leaseback?

Companies have found this as a way to help them reduce debt and as an effective means of acquiring capital that can be reinvested into the company. The funds are infused to expand the brand and in many cases the returns far exceed the capitalization rate at which they pay for in rent, which can vary because of competition.