Sale-Leaseback Basics

Each profession has its vocabulary, and commercial real estate (CRE) is no different. CRE is full of the compound and hyphenated terms that communicate concepts in shorthand. "Sale-leaseback" is one such example.

Real estate professionals use the term to describe a transaction where the owner of a property, who also occupies it and runs their business out of it, sells it off to an investor. Then, instead of vacating the building, the previous owner leases it back from the new owner.

The transaction was done to raise more cash than the real estate asset.

Who Carries Out a Leaseback?

You can either sell-leaseback a small business with one property or a large corporation that has many properties in multiple markets. The goal of any sale-leaseback is to maximize their real estate assets.

A sale-leaseback may be an option for a smaller business to expand its operations. A cash injection can be used to fund these efforts, and a lease agreement is signed with the new owner to allow the business to continue operating from its current location.

They might see a building as a non-essential asset and want to remove it from their balance sheet. Instead of holding equity in real estate, the company could create liquidity and reallocate funds to the building.

This is like having your cake and eating too. You sell your building, take the cash and stay in your current location.

Selling Motivations Other Than Cash

There are many other reasons than financial incentives to initiate a sale-leaseback for both small and large businesses.

Don't Focus On Real Estate:

Sometimes business owners want to get out of the real estate business. Managing a real estate property can become a burden for business owners who want to concentrate on their mission. Many don't have the time, skills, or ability to shovel snow from sidewalks or parking lots, monitor and pay taxes, insurance, and utilities, or fix or repair things that are broken or worn out.

Flexibility:

This is another important driver for sale-leasebacks. Large and small companies can watch the changing conditions affecting their business and how locations change or become more popular. Companies can lease space to expand or contract as needed.

Although they won't manage or maintain the building, this flexibility could pose risks once the lease ends. The rent rates will be higher, space may not be available, and clients and employees could find it very difficult to move.

Invalid for Retirement Strategy

The sale-leasebacks can be used to help all kinds of companies, from entrepreneurs who are preparing for retirement to large corporations that are constantly strategizing and managing assets.

Cash flow and lump sum. This type of transaction is most common for small businesses. It occurs when a business, such as a restaurant or law firm, has been operating from the same building for many years. The building owner/businessman who has been in business for many years wants to keep their business there and turn the asset's equity into cash.

Imagine an entrepreneur who owns both the building and the company that operates it. An investor buys her stake in the building and her operating company. This could be a law firm or a medical practice. The new buyer rents the property. This is usually when the property owner wants to monetize it. For example, the owner of the building or company might be approaching retirement and wants to monetize it to receive a lump sum but keep the ownership of the operating business to continue to earn an income stream.

Corporate strategy and mitigating risk. A sale-leaseback is part of a larger corporate strategy. This involves reorganizing a real estate portfolio and disposing of, buying, leasing, or leasing assets in different markets around the world. Large business owners may initiate sale-leasebacks on an occasional basis or on an ongoing basis as part of a larger real estate strategy that allows them to change their real estate portfolio in response to changing business needs.

The corporate real estate divisions are responsible for following economic and employment trends to ensure that companies have access to skilled workers, raw materials, or other resources necessary for their operations. They must also monitor real estate market conditions to optimize when they enter, renew, or exit a market. Sale-leasebacks are tools to help them do this. Unfortunately, it is almost impossible to time a building's purchase, sale, or lease agreement correctly. However, selling a building early and leasing it back in advance of a planned departure reduces the risk associated with selling in an uncertain future market or economic environment.

Conditions For A Buyer

What makes a sale/leaseback appealing to a buyer? There are four characteristics that are essential to any real estate purchase. First, apart from adequate cash flow, the purchaser is seeking a long-term lease and a creditworthy tenant. He also stated that he was looking for a flexible, reusable, and sustainable real estate asset.

Lease Length:

A longer lease means a higher price for the property. The longer lease allows for expenses like legal fees, broker commissions, and buildout allowances to spread over a longer period. This also reduces the time and costs involved in renewing short-term leases. A purchaser will be most interested in a sale-leaseback if there are at least seven years.

Creditworthy Tenant:

The asset is more valuable if the tenant has strong credit. A tenant who has strong financial records and a history of paying rent on time will be more likely to pay rent and avoid bankruptcy.

It is important to remember that strong credit tenants will negotiate more than just the rental rate and lease length in a sale/leaseback negotiation. Tenants with strong credit in growing and healthy industries might also be eligible for concessions like free rent or tenant improvement allowances. Although it may seem strange to imagine a business that currently occupies a building being able to negotiate concessions, the prospective tenant must still complete the lease details in a sale-leaseback as though they were negotiating a new lease.

Building Reuse:

The purchaser must consider the costs of preparing the building for a future lease. He asked, "If a tenant leaves, can the building be reused without having to spend significant amounts of money to refurbish and refit it?" It may be costly to rent a building that has been customized to suit the needs of an owner/occupier. A building that is more easily reusable is more valuable to a buyer.

Location:

Location is an important consideration. The location will determine the reusability of the asset and the speed at which it can be sold or rented to another tenant.

A sale-leaseback transaction offers buyers and sellers unique opportunities as well as potential complications. It can create liquidity and flexibility for business owners while allowing them to concentrate on their core mission. It also provides property owners with a new asset, including a rental income stream and long-term tenant.