In the dynamic world of commercial real estate, traditional methods of raising capital like loans and equity financing have been the go-to, historical choices for investors. But did you know that there’s another lesser-known but highly effective strategy worth considering: sale-leaseback transactions.
In this post we’ll explore the following: What exactly are sale-leaseback transactions and how can they help investors like you unlock capital and enhance their financial flexibility?
What is a Sale-leaseback?
Sale-leaseback deals offer property owners and tenants a stable, long-term solution to restructuring their debt.
A sale-leaseback is an arrangement in which the company that sells an asset can lease back that same asset from the purchaser. With a sale-leaseback the details of the arrangement, such as the lease payments and lease duration, are made in conjunction with the sale of the asset. Simultaneously, the two parties enter into a long-term lease agreement with the new property owner, becoming the landlord and the seller becoming the Tenant.
This type of transaction allows the business to convert its real estate asset into cash while retaining operational control of the property through a lease agreement. The lease agreement typically has a long-term duration, often ranging from 10 to 20 years or more, ensuring that the business can continue to use the property as before. Essentially, a sale-leaseback transaction provides businesses with an opportunity to monetize their owned real estate assets while still enjoying the benefits of property use. The most common users of sale-leaseback transactions are growing companies with high-cost fixed assets such as fast food franchisees.
What a Sale-leaseback Is Not
A sale-leaseback is neither debt nor equity financing. It is more like a hybrid debt product. With a leaseback, a company does not increase its debt load but rather gains access to needed capital through the sale of assets.
How Does a Sale-leaseback Work?
In sale-leaseback agreements, an asset that is previously owned by the seller is sold to a real estate investor and then leased back to the first owner for a long duration. In this way, a business owner can continue to use a vital asset but ceases to own it.
A sale-leaseback enables a company to sell an asset to raise capital, then lets the company lease that asset back from the purchaser. In this way, a company can get both the cash and the asset it needs to operate its business.
A loan must be repaid and shows up on the company’s balance sheet as a debt. A leaseback transaction can improve a company’s balance sheet health: The liability on the balance sheet will go down (as the company avoids taking on more debt), and current assets will show an increase (in the form of cash and the lease agreement). Although equity does not need to be paid back, shareholders have a claim on a company’s earnings based on their portion of its stock.
Who Uses Leasebacks and Why?
When a company needs to raise cash, it typically takes out a loan (incurring debt) or effects an equity financing (issuing stock). Companies use leasebacks when they need to utilize the cash they invested in an asset for other purposes but they still need the asset itself to operate their business. Sale-leasebacks can be attractive as alternative methods of raising capital.
The most common users of sale-leasebacks are builders or companies with high-cost fixed assets—like property, land, or large expensive equipment. As such, leasebacks are common in the quick service retail sector.
2024 Trends in Sale-leaseback Transactions
As we look into 2024 and potential, additional interest rate hikes from the Federal Reserve, here are the trends the Advisors here at Westwood are seeing:
Some lenders are taking a critical eye to refinancing, so sale-leasebacks are becoming “liquidity of choice” to jumpstart debt redo.
An increasing number of sellers are opting for sale-leaseback deals because they need to rehabilitate their cash flow and can’t wait for cap rates to compress again.
Sellers are choosing long-term net lease deals as the first step to address their balance sheets, using the proceeds from the sale-leaseback to jump-start their debt restructuring.
What are the Benefits of Sale-leasebacks?
A less expensive, alternative form of borrowing that can close faster, sale-leasebacks deals also don’t require back-end balloon payments that often come with traditional financing.
Sale-leaseback transactions may be structured in various ways that can benefit both the seller/lessee and the buyer/lessor. Sale-leaseback transactions can offer tax benefits, such as potential depreciation and interest deductions. It’s advisable to consult with a tax advisor to fully understand the tax implications of a specific transaction. All parties must consider the business and tax implications, as well as the risks involved in this type of arrangement.
One of the most prominent advantages of sale-leaseback transactions is the immediate access to capital. By selling a property and leasing it back, you can free up substantial amounts of cash that can be reinvested elsewhere. Sale-leasebacks can also recapitalize existing mortgage yields
Sale-leaseback transactions enhance a company’s liquidity, which can be critical in times of economic uncertainty or when facing unexpected expenses. This increased liquidity can help the business maintain operations, pay down debt, or seize new opportunities as they arise.
Balance Sheet Enhancement
Removing owned real estate from the balance sheet can improve financial ratios and creditworthiness, making it easier for businesses to access financing on more favorable terms. This can be particularly valuable for companies looking to secure loans or lines of credit for working capital needs.
Benefits of Sale-leaseback Transactions to Sellers / Lessee
Restructuring and Recapitalization: In times of financial distress or restructuring, businesses may opt for sale-leaseback transactions to improve their financial position and maintain operational continuity.
Monetizing Real Estate Holdings: Companies that own significant real estate assets but want to focus on their core operations can monetize these properties through sale-leasebacks. This strategy allows them to access the value of their real estate without the responsibility of ownership.
Expansion: Enables a company to expand its business. Companies looking to fund expansion, whether by opening new locations or acquiring competitors, can utilize sale-leaseback transactions to raise the necessary capital without depleting their cash reserves.
Less-expensive cost of capital and extra liquidity during tough times. Holders of fungible, mission-critical real estate that are willing to sign a long-term lease with market or better rental increases built in can establish an underlying rate that lets them monetize those assets and is inside the going long-term borrowing rate
Benefits of Sale-leaseback Transactions to Buyer / Lessor
Sale-leaseback transactions can be beneficial to both the seller (lessee) and the buyer (lessor).
After the completion of a sale-leaseback transaction the buyer (lessor) can benefit from a:
- A stable long term lease from the user tenant with past operational history.
- A fair return on investment (ROI)
- The ability to negotiate lease terms that benefit the Buyer.
Sale-leaseback buyers must make sure sellers are creditworthy before they agree to sale-leaseback deals.
Important Considerations Before Entering into a Sale-leaseback Agreement
The terms of the lease agreement, including rent escalations, renewal options, and lease duration, can significantly impact the business’s long-term financial stability. Negotiating favorable terms is crucial.
The selling price of the property should be carefully considered to ensure it accurately reflects its fair market value. An appraisal or valuation by a reputable expert can help achieve a fair deal.
Sale-leaseback transactions often involve long-term leases, which can limit a business’s flexibility to adapt to changing circumstances. Careful planning and consideration of future needs are essential.
The financial commitment to lease payments must be sustainable for the business over the long term. It’s crucial to project future cash flows to ensure the company can meet its lease obligations.
The tax implications associated with sale-leaseback transactions could be both a benefit and a risk. It’s essential to understand how a given transaction will affect your company’s tax situation and seek professional advice if necessary.
Both buyers and sellers need to conduct thorough due diligence to ensure that the transaction proceeds smoothly and according to the agreed-upon terms.
What Do Sale-leaseback Transactions Mean for NNN Lease Buyers?
NNN lease buyers benefit from and can utilize sale-leaseback transactions in the following key ways. NNN buyers can:
- Sell an existing property through sale-leaseback and use the infusion of cash funds to purchase a NNN-lease property
- Purchase a NNN lease property through a sale leaseback transaction
In a market where interest rates are high and cap rate returns are lower than many buyers would like, sale leasebacks are NNN lease buyers’ best bet for restructuring debt and purchasing a new property under the most favorable terms possible, given the current market.
Sale-leasebacks Benefit Buyers and Sellers Alike
Sale-leaseback transactions are a powerful financial tool that can help businesses unlock capital, improve liquidity, and enhance their financial flexibility. While they come with certain risks and considerations, careful planning and negotiation could mitigate potential drawbacks. For businesses seeking to access the value of their owned real estate assets without relinquishing operational control, sale-leaseback transactions can be a strategic move that paves the way for growth and financial stability.
Please note that this article is not legal tax advice. It is purely informational about different tax options. Consult your CPA or go to the IRS’s website for more.