A sale-leaseback is a real estate transaction where the owner of a particular piece of commercial real estate becomes a seller and then tenant in his own property. The owner's property is offered for sale with the understanding that he will sell it to a buyer who will in turn become his landlord. The buyer/landlord agrees to lease the property back to the seller/tenant for a specified period of time under pre-determined terms and conditions.
The advantages of this strategy to a seller/tenant are many--some obvious, some less so. First and foremost the seller/tenant converts his illiquid real estate asset into liquid cash. Although the real estate is serving a purpose when owned, the knock on real estate in general as an investment is its illiquidity. With the real estate off the books, its value is converted to cash and can now be put to work meeting some of the other needs of the business. Many companies, when establishing a new location, like the option leasing provides. In a new build-to-suit situation, valuable cash can be put to work other places when a company chooses to pay $100,000 annually for leased space rather than say, $1,000,000 for new construction.
Another advantage to the business owner is the flexibility leasing provides over owning. The tenant is only obligated to occupy the property through the base term of the lease. This may be 5, 10, 15, or in the case of Walgreen's and others, 20-25 years. Since no business can be sure how long its real estate will continue to enhance its bottom line, leasing provides a hedge against an outmoded location or other factors which might make a new location more attractive.
If the business owner/tenant is not sure what the future holds but wants to remain in the driver's seat at the end of the base lease term, he simply negotiates a series of options (usually in 3-5 year increments) which allows him to stay in the real estate as long as it is still advantageous to do so. It is important to note that options are uni-lateral, meaning it's solely at the tenant's discretion whether or not it is exercised. The option conveys a right to occupy the property beyond the base lease term, but does not represent an obligation to do so. Some national tenants can effectively tie up property with the judicious use of options for as long as 75 years.
Another advantage of a sale-leaseback transaction is it allows the seller/tenant to effectively "write his own ticket." The seller often writes his own lease before putting the property up for sale. This practice allows the seller/tenant to better control his future costs and obligations.
Other sale-leaseback advantages are a function of timing. Many believe now is a good time to clear the books of real estate because of the pending threat of higher capital gains taxes which may be on the horizon. Another issue, simply put, is in this current market a new private investor/buyer/landlord may be more willing to buy a property than a bank would be to lend on it.
Investors like sale-leaseback transactions because they know the tenant already has some level of commitment to the property and will be less likely to move because of minor inconveniences. Further, investors like sale-leaseback deals because they often provide accessibility to smaller, more manageable (financially) properties. Since sale-leasebacks usually include triple net leases, landlords like the fact that the tenants continue to pay taxes, insurance and maintenance and the investment virtually becomes a coupon-clipping, check-cashing machine.
Sale-leasebacks are not for everyone. Many would-be seller/tenants bristle at the notion of paying all the occupancy costs of the real estate without enjoying their ownership "bundle of rights." Also, an owner/tenant's lease payments will be a funciton of the buyer/landlord's capitalization rate and purchase price. Assuming a purchase at prevailing market cap rates, a higher purchase price will mean higher ongoing rent. If the tenant desires to keep rent low, the amount of cash generated at the sale will be proportionately lower and presumably of less benefit for other business operations.
On the investor/landlord side, some will be scared off by smaller tenants or the threat of non-payment that may go with a less creditworthy business. Or, given a perceived higher risk, the investor may demand a cap rate on the deal which exceeds those in the current marketplace.
An issue that should be addressed, both pro and con, from both the landlord and tenant perspectives is that of property apprecition/depreciation. In a sale-leaseback transaction, the tenant is assuming the risk that the property will become much more valuable in the future. At the same time, however, he is freeing himself from the risk that the property will, dare we say it, depreciate in value in the future. And although this latter risk at one time seemed unthinkable, it has often been the reality in this past year's deflationary environment. The landlord obviously is dealing with these risks/rewards in a converse fashion.
Leasing vs. owning is a question many businesses weigh from time-to-time. Recognizable retail names such as Walgreen's, Wal-Mart, and Applebee's/IHOP have been committed to leasing rather than owning over the years. Some business like Wal-Mart have shifted their focus from leasing to owning and sometimes back again to leasing depending on the business climate and corporate philosophy at the time.
If the sale-leaseback transaction has not been on your company's radar screen, consider its benefits for freeing up valuable cash. It may be a lot less painful than arm wrestling your banker for a new loan.
If you're an investor, consider the sale-leaseback as a way of diversifying your real estate portfolio. It may be a great way of adding to a quality tenant mix and broadening your investment horizons. And, if you encounter the right seller/tenant at the right time, you may be rewarded with above market cap rates.
Please give us a call here at Sperry Van Ness/Fiducia Properties to discuss sale-leasebacks or any of your other commercial real estate needs. We can be reached toll free at 888.879.2083 or by email at greg.finley@svn.com.
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