If you own commercial real estate, you may be considering several options to monetize your investment. A sale-leaseback is one strategy to explore to maximize value and financial return.
In this article, we will discuss everything you need to know about a sale-leaseback, including:
- What is a sale-leaseback?
- Sale-leaseback: Advantages
- Sale-leaseback: Disadvantages
- Why would you do a sale-leaseback?
- Is a sale-leaseback right for me?
A sale-leaseback is a real estate transaction in which a real estate owner sells a property to a new owner and then leases back that same property through a long-term lease. Also known as a sale-and leaseback or a leaseback, the transaction enables the seller to become a lessee and the new owner to become a landlord.
Real estate owners use sale-leasebacks to raise capital or divest real estate assets without selling equity ownership in their underlying operating business. Once the property is sold to a new investor, the seller enters into a lease agreement for an agreed-upon rent for a set duration. Once a sale-leaseback is completed, the seller of the real estate property becomes the lessee and the purchaser becomes the lessor. As a lessee, the seller can raise capital, divest a real estate asset, and use the real estate to operate its business.
Sale-leasebacks are attractive to real estate owners who want to use an alternative, creative strategy to raise capital other than traditional debt financing or equity financing.
A sale-leaseback offers several advantages to both sellers and purchasers of commercial real estate property.
Sellers of real estate can enjoy the following benefits through a sale-leaseback:
- Raise capital. Selling a real estate asset provides immediate cash to an owner to pay off high-cost debt, issue a cash dividend to investors, fund acquisitions, or fund business growth.
- Strengthen balance sheet. Sellers can strengthen their balance sheet by swapping a fixed, illiquid asset (real estate) for a liquid asset (cash). With an operating lease, a seller can strengthen its balance sheet and potentially achieve more debt capacity on better financing terms.
- De-leverage. Sale-leasebacks are an effective tool to de leverage the balance sheet. Corporate sellers can move debt off balance sheet and use the proceeds from a leaseback for accretive share repurchases. Therefore, leasebacks are both deleveraging and shareholder value creation tools.
- Financing alternative. Sellers can avoid traditional real estate financing without the burden of term sheets, mortgages, interest payments, debt covenants, and refinancing.
- Use the property. Once the property is sold, the seller can enter a long-term lease with the new owner to continue to use the property to operate the business.
- Fixed expenses. A long-term lease helps a business owner have fixed, predictable expenses.
Purchasers of real estate can use sale-leasebacks to gain several advantages, including:
- Cash flow. A real estate purchaser can access a cash-flowing real estate asset.
- Existing tenant. Unlike many real estate transactions, a buyer can purchase a commercial real estate property with an existing tenant.
- Long-term lease. With a long-term lease, a purchaser can have stable, predictable rent that can mitigate financial risk during an economic downturn.
- Long-term appreciation. In addition to collecting consistent rent payments, the purchaser can benefit from property appreciation.
- Depreciation. Purchasers can enjoy the benefits of real estate ownership, including depreciation and other tax benefits.
While there are many advantages to entering a sale-leaseback, buyers and sellers should weigh the disadvantages as well. For example:
- Loss of real estate. Sellers must be comfortable with divesting their real estate. After the completion of the transaction, title will transfer from seller to buyer.
- Long-term lease. If the leaseback includes a long-term, fixed lease, then sellers may be disadvantaged if they need to break the lease or want to negotiate lower rent.
- Lease renegotiation. Once the lease term expires, the seller/lessee potentially is susceptible to higher market rent or may need to vacate the property.
- Limited flexibility. Depending on the terms of the lease, the seller/lessee may have less flexibility to upgrade or alter the property.
Lease default. A seller/lessee could default on the lease, which could be a material risk for a buyer/lessor. If a buyer/lessor cannot secure a replacement tenant, the buyer could risk lost rental income and vacancy.
Property management. As a real estate owner, the buyer/lessor is financially responsible for repairs, maintenance, and upgrades.
Why would you do a sale-leaseback?
As a commercial real estate owner, there are several reasons why you would consider a sale-leaseback. For example:
- Access To Capital. A leaseback improves access to capital for real estate owners. By selling your real estate, you can extract cash from a real estate asset without selling your business or using traditional debt financing. By deploying the cash proceeds into your business, you could achieve a higher investment return compared with real estate ownership.
- Operational Focus. This transaction is especially helpful for commercial real estate owners who want to operate their business but who don’t want to own the underlying real estate or be responsible for upkeep.
- Business Continuity. With a leaseback, operators can remain in their current property post-transaction as a lessee, which creates business continuity.
- Tax Benefits. Leasebacks also offer multiple tax benefits. For example, real estate ownership with a traditional mortgage enables you to deduct mortgage interest and depreciation. In contrast, as a lessee, rental payments are deductible.
- Maximize Cash Proceeds. A sale-leaseback can help real estate owners get 100% fair market value for their real estate asset. In contrast, traditional financing allows you to extract approximately 80% of fair market value through refinancing, for example.
Is a sale-leaseback right for me?
If you’re considering financing options for your real estate asset, you may be wondering, “Is a sale-leaseback right for me?” To answer that question, make sure to consider several variables.
First, it’s important to understand that a sale-leaseback allows you to sell your real estate without selling your business. If you plan to operate your business but no longer want to be an owner-operator, then divesting your real estate asset to raise cash can be an effective strategy.
Second, if you’re considering selling your business, a leaseback can help you maximize profit. For example, separating your operating business from your real estate creates more transparency, which can result in a buyer paying you fair market value for your real estate asset. In contrast, selling your business inclusive of real estate ultimately could result in a purchase price that undervalues your real estate. Plus, by negotiating a longer-term lease, a buyer may be willing to pay a higher price given a longer horizon of predictable cash flow.
Third, a leaseback can provide flexible financing if you need to pay off debt, fund operations or increase growth. Rather than sell equity or raise more debt with covenants, a leaseback can provide an alternative financing solution.