Sale-leaseback transactions are an appealing option for both corporate property owners and commercial real estate investors. But before we dive into the advantages and disadvantages of a sales-leaseback transaction, let’s first take a minute to review some logistics.
In a sale-leaseback transaction, the owner of a commercial property sells the asset to an investor and enters into a lease for a mutually agreeable term or time period, lease rate, annual lease increases, and lease type. Depending on the asset and situation, the lease could last anywhere between 7-15 years. The typical lease structure is a triple net (NNN), which makes the lessee responsible for all of the property’s expenses including real estate taxes, building insurance, and maintenance. Following the end of the lease, sale-leaseback transactions may include an option for the seller to renew their lease, repurchase the property, or vacate the premise.
- Converts Equity into Cash – Sellers can convert illiquid assets into cash while still retaining use of the properties. In some cases, the seller may receive more capital than they would with traditional financing or selling as an owner/user property.
- Alternative to Conventional Financing – A sales-leaseback transaction offers the seller options to structure the initial lease term and renewal options while conventional mortgage financing has no guarantee for refinancing terms.
- Balance Sheet Improvement – Sellers replace a fixed asset with a current asset, such as the cash proceeds from the sale. The seller’s rent obligation is disclosed in a footnote to the balance sheet rather than a liability. This ultimately increases the ratio of current assets to current liabilities and serves as an indicator of a business’s ability to service short-term debt obligations to lenders.
- Loss of Residual Property Value – The seller transfers title to the new owner. Sellers can include a repurchase option in the leaseback however, this changes how the sale-leaseback arrangement is reported for accounting purposes. The lease will be recorded as an asset and capitalized and the obligation to make the future lease payments will be shown as a liability.
- High Rental Payments – Rental payments under the lease cannot be adjusted without the consent of the buyer. It Is rare that an owner renegotiates the lease. If there are changes in rental market conditions, the seller may be locked into a higher rental rate negotiated at the time of the sales-leaseback.
- Loss of Flexibility – The seller loses the right to change, discontinue use of the property or modify the building without the written consent of the owner. Furthermore, a sale-leaseback can restrict the seller’s right to transfer the leasehold interest. The leasehold Interest can be negotiated differently upfront in the initial lease.
- Lease Customization – The buyer can write up specific lease terms using nontraditional documents to meet unique demands not typically found in standard leasing documents. This allows buyers to add clauses to ensure high returns. Including a personal or corporate guarantee helps with a resale in the future.
- Built-in Tenant – In purchasing the property, the buyer has a built-in tenant with operating history at the location. When the lease supports the tenant’s business model, the tenant generally stays for a long time.
- Possibility of Seller Default – If the seller defaults on the lease, the buyer is left without a tenant. Depending on market conditions, the buyer may have a difficult time finding a new tenant. However, there Is always the option to sell the building to an owner/user.
- Required Property Management – The typical lease structure is a NNN which makes the lessee responsible for all the day-to-day management during the lease term. However, the buyer will still be responsible for making sure that the seller pays property taxes on time and for reviewing the insurance coverage on the property.
Whether you are a building owner considering a sale-leaseback or an investment buyer, having the right broker by your side is essential. Having the integrity of representation helps protect your company during the negotiation process.
For more helpful information on buying commercial real estate, look for Simply Own It, the American Dream, coming soon.
About Andrea Davis
Andrea Davis, CCIM, has practiced commercial real estate for over twenty years. Davis’s breadth of knowledge stretches from developers to landlords to buyer/tenant representation and investments. Within the commercial real estate industry, Davis has won numerous awards. The Phoenix Business Journal ranked Andrea Davis CRE in the top 10 of Ranking Arizona for the category of Office Brokerage. Her book, SimpLEASEity™, focuses on leasing and is the first in a series of commercial real estate guidebooks. Her next book, Simply Own It, the American Dream, is forthcoming this year.