What is a Sale-Leaseback?
Many companies today are not in the business of owning real estate but need the utility of land and buildings to produce their products or services. A sale leaseback enables a company to reduce its investment in these non-core business assets (the land & building) and liberate the cash in exchange for executing a lease and paying rent. In a sense, a sale leaseback separates the “asset value” from the “asset’s utility value” in a company’s real estate investment.
A real estate sale-leaseback is a transaction in which the owner-occupant sells the land and building used in its business operations to an investment firm or real estate trust and then simultaneously leases the property back from the investor on lease terms agreed to concurrent with the real estate sale transaction. Typically, this will be a long-term investment for the special purpose investor so the seller is able to negotiate directly with the investor a mutually agreeable and clear set of lease terms. The full value of the real estate is extracted and there is no operational disruption. The seller continues to conduct business in the facility as if they still owned it.
Sale Leaseback Potential Benefits:
Flexible Lease Terms
Because the seller is also the lessee, the seller has significant bargaining power in structuring the property lease. In addition to realizing their investment in the real estate, the lessee has the opportunity to negotiate an acceptable lease agreement with the investor acquiring the property. Typical leases run 10 to 15 years. The seller, now the tenant, can also negotiate extension options after the lease expiration, and can also include terms for early lease termination if the tenant sees a need for more flexibility.
Retain Control of Real Estate
Most sale leasebacks are structured as triple-net leases, so the tenant will be responsible for the taxes, insurance, and common area maintenance. A long-term, ‘hands-off’ lease from the investor provides the tenant similar control over the property as was the case when the tenant owned the property. The tenant can work with the buyer to include options that will provide for future expansion and sublease of the property.
Potential Tax Savings
Generally, lessees that are engaged in a lease are able to write off their total lease payment as an expense for tax purposes. As property owners, the interest expense and depreciation were the only tax deductions available. As a result, a sale leaseback may have a greater tax advantage.
Greater Value to the Real Estate
Unlike a mortgage, a sale leaseback can often be structured to finance up to 100% of the appraised value of the company’s land and building. As a result, a sale leaseback more efficiently uses the company’s investment in the real estate asset as a financing tool.
No Financial Covenants
Because a sale leaseback is not technically a financing instrument it does not have any covenants on the company. Fewer covenants provide a company with greater control over its own business and operations. The transaction rarely includes any type of personal guarantee.
Attractive Implied Financing Rates
A sale leaseback has an implicit financing rate, (“cap rate”) imbedded in the future rent payments. Although the sale leaseback cap rates are frequently slightly more than similar mortgage rates, a sale leaseback provides cash proceeds for up to 100% of the appraised value of the property versus the 70% to 80% of appraised value under a typical mortgage. A sale leaseback investor has only the real estate as collateral and a relationship with the seller through the lease agreement.
Capital for Growth
A sale leaseback can be used to free up cash to grow a business through acquisition or acquire additional facilities, technology, and equipment. With the tightening of the credit markets, many businesses do not have access to as much credit as they need to achieve their growth objectives. Sale leasebacks can be used as an off balance sheet financing structure that gives the seller the opportunity to turn a non-earning asset into growth capital. The company can then save the available bank financing for acquisitions and growth opportunities in the future. The proceeds could also be used for other corporate purchases like the buyout of a shareholder or a special cash distribution to all the shareholders. The absence of covenants in sale leasebacks provides business owners with significant flexibility on the best use of their company’s cash.
Corporate Restructuring/Exit Financing
Businesses that are struggling for liquidity to pay creditors or are considering a bankruptcy might look to a sale leaseback for capital. Depending on the value of the company’s real estate, a sale leaseback can supply a considerable amount of liquidity and be a quick initial step to begin a reorganization process.
Our investors can work to meet tight time frames and close the transaction with all cash. If a potential seller is able to provide good historical financial statements, a business plan, and projections and a description of the planned uses of proceeds from the sale-leaseback as its role in the reorganization, then in these circumstances these special investors can make rapid investment decisions often within 45 days, if the due diligence materials are readily available.
Packaging Business for Sale
Most PE firms are not in the business of owning and managing real estate. A business owner who is contemplating selling his company can benefit by taking the real estate out of the company sales transaction and, by doing so, maximize the value of the real estate and increase the overall gross sale proceeds.
If the real estate is left in the transaction the full value is seldom realized, as the EBITDA multiple often does not value the company’s real estate at its true fair market value. Sale leaseback investors will typically make their offer price based on an appraisal, extensive real estate market study, and a review of comparable market lease rates. The seller can complete a sale leaseback and negotiate a long-term lease and pull out the real estate sale proceeds or repay corporate debt before the sale of the business.
The Investor Underwriting Process
The REITs we partner with use a disciplined approach to conduct their due diligence in a timely manner. Building and land appraisals, local market research, comparable lease and sale data, location, and accessibility analysis are just a few areas which will be considered during due diligence. The buyer will also evaluate the tenant’s credit strength using analysis similar to lending institutions and corporate acquirers. Finally, when a sale leaseback investor considers an investment opportunity they will consider the long run marketability of the real estate if it ever becomes vacant.
The size and shape of the building will also play in the functionality equation when underwriting the property. The investor is very interested in the alternate uses and users for the real estate if and when the tenant vacates the property. All of these alternative use factors will affect the lease payment in the sale-leaseback transaction.
A sale leaseback transaction represents a great alternative for mid-market companies to raise capital and fund future operations and growth.
If structured properly, a sale leaseback can more efficiently use a company’s assets as a financing tool. It is important to work with an experienced team of attorneys, tax professionals and investment bankers to structure a deal that meets the company’s specific circumstances. At Kwekel Companies, we have identified and built strong relationships with a wide variety of private investment firms to meet the needs of our clients.