Own to rent | The often overlooked benefits of a sale-leaseback transaction
“Why rent when you can own?” It’s an industry standard question. Typically, I’d make a fine argument to support the pleasures of property ownership. However, this time I will outline the benefits of transitioning from an owner to a tenant via a specific real estate transaction called a sale-leaseback. In some cases, you should rent as opposed to own.
The basic definition of a sale-leaseback is the sale of commercial property by an owner/occupant and the simultaneous execution of a lease by that occupant to remain in the building for a defined amount of time. For example, a nationally credited company owns a 10,000-square-foot retail building located in a commercially vibrant area. For a variety of reasons (outlined below), the company chooses to sell the building but wants to remain as a tenant. The going market annual lease rate for their building is $15 per square foot, triple net (meaning the tenant is responsible for all operating expenses excluding capital repairs). The company will agree to sign a 10-year lease with three five-year options at the closing of a sale.
We would then market the building to investors as a single-tenant sale-leaseback. By applying a capitalization rate to the annual income, we can assume a market sale value. For the sake of argument, let’s apply a 10% cap rate on the $150,000 per-year rent, meaning the building is worth $1,500,000 to investors. Of course, this is a simplified example of what can be a creative and sometimes complicated transaction. I would strongly encourage you to consult your broker and accountant to discuss your specific needs and the impacts this type of transaction may have on your company.
So, why rent when you can own? Let’s examine the appeal a sale-leaseback would have to both sellers and buyers.
Liquidity
Today’s credit market is very difficult. Lenders have learned their lessons and have significantly tightened their purse strings. As such, working capital is scarce and a sale-leaseback can be an effective means of converting a business’ real estate equity into cash. With the net proceeds of a commercial sale, a business can reinvest in other growth areas, expand operations, invest in other higher-earning ventures, etc. Furthermore, by reducing debt from the prevailing mortgage, you simultaneously lower operating costs and increase cash flow.
Control your destiny
As the seller and controlling operator, you have significant leverage when it comes to negotiating the lease. While a purchaser will want to see at least market rental rates, you can negotiate a long-term hold. For example, sign a 15-year initial lease with four or so five-year tenant options to renew. You will ensure facility control for the reasonable useful life of the building while avoiding the potential pitfalls of real estate depreciation and market lulls. You may also work out low annual increases so, after the initial lease term, you may be well below market lease rates. Furthermore, in the short term, you’ll save on costly moving expenses associated with relocation. A final benefit is that some company owners simply shouldn’t be in the commercial real estate game. If you’re a widget producer, you can focus on producing widgets and not worry about mortgages, property tax increases, building management and maintenance, and other headaches associated with owning commercial real estate.
Investors delight
One definitive trend I’ve seen in the commercial market is the lack of quality investment properties for sale. Cash-flowing assets are just not exchanging hands as much as they were five to 10 years ago. As a result, there are investors aggressively seeking deals. Creditworthy companies that own their buildings have great negotiating power and can drive the sale price up. A tenanted, commercial property secured by a long-term, credit lease would have great appeal today.
Bridge the gap
In recent years, we’ve seen a variation of the sale-leaseback where it serves less as an investment and more as an incentive to close a sale. That is, a short-term or partial leaseback. For example, if a buyer has a use for a building or a part of a building, they may look to the seller to lease back a portion of the property on a shorter-term basis just so the new buyer can get up and running and grow into the whole space. The leaseback is essentially a gap-filler and can serve as a temporary solution to bring the deal to fruition. This scenario appeals to the seller as well, as it allows reasonable time to vacate the building and transition to the next step in their operations.
It is important to recognize and consider different options and solutions in this difficult commercial real estate market. The sale-leaseback transaction can increase a company’s liquidity, ensure controlled longevity within a space and have real appeal to buyers. If positioned and marketed appropriately, it can lead to positive returns for all parties.
Justin Lamontagne, associate broker at CBRE/The Boulos Co. in Portland, can be reached at jlamontagne@boulos.com. Read more of Justin’s columns at here.
Most Recent
Most Recent
Comments