By: Michael Bull, CCIM, CEO of Bull Realty and host of the Commercial Real Estate Show
A noticeable trend in brokerage today is the rise of sale-leaseback transactions. In a sale-leaseback, a company sells a property they occupy and control it on a long-term lease. The seller, now tenant, has full control of the real estate for whatever initial lease term and renewal options the company chooses to offer.
Our brokers at Bull Realty have seen an uptick in sale-leaseback transactions. According to CoStar, the sales volume of sale-leaseback transactions in metro Atlanta is on the rise. This year has seen the highest sales volume of sale-leaseback transactions in the past 5 years, topped only by sales volume pre-recession…and the year isn’t over yet!
There is no doubt that many business leaders are looking at the current real estate cycle and realizing this could be a good time to consider a sale-leaseback transaction.
Many analysts are suggesting commercial real estate prices are at the top of the market at this point in the cycle. Rising interest rates and the possibility of changes in the tax code are beginning to cause cap rates to flatten or rise, depending on the location, sector, class and price range. While companies do sale-leasebacks at various points in the cycle, selling in the expansion phase has historically been the best time to sell. Selling at the right point in the cycle may not be the only reason for increased volume of sale-leaseback transactions.
These are some of the other benefits to consider in a sale-leaseback transaction:
- Higher returns – Companies typically earn higher returns investing in their business than returns provided by real estate.
- More equity – Selling the property unleashes 100% of the equity to invest in the business. Financing typically unleashes only 70% to 80% of the equity, and there are refinance costs every three to five years, plus the market risk of loan payoff at maturity.
- No covenants – The absence of a loan removes loan covenant issues for the company. This offers more control of financial decisions by the company and removes the risk of violation of these covenants.
- Flexibility – At the end of the initial lease term, the company can exercise a renewal option or simply leave for a better location. The company does not have to sell a vacant building. Vacant buildings have a much smaller buyer pool and can sometimes be difficult to sell.
- Potential tax advantages – The seller, now tenant, writes off the full lease expense rather than just the interest on a loan and depreciation, which must be recaptured.
- Speed – Priced and marketed appropriately, sale-leasebacks can typically close quickly.
- Selling business – Business sellers may realize greater returns in a merger by selling the real estate to the highest paying investor prior to selling the business. For example, if a business sold at 4 times EBITA, $100K of EBITA would sell for $400,000. In comparison, $100K of NOI at a 7% cap would sell for over $1.4 million. This amounts to a million-dollar reason to consider a sale-leaseback before selling your company. Additionally, separately selling the real estate and business can separate the tax years and reduce the cash outlay for the business buyers, which may increase demand.
While there are many factors that impact value in a sale-leaseback transaction, there are some major themes to consider:
- Rental amount – The higher the rent, the higher the value.
- Length of lease – The longer the initial term of the lease, the more value. For example, a 20-year initial term creates more value than 10 years.
- Strength of tenant – The higher the credit rating and financial strength of the income stream from the tenant, the more value the property will have.
- Rental rate escalations – Rental increases during the term also create more value. For example, a 2% annual rate escalation creates more value than 1% per year.
- Location – The location, demographics, and barrier to entry can all be value factors.
- Age, condition and use – The age of the facility, condition, potential functional obsolescence, and properties suitable for a specific use can impact value.
- Lease language – The more the lease eliminates potential landlord costs or involvement, the higher the value. Most leases are true triple net with the tenant handling all property operating costs.
- Rental rate compared to market – If the offered rent is higher than market rents, the risk of re-leasing can reduce value.
- Market performance – The trends for rental rates, occupancy, absorption and new supply in the market area can impact value.
- Interest rates – The interest rates at which buyers can borrow will impact value.
- Disposition process – The laws of supply and demand impact the value of everything. An effective marketing process can increase value.
Properly structured, a sale-leaseback can be a great tool to increase a company’s returns and value. If we are at the top of the current cycle, it’s possible that you might look back at the low interest rates and this current expansion phase, and say, why didn’t we sell on a sale-leaseback?
Michael Bull, CCIM, is a commercial real estate advisor, broker, trainer, writer, author, speaker
and radio show host. He has closed over 5 billion dollars of sale and lease transactions over his
30 year career.
Subscribe today and get future blog posts your email.