Sale Leaseback Overview
What is a Sale-leaseback and how could it impact your business? A Sale-Leaseback (SLB) is when an owner of real estate sells their real estate subject to a new long-term lease, and then sells the real estate to an investor. This can have a variety of benefits and uses including providing a means to raise capital for growth, as an effective exit-planning tool, helping improve the balance sheet, and potentially positioning owner for exit of market. If a growing company’s returns on their core business outweighs the returns on real estate deal, then it is generally recommended to sell the real estate and invest in operations. Often terms for a sale-leaseback are preferable to debt financing, especially for a growing company. Many national retailers, fast-food franchises, and medical practices utilize sale-leasebacks to grow their business. A sale-leaseback analysis and comparison to debt financing should be something every executive should review for their business.
- A Sale-Leaseback is when an owner sells their real estate to an investor, and in the same transaction leases the building back from the new owner. Typically, these leases are long-term triple-net leases.
The Four Primary Uses for Sale-Leasebacks
- Financing: Allows for off-balance sheet financing (100% of equity can be made available for investment, as opposed to 75% with traditional financing) and at a lower cost. This can allow for faster growth.
- Improved Returns: Firms may earn a higher return on their primary business rather than in real estate, so they consider moving capital to principal business to expand operations.
- Balance Sheet Improvements: Tool for improving the balance sheet which can be important for exit planning and larger corporations.
- Exit/Repositioning: When a firm determines they want to exit a given market/location, they can execute SLB to cash out of a given asset in advance, and then have 5-10 years to find new location.
Case Study: Exit plan for Medical Office
Hypothetical case study based on real-life business: A local medical practice with an almost 40-year history is determining how to transition from the founders to the two younger partners. The senior partner owns the building. The business is grossing about 3.5M per year. The building has a tax value of 1.4M. What’s the best way for the senior partner to sell the practice and real estate?
The building is a 10,000 SF building. Leased at $18NNN, at an 8% discount rate, that would be a sale value of 2.25M. Likely an investor could do a little better than that, depending on balance sheet. The 180,000 rent payment would be about 5%, which is within the industry standard of 5-7%. The building empty would likely sell for around $160/SF, or about 1.6M.
Executing a sale leaseback could allow the senior partner to cash out of his investment with a lump sum, and finance the business to his partners. The junior partners could also get bank debt to purchase the business and the building, potentially with SBA and competitive terms. Often, the value of a leased asset can be higher than the value an appraiser would put on the building, and higher than the valuation a bank would put on a building. Regardless, the value of the lease to an investor can help the senior partner set a value on the practice.
The Medical Practice engages a commercial broker to create an analysis of the sale leaseback. Working with a commercial lender and business financial planner, the team reviews the past three years’ tax returns, balance sheets, and P&Ls for the practice. With this information, the team generates the analysis. The financial planner gives an analysis of the business sale with and without the real estate. The commercial real estate broker generates an opinion of value for the building itself and its potential value to an investor subject to a long-term lease. Also, the commercial lender can present terms for financing for both the business and the building.
What are your thoughts on SLBs? Have you ever purchased or evaluated a SLB? If you’re a business owner, what have been your considerations regarding SLBs?