The Four Primary Uses of Sale-Leasebacks

 

Today we’ll be discussing the four primary uses of sale leasebacks: Financing, Improved Returns, Balance Sheet Improvements, and Exit/Repositioning.  

 

The Four Primary Uses for Sale-Leasebacks

  1. 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
  2. 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
  3. Balance Sheet Improvements: Tool for improving the balance sheet which can be important for exit planning and larger corporations
  4. 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.

Financing

Sale-leasebacks are a popular means for companies to fuel growth by moving capital out of real estate and into their principal business.  Often, releasing capital in real estate is more affordable and has better terms than bank financing.  With bank financing, you may only be able to release 75-80% of the equity in your real estate, and that loan will likely come with a 3-year balloon payment.  And often the appraised value of the building is the value of the vacant building.  With a Sale-leaseback, a business owner can tap into 100% of the equity in the real estate, with no balloon payment, and often the value of the NNN lease to an investor is higher than the appraised value of the empty building (depending on the owner’s creditworthiness and balance sheet).  Also, a risk of bank financing is that if the appraised value falls below the agreed-upon LTV, the loan is in default and immediately called (think 2008).  The sale-leaseback puts the market risk on the new owner.

Improved Returns

If the returns from a company’s principal business are higher than the returns on the real estate, it often makes sense to move equity out of real estate and invest it in the company’s core business.  The goal is always to maximize return.  For example, if the business is able to gain a 20% return from day-to-day operations, and the ownership of the real estate where the business resides is only netting an 8% return, returns would increase if the business could divest of the real estate to allow for greater investment in the core business.  Through the signing of a long-term lease, the real estate can be sold, the business remains in operation in its current location, and operations could conceivably be expanded with the opening of a new location or other operational expansion. 

Balance Sheet Improvements

As a seller looks to exit their business, it can become important to improve financial statements.  With this strategy, the seller replaces a fixed asset with a current asset. This increases the current ratio (current assets/current liabilities).  Sometimes referred to as the Working Capital Ratio, investors see this as an indication a company’s ability to service its short-term debt. 

Exit/Repositioning

A Sale-leaseback can be a useful tool for a business that knows it wants to move from a given location into another market or trade area in the future.  It can also be a means to exit from an overly specialized or obsolete building.  An example could be a prison or a hospital, or a retailer realizing that growth is moving in a given direction and determining that in 10 years it will move to follow growth, or that they will centralize their operations in a new building. 

 

What are your thoughts on SLBs?  Have you ever performed one?  As a growth plan, have you evaluated a SLB?  What are pros and cons in your opinion?  We’d love to hear from you.  Please comment below, share with friends, and thanks for reading! 

 

Sale Leaseback Overview and Medical Office Case Study

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. 

 

The Definition

  • 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

  1. 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.
  2. 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.
  3. Balance Sheet Improvements: Tool for improving the balance sheet which can be important for exit planning and larger corporations.
  4. 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?

Augusta Medical Office Building Market Report

 

This is Jonathan Aceves wth Meybohm Commerical here with a brief update on the Medical office market. Click here to download the Report.  

 

Overall, well-located and in good condition, medical office space in Augusta is leasing for around $18/SF, and selling for around $150/SF.  As expected, offices in Evans commanded a premium (around $200/SF), and offices around Trinity sold at a discount ($120/SF).  This is slightly higher than standard office space, and tends to be clustered around hospital facilities:  University, Doctors, AU Health, and Trinity(University Hospital Summerville)

 

One outlier that we see is with the rise of Urgent and Prompt Care clinics, which tend to lease in line with NNN leased retail space.  We are seeing them leasing at around $30/SF NNN and trading at corporately-guaranteed retail cap rates. There has definitely been a rise in Medical/Dental/Physical Therapy providers taking space in shopping centers and even developing practices on retail out-parcels.  The impact is that these lease rates fall in line with their competitors for these spaces.  

 

POB Buildings.  The POB buildings are a good milestone–what would it cost a physician to locate inside the hospital complex, with a full-service lease?  Asking rates there tend to be around $25/SF Full Service, potentially you could lease space there between $20-21/SF.  If we back out the full-service items, it’s a helpful comparison.  That might get us to a rate around 18/SF. 

 

Renovation of office buildings.  Another helpful number is what would it cost a physician or dentist to purchase a 4000 SF building and convert it to a medical practice?  Our guess is that in good condition, it would cost around $25/SF. so in theory an office building could be purchased and 100-150K invested in it to make the conversion.  Alternatively, an office could be leased, and the improvements amortized into the rent, which would equate to 4-5/SF/YR on the rate.  At those numbers, it is slightly more cost-efficient to lease or purchase an existing medical office than to convert an office building into a  practice (which makes sense).  

 

On a related note, we are seeing a large demand for purchase of NNN leased medical office space.  If you own a practice and the real estate, it may be a great retirement planning tool to investigate the value of leasing back the building and selling the real estate.   Also if you are selling your practice or looking towards retirement, it might be a good idea to sell the practice along with a  lease on the building, and then sell the leased building. That may be a great way to cash out of your investment and give your new partners a fixed and budgetable cost.

 

Notable Sale:

Augusta GYN sold their building earlier this year to University Hospital.  

 

Notable Lease:  

Pruitt Health.  12.60/FT, Modified Gross.  1220 Augusta West Parkway.  

 

Thanks for reading!  Please let us know your thoughts on the market for medical office buildings.  What are you seeing?  What’s your experience been?