What Is a Sale-Leaseback?

Every profession has its own unique lingo and commercial real estate (CRE) is no exception. CRE is riddled with hyphenated and compound terms that convey concepts in shorthand, and "sale-leaseback" is among one of the most colorful and least understood.

What is a Sale-Leaseback?

A sale-leaseback is a financing option that allows businesses to raise capital by selling a building and leasing it back from the buyer. This arrangement provides businesses with immediate access to cash, while still allowing them to use the building to operate their business.

According to Mark Fornes, president of Mark Fornes Realty, Inc., based in Dayton, Ohio, this transaction is carried out primarily to "raise cash that might be more useful in the operation of the business than tied up in the real estate asset."

How Does it Work?

In a sale-leaseback transaction, the business sells an asset, such as a property or equipment, to a third-party investor. The investor then leases the asset back to the business for a specified period of time. The business makes regular lease payments to the investor, which can be structured to fit their budget and cash flow needs.

Restrictions and Requirements for a Sale-Leaseback

While a sale-leaseback can be a valuable financing option for businesses, there are certain restrictions and requirements that must be met in order to qualify.

Ownership Requirements

One of the primary requirements for a sale-leaseback is that the business must own the equipment outright. This means that the business cannot have any outstanding loans or liens on the equipment, and must have full ownership and control over the asset.

Resale or Auction Value

Another requirement for a sale-leaseback is that the equipment must have a resale or auction value. This means that the equipment must be in good condition and have a market value that can be determined through an appraisal or auction.

Other Requirements

In addition to ownership and resale value, there are other requirements that must be met in order to qualify for a sale-leaseback. These may include:

• The business must have a good credit history and be able to demonstrate a stable financial situation.
• The equipment must be in good condition and have a reasonable lifespan.
• The business must have a clear and enforceable lease agreement in place.

Who Carries Out a Sale-Leaseback?

A sale-leaseback can be undertaken by a small business that owns and works out of just one building or by a large corporation with thousands of employees that owns and occupies numerous properties across many markets. In either case, the overarching objective is to monetize their real estate asset.

With a smaller company, the motivation to initiate a sale-leaseback might be an opportunity to open additional offices or locations. The cash infusion can help fund those efforts and a lease agreement with the new building owner enables the business to continue to operate from its existing location.

For a large company, Larry Fitzgerald, a commercial real estate broker based in Northern Virginia with Newmark Knight Frank, said that the enticement might be the realization that a building "is a non-essential asset and they want to get it off their balance sheet." Instead of having equity tied up in the real estate, the company can create liquidity, reallocate the funds and remain in the building.

Think of this as having your cake and eating it too: you sell your building and take the cash, while avoiding the disruption of relocating your business, thereby remaining easily accessible to clients, employees, suppliers, etc.

Seller Motivations Beyond Cash

For both small and large companies, there are additional reasons beyond financial incentives for initiating a sale-leaseback.

Focus on mission not real estate. In some cases, business operators simply want to get out of the real estate business. Owning, operating and maintaining a real estate asset can be an unnecessary burden, especially for business owners that want to focus exclusively on their company mission. Many do not have the skills, interest or capacity to shovel snow from sidewalks and parking lots; monitor and pay utilities, insurance and taxes; or continuously fix things that break or wear out.

Flexibility. The need for flexibility, either immediately or in the future, is another significant driver of sale-leasebacks. Companies both big and small watch as conditions affecting their businesses change and locations come into or fall out of favor. Leasing space enables companies to expand and contract as necessary.

However, while they won't have the responsibility of managing and maintaining a building, this flexibility will present risks when the lease expires. Rental rates will likely be higher, the space the company wants may not be available, and the hassle of moving could be very disruptive for clients and employees.

Applicable to Retirement as Well as Corporate Strategy

Sale-leasebacks are tools that help companies of all sizes, from entrepreneurial firms with principals preparing for retirement to corporations continuously strategizing and managing their assets.

Lump sum and cash flow. For a small company, this type of transaction typically takes place when a small business, like a law firm or a restaurant, has operated from a building it has owned for many years. The long-time business/building owner wants to continue to operate their business in that location and wants to convert the equity they have accumulated in the asset into cash.

Fitzgerald provided the following example. Consider an entrepreneur that owns both a building and the operating company working in it. She sells her ownership stake in the building to an investor and her operating company rents the property back from the new purchaser. Fitzgerald said, "It's usually a situation where the building ownership wants to monetize the asset. Maybe the person who owns [the building and the company] is approaching retirement," so she wants to monetize the physical asset to get a lump sum for retirement, but retain ownership of the operating company, to maintain an income stream.

Corporate strategy and mitigating risks. A sale-leaseback can be part of a larger corporate real estate strategy that completely rearranges a real estate portfolio by disposing, acquiring and leasing assets in markets across the globe. Some large business owners initiate sale-leasebacks, occasionally or on an ongoing basis, as part of an overall real estate approach that enables them to modify their real estate portfolio as business needs change.

Corporate real estate divisions are charged with following economic and employment trends so they can readily access skilled workers, raw materials or other resources that are necessary for a company to function. They are also expected to follow real estate market conditions so they can optimize when to enter, renew or exit a market and sale-leasebacks are tools that help them do this. Timing a building purchase, sale or lease agreement perfectly is nearly impossible, but selling a building and leasing it back years in advance of a planned departure mitigates the risks associated with selling in future unknown market or economic conditions.

Key Conditions for a Purchaser

What makes a sale-leaseback attractive to a purchaser? Fornes identified four characteristics that are fundamental to virtually any real estate purchase. He stated that apart from appropriate cashflow, the purchaser is looking for a long-term lease, a creditworthy tenant, a flexible and reusable real estate asset and a solid location.

Length of lease. "The longer the lease the more a purchaser will pay for a property," he said. A longer lease means expenses such as legal fees, broker commissions and buildout allowances can be spread out over a longer period, and the costs and time involved in executing short-term leases or renewals can be avoided. Fornes emphasized that "usually you need at least seven, preferably ten years, for a purchaser to be interested in purchasing a sale-leaseback."

Creditworthy tenant. A creditworthy tenant is essential for a sale-leaseback. A strong credit tenant is more likely to pay rent on time, avoid bankruptcy, and see the lease through to the end of the term. In a sale-leaseback negotiation, strong credit tenants may also negotiate concessions such as free rent and tenant improvement allowances.

Purchasers must also consider the building's reusability. As Fornes noted, "if a tenant leaves, is the building fairly reusable without spending considerable amounts of money to refit and refurbish it?" A building that is easily reusable is more valuable to a purchaser.

Location. There is also the age-old consideration of location. Fornes said, "location will drive the reusability and the velocity of finding another tenant or selling the asset."

For both buyers and sellers, a sale-leaseback transaction presents unique opportunities, as well as possible complications. In an ideal scenario, though, it creates liquidity and fosters flexibility for business owners, while enabling them to focus on their core mission. Simultaneously, it provides property owners with a new asset that features an existing rental income stream and a long-term dedicated tenant.

Understanding the Difference Between a Line of Credit and a Sale-Leaseback

When it comes to financing options, businesses often have to choose between a line of credit (LOC) and a sale-leaseback. While both options provide access to capital, they have distinct differences that can impact a business's financial situation.

Line of Credit (LOC)

A line of credit is a type of loan that allows a business to borrow funds up to a predetermined limit. The loan is typically secured by short-term assets, such as accounts receivable or inventory, and has a variable interest rate. This means that the interest rate can fluctuate based on market conditions.

Key DifferencesKey Differences

• Security: A LOC is typically secured by short-term assets, while a sale-leaseback is secured by long-term assets.
• Interest Rate: A LOC has a variable interest rate, while a sale-leaseback has a fixed interest rate.
• Flexibility: A LOC provides more flexibility in terms of borrowing and repayment, while a sale-leaseback provides more flexibility in terms of using the asset.

While both LOCs and sale-leasebacks provide access to capital, they have distinct differences that can impact a business's financial situation. Businesses should carefully consider their options and choose the financing solution that best fits their needs.

This article was updated on 7/23/2024