Corporations that own their buildings might find it advantageous to lease back their real estate holdings. By deploying a sale-leaseback strategy, capital tied up in real estate can be redirected toward an entity’s core business.
The current investment climate makes this strategy particularly attractive, given the high demand for corporate real estate. “The outlook for corporate real estate, especially properties leased by credit tenants on a long-term basis, looks extremely good now and for the foreseeable future,” says Keith Yearout, a senior associate, investment properties for CB Richard Ellis.
Smart Business spoke with Yearout about sale-leaseback transactions, how companies can benefit from such an arrangement and why the environment for leasing back commercial properties is so favorable right now.
How does the practice of leasing back real estate holdings work?
A sale-leaseback transaction entails the sale of corporate real estate and the simultaneous commitment to a long-term lease, generally 10 years or longer. This strategy allows a company to redeploy the capital that had been tied up in ‘sticks and bricks’ into the core business. You effectively control the property after the sale, and can even retain the right to buy back the property at a pre-agreed price.
How can a company benefit from such an arrangement?
The biggest benefit of a sale-leaseback transaction is the ability to increase a company’s financial flexibility by offloading real estate at attractive price levels and redeploying the proceeds into its core business to yield a higher rate of return than it would otherwise get from owning its real estate.
Another advantage of a sale-leaseback transaction is that it improves the balance sheet by reducing the negative impact of depreciation and interest on your income statement. It also provides off-balance sheet financing, hedges against obsolesence, and may help you avoid or reduce tax liability.
What considerations should be taken into account when deciding if this is a viable strategy?
In determining if a sale-leaseback strategy makes financial sense, a company needs to ask itself the question, ‘Is our corporate rate of return on our core business greater than the yield we get from owning our real estate?’
Due to functional obsolesence, most commercial buildings depreciate in value over time so the sale-leaseback strategy makes sense for many companies though it’s not without risk.
One potential pitfall includes the possible forced relocation at the end of the initial lease term. At the end of a lease without any renewal options, a tenant may be forced to either negotiate an extension at current market rates or relocate. To prevent such a situation, a company should consider employing a long-term lease or ensuring that the initial lease agreement includes renewal options that allow the tenant to renew at pre-determined rates.
What are the first steps that should be taken if a company decides to lease back its real estate?
Once a company decides to explore a sale-leaseback transaction, the first step should be to request a disposition proposal including an ‘opinion of value’ from a commercial broker who specializes in the sale of income-producing real estate. My team at CBRE provides this service free of charge, and the proposal includes a detailed sale-leaseback vs. own analysis. This helps the company to determine if it makes sense to continue to own its real estate or invest capital back into the core business.
In addition to engaging a qualified commercial broker, a company should also consult its tax adviser to make sure that any potential tax liabilities generated from the transaction are fully considered. It is possible to defer a considerable portion of the tax liability, and having a tax adviser on the team with specific knowledge in this area is very beneficial.
How does the current investment environment look for corporate real estate?
We are experiencing an unprecedented amount of liquidity in the investment real estate market resulting in record high prices for corporate real estate. Investors seeking income-producing vehicles are being drawn to corporate real estate due to its ability to provide superior returns compared to treasury bills, municipal bonds, corporate bonds and other income-oriented investments including certificates of deposit. With baby boomers nearing retirement age over the coming years, more investors are shifting from capital accumulation mode and reallocating into income-producing investments. As a result, we currently have more capital chasing corporate real estate than we have product available.
KEITH YEAROUT is a senior associate, investment properties for CB Richard Ellis. Reach him at (513) 369-1334 or firstname.lastname@example.org.