Any business, no matter what the economic cycle or stage of growth the company is in, is looking for ways to free up capital and increase flexibility.
“Any business that owns real estate should evaluate a corporate sale lease-back transaction as an efficient means to accomplish some or all of these objectives,” says Patrick Shannon, vice president of the Investment Group at Grubb & Ellis in Detroit.
The economy is still in a state of near-recession, so investors are looking to diversify their portfolios. Commercial real estate is an asset class that more and more investors have gravitated to over the last 10 years.
“There are still far more investors in the commercial real estate arena than there were 10 years ago,” Shannon says. “Corporate sale leasebacks are attractive options to real estate buyers because of the immediate cash flow and long-term value of real estate. Businesses, meanwhile, are open to corporate sale lease-backs because they are a commonly accepted and economically efficient means to raise capital.”
Smart Business talked to Shannon about the benefits and drawbacks to a sale leaseback agreement.
What exactly is a corporate real estate sale leaseback?
In its simplest form, a sale leaseback is a financial transaction whereby a company sells its real estate to an investor, who then leases the property back to the seller. Typically, the leaseback term is for a period of 10 to 20 years and is structured under a triple net lease.
How are that and other sale leaseback terms determined?
The two most significant negotiable factors of the sale leaseback transaction are the price and the rental rate. Factors that influence price and rental rate include the market rent and values, comparable sales, the tenant’s creditworthiness and the length of the lease term. The longer the lease term, the more the pricing becomes influenced by the credit of the tenant. The shorter the lease term, the more influence market value and market rent will have on the property.
With many variables subject to negotiation and market influence, it is important to fully comprehend the ‘big picture’ of the deal structure to ultimately negotiate terms most favorable to you.
What are the benefits of a corporate sale leaseback?
The sale leaseback turns noncore assets into investment capital. The transaction is essentially an alternative financing method that provides up to 100 percent of value, whereas other financing methods may have a threshold of less than 100 percent of value.
What are some of the drawbacks?
From the buyer’s perspective, there are obvious risks. The tenant can choose to leave the building, the tenant might not maintain the building to marketable standards, or the tenant might go into default on the lease. But all of those factors are examined before the agreement is signed, and their risk is priced accordingly.
From a corporation’s perspective the seller’s perspective one risk is that you might grow out of the property, but owning the property wouldn’t change that. If real estate values jump, then there could be seller remorse. Real estate values could go south, too, making a sale lease-back an even better strategy.
Other risks include a lease that may limit your ability to make structural improvements and reaching the end of the lease’s term without renewal options.
What about timing? Would it be better to do a sale leaseback now or wait until the market improves?
A business argument can be made for doing it now. You want to put all your money into the core business to yield the largest return possible. That’s a good decision at any time. The cash proceeds from the sale may not be as great, but the return on your business investment might well be better.
The current market is tending to lengthen lease terms. That gives the buyer more stability, but if you’re looking for a longer term anyway, such an arrangement could serve your needs.
Experienced real estate agents can help clients understand those factors based upon their experience. They can judge how the market can perceive each of those items and reasonably estimate expected proceeds based on various sale leaseback terms.
PATRICK SHANNON is vice president of Grubb & Ellis Company’s Detroit Investment Group. Reach him at (248) 357-6593 or email@example.com.