Ben Smith, Vice President, Plante Moran CRESA
Businesses are successful in part by remaining keenly focused on a core product or service offering. This focus includes allocating management time and cash to support and grow the business. Often companies that own their real estate are able to redeploy these resources for additional growth by executing a sale/leaseback strategy.
“Many companies that own real estate are able to generate substantial proceeds through a sale/leaseback,” says Ben Smith, vice president of Plante Moran CRESA.
In addition to monetizing an owned real estate asset to provide cash flow to reinvest in your core business, sale/leasebacks can allow you to devote more time to your business.
“Being a tenant in your building instead of an owner may shift the responsibility of property management to another party,” he says.
Smart Business spoke with Smith and Josh Lanesky, senior associate at Plante Moran CRESA, about who can benefit from sale/leasebacks and how to approach them.
What is a sale leaseback?
A sale leaseback occurs when a business sells a building that it owns and occupies to an outside investor and subsequently enters into a long-term lease agreement with that investor as part of the transaction.
Once any pre-existing debt on the building is retired, the company is able to utilize the sale proceeds to reinvest in its core business or to meet other financial obligations. While this results in an ongoing lease obligation, the return on investment on redeployed capital can often outweigh this cost.
What are the drawbacks?
Because of the dramatic reduction in real estate values that has occurred since 2008, the existing debt on a building may exceed its market value, even with a lease in place. If this is the case, it is not advisable to perform a sale/leaseback transaction until that debt obligation is reduced. There are also instances, particularly in family-owned businesses, whereby the corporate real estate portfolio is held in a separate entity also controlled by the family. Often, this is considered a separate profit center and is used as an estate planning tool.
What kinds of companies qualify to execute a sale/leaseback?
Companies or other organizations with a strong balance sheet and owned real estate are excellent candidates to enter into a sale/leaseback transaction. It is important to note, however, that to successfully execute this strategy, the company must be willing to enter into a long-term lease with the investor purchasing the building.
At a minimum, the financial and risk metrics of the transaction will not be palatable to an investor unless a lease term of at least 10 years is in place. Effectively, these investors are purchasing a stream of future rental payments, so the investment is analyzed based on the overall risk and stability of that future cash flow. Accordingly, investors seek companies with a healthy balance sheet and a proven operating history. This allows for easier leveraged financing for the investment, and supports investor interest in the transaction.
Finally, sale/leaseback transactions often occur as part of a merger or acquisition transaction. If the purchasing company does not desire to acquire the real estate with the business, it will many times conduct a sale/leaseback transaction concurrently with its acquisition of the business.
Why is now a good time to consider this?
The current state of the capital markets is extremely favorable for investors — interest rates are at historic lows, and this low cost of capital allows investors to earn greater returns on leveraged investments such as real estate.
Additionally, many market analysts expect inflation to occur over the next several years. Deploying capital at low interest rates in stable real estate investments allows investors to ‘hedge’ against inflation and protect returns.
Where can a business turn for assistance with a sale leaseback?
Any organization considering a sale leaseback should consult with an independent, professional real estate adviser to ensure that its interests are represented. Your adviser should have the ability to assess the transaction holistically, understanding the perspective of the investor and providing advice as your fiduciary to ensure that the value of the transaction is maximized and the terms are fair. Utilizing this perspective, your adviser can present the investment to a broad marketplace of potential investors to fully leverage a competitive environment and help you identify and select the best offer.
How can a business initiate the process?
The first step is to consult a professional real estate adviser who can help identify the parameters of the transaction and the potential value that could be generated by the sale/leaseback. Together, you can determine the value and impact of the transaction to your business and define the best path forward and implementation strategy. Your adviser will help you gather and review the due diligence items required for the transaction, including financial statements, environmental reports, surveys, historic operating expenses, maintenance records and title work. These items are crucial for investors to review when determining the risk and return associated with doing the deal.
How long does a transaction take to close?
The timing can vary, but typically there is a defined marketing period for the investment, followed by a ‘call to offers.’ This can last from 30 to 60 days. Once offers are reviewed and one is chosen, the investor will require additional time to review due diligence items and arrange financing. This period could be up to 90 days. Once that is complete, if the investor opts to move forward with closing, the transaction should be complete within 30 days.
Ben Smith is vice president of Plante Moran CRESA. Reach him at (248) 223-3275, [email protected] or visit www.pmcresa.com. Josh Lanesky is a senior associate with Plante Moran CRESA. Reach him at (248) 603-5092 or [email protected]
Insights Real Estate is brought to you by Plante Moran CRESA