The topic of sale/leaseback is back in vogue after spending the last few years in limbo. A tool companies can use to raise capital to finance growth, sale/leaseback can even help companies get out of debt.
“It tends to work well in environments where you have investors actively looking for property and businesses doing well,” says Alec Pacella, a senior vice president at NAI Daus. “There should be an active pool of investors on one side and companies that are doing well and have prospects for doing even better if they can get an injection of capital on the other side.”
Smart Business spoke with Pacella about the process of selling property and leasing it back — and how it can be a win-win for both parties.
What is attractive about a sale/leaseback?
The investor gets a good piece of real estate with a good, growing company. The company gets to access capital at basically little or no cost, unlock the real estate capital and reinvest the proceeds into its business. Then it can earn a substantially higher return on that capital versus having locked-in real estate and earning little.
It is an opportunity to acquire real estate as a long-term lease with a long-term tenant in place. But because there is usually only one tenant, it’s an indirect investment into the company. If a company goes bankrupt, then the investor has an empty building.
On the investor side, what types of concerns should be examined?
An investor has to avoid paying either under market or over market for either the purchase or the leaseback. The more the tenant is willing to pay in rent, the higher the value of the real estate.
Let’s say it is only a $5 market and the tenant is paying $8 in rent. That is probably not the best situation. If the tenant does happen to leave, it’s important for the rent to be near what the market is bearing.
Another factor for an investor to consider is whether the property is a specialty building. Maybe it is a facility with heavy power demands and low ceilings, so it is not generic. That’s good in some ways because then the company is tied to it. It would be hard to replicate that somewhere else.
If, however, that tenant does happen to move or has to downsize and that building comes back to the investor vacant, it may be a challenge to find another tenant.
What are some issues as far as the tenant is concerned?
The first is that the tenant (the former owner) is losing control of the building. The tenant can’t make alterations or expansions without getting the consent of the landlord.
When the tenant has a high-quality image, there should be teeth in the lease that the desired property image will be maintained.
The second concern is that once a company sells its property and leases it back, it loses control of its destiny. The company is in that building until the lease is up. There is nothing to stop the landlord from not renewing the lease.
What is a reasonable time for a lease in a sale/leaseback situation?
Sometimes there are shorter terms, such as five years, but usually for investors that is a red flag, prompting the question of why the landlord won’t extend it.
Seven years is about the least amount of time to reasonably consider. Ten or 12 years is a more common length. Some leases are for 15 years but that is a long time. The tenant may start having problems as that lease nears its end.
Are there any issues relating to the proceeds from a sale/leaseback?
Sometimes it may be a substantial influx of capital. The investors will want to know how the capital will be spent. After all, they are indirect investors in the business. A lot of private companies have a hard time with transparency, so they should be prepared for that issue. ●
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