A sale-leaseback is a transaction that separates a business’ real estate from the business operations. It converts an illiquid, long-term asset into immediate working capital. The process involves an owner-occupier of a building selling the property to a new owner. The seller then leases back the space so they can continue operating in it. The end result is that the seller becomes a tenant of the property. In this article, we’ll look in-depth at what’s involved in performing a sale-leaseback, why you might consider one, and go through an example to help solidify the concepts.
What Are The Steps Involved?
1. Put together the right team. The people you choose to help execute a sale-leaseback can be critical to its success. You should look for an experienced team who is aware of any potential pitfalls. This team is made up of an attorney and realtor/broker. Your realtor should have a large enough network that they are able to find several potential (national) buyers. Using a realtor who has a smaller network, such as a local realtor, may lower the probability of finding a buyer in a timely manner.
2. Create an offer. Working with your team, put together what you expect the potential lease to look like. This provides concrete numbers for the buyer to evaluate the potential of the offer. The following is an example, at a high level, of what an offer might look like:
- Tenant: $60,000 per year in rent maximum.
- Buyer: 8.5% yield maximum.
- Potential sale price: $60,000 / 8.5% = $705,900.
3. Submit your offer. Submit the details of your lease and purchase price to the potential buyer.
Why Should I Do A Sale-Leaseback?
There are a number of reasons to consider a sale-leaseback. Below are just a few:
- Raise operating capital. Immediately convert a long-term, illiquid asset into working capital.
- Replace a fixed asset (real estate) with a current asset (proceeds from the sale). This increases your current ratio, which can help when borrowing future funds.
- Separate business operating activities from real estate.
- Reduce debt and liabilities. The business’ mortgage (liability) is converted to an operating lease, which is an off balance sheet transaction.
- Deduct full lease payments instead of partial deductions that come with ownership (i.e., depreciation and interest-only expenses).
- Eliminate operating (loan) covenants. Breaking a loan covenant can mean defaulting. Leases don’t have such covenants.
- Mirror ownership by deciding your lease terms: triple net (NNN), long-term (10yr+), short-term, right of first refusal, or right to purchase.
Examples Of A Sale-Leaseback
Let’s look at an example of a sale-leaseback.
Bob is the owner of Bob’s Accounting and owns the building that his practice is working out of. Bob decides that a sale-leaseback is the best way for him to free up the capital he needs while still being able to run his practice out of the building.
Bob enters into an agreement with AAA Holdings to sell his building for $900,000. Accumulated depreciation on the property is $400,000, and the building has a market value of $1 million. Part of Bob’s agreement is that he will lease the building for 10 years at an annual rate of $72,000. Here’s a summary of the transaction:
- Market value of property: $1 million
- Proceeds to seller/lessee: $900,000
- Annual lease: $72,000
- Total lease payments: $720,000
- Lessor/Landlord annual yield on property: 8%
As with all investments, there are potential risks that an investor should evaluate before pursuing a sale-leaseback. However, all things considered, a sale-leaseback can be a great way to free up long-term capital by converting it to working capital. You remove the need to keep up maintenance on the property (depending on the lease type) and can deduct all lease payments. Putting together an experienced team to complete the transaction will help to ensure a higher probability of success with fewer issues.
Examples presented are hypothetical and for illustrative purposes only. Actual results may vary and be more or less favorable than those illustrated. This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.
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