The Real Estate Sale-Leaseback - Is it The Right Strategy For You?

Why A Real Estate Sale-leaseback Might Be Just the Right Ticket for Your Real Estate Investment Business

Peter Eiseman February 23, 2023

The sale-leaseback is a strategy that is frequently used by both business owners/end-users and real estate investors alike. By the end-user, I’m referring to the actual business entity that operates in the subject real estate.

As the name implies, the sale-leaseback is a two-part transaction involving 1) the sale of the property and 2) the leaseback of the property to the seller for a term anywhere up to 30 years.

The Sellers Side of the Transaction:

The business owner/seller that operates out of the property usually uses this strategy to monetize the value of the real estate. Keep in mind that the seller can also be a real estate investor operating as a landlord. For example, the seller may own a small strip mall with 10-15 different tenants. They can use the sale-leaseback strategy to monetize the property by utilizing the equity in the property without putting another mortgage on it.

They may want to cash out and utilize the funds to grow and scale their business, hire employees, buy equipment, buy advertising, pay down debt, expand to other locations or fund any other needs they might have. They might want to make improvements to the property, make necessary repairs, add some amenities, etc.

If the seller is a real estate investor operating as a landlord, the goal is to profit from the difference they realize from the rent they collect and the rent they pay the new owner. The seller also maintains the right to continue to operate at this location; the only difference being that they are now the tenant, not the owner.

It can be a great alternative to placing another mortgage on the property. The sale-leaseback could provide up to 100% of the equity in the property vs only 60-70% they would realize with a typical bank loan.

The Buyer/Real Estate Investor

The sale-leaseback strategy can be a great tool for real estate investors on the buy side as well. It provides a nice package deal for the buyer with the property and tenant(s) bundled together in one transaction. The buyer doesn’t have to go through the process of finding and vetting all new tenants’ especially if the existing tenants are long-term tenants with a verifiable history of on-time rent payments.

Another great benefit for the investor is the fact that these sale-leasebacks are usually structured as triple-net leases whereby the tenant / business occupying the property pays the taxes, insurance, utilities, and a portion of the maintenance. This provides the buyer with a passive investment and a nice, long–term stream of passive monthly income.

Advantages of Using the Sale-Leaseback Strategy

• Monetize the full value of the property - A sale-leaseback could provide the seller with close to 100% of the appraised value of the property. This compares very favorably with a 60 –70% net cash return they might realize with a refinance.
• Attractive rates compared to other alternative financing options: Other types of financing such as mezzanine & bridge can be expensive. With the sale-leaseback strategy the market rate rental that you would pay could be much less expensive than the monthly payment on a mezzanine loan. Additionally, the rental payment you’d be making would be fully tax deductible unlike the payments you’d be making on a loan where only the interest portion is deductible.
• Free up capital from the real estate to use for more immediate needs: Use the capital from the sale to finance business expansion, other real estate opportunities, business related expenses, reduce other debt, return capital to investors on high interest, short- term loans or hire employees, pay for advertising, etc.
• Negotiable, Fair and Reasonable Terms: In a sale-leaseback the principals can work out fair and reasonable terms that meet the needs of both the buyer and seller. Rental rates can be at or even below market rates. The buy-back price and terms, renewal options as well as the length of the lease can be negotiated. Additionally, the new owner might also provide capital for improvements and ongoing maintenance of the property.
• Potential Disadvantages of a Sale-Leaseback - It’s common knowledge that there are no investments, real estate or otherwise, that are entirely risk free. While there are many advantages to using a sale-leaseback strategy, it’s also important to understand the potential disadvantages as well.
• Tax Consequences - It’s essential to consult with your tax attorney before you engage in any real estate transaction so you can avoid the potential disadvantages that might result from engaging in that transaction. One critical issue to be considered is the potential tax liability associated with the capital gains that you might incur after the sale of your property.
• Control of the Property - Another important thing to consider is the possibility of losing control of the property if you don’t negotiate a triple net lease structure. If you don’t employ the NNN lease structure, you’ll no longer have control of the asset. So, it’s critically important to consider the structure of the lease before signing any contracts.
• Appreciation and Depreciation - Finally, one more important consideration to consider is what you might be giving up when selling the property. You won’t be able to leverage any depreciation benefits. You’ll also be forfeiting any future appreciation unless you’ve put a purchase option in place. If you don’t have a purchase option as part of the transaction you would want to make certain that you engage in an SLB transaction at the top of the market when you could get the highest price for the sale of your property if you’re able to do so.

When Should You Consider a Sale-Leaseback?

How do you know if it’s the right time or right strategy for you? It’s obviously going to be different for every investor and every business. The following points can help you determine if it’s the right time for you to consider this strategy:

1. If you need a capital infusion to grow your business or for any of the other reasons mentioned earlier in this article
2. To improve or save your company from going under
3. If you’re preparing to sell your business, you might want to consider whether selling the real estate separately from the core business will increase the value of the business
4. Recouping funds tied up in the real estate to pay down debt
5. If you are considering selling your business anytime soon. Make sure to consider where you are in the real estate market cycle. Always try to sell at the top of the market whenever possible.

Summary:

A sale-leaseback can be a great strategy for any business owner looking to take advantage of the capital locked up in the actual real estate. It can provide a substantial amount of capital without the limitations of debt financing through a traditional lender.

For the buyer it can be a great strategy for acquiring a quality asset with an already established and proven tenant base. Additionally, there is the potential to become a partner in the business depending on how you structure the transaction.

If you’re considering a sale-leaseback or cash-out refinance for your property or you just have some questions about the process, please reach out to me @ 888.720.2262 or [email protected]?