Commercial real estate transactions do not have to be as straightforward as a sale or lease. In fact, a deal can be a combination of the two to meet the needs of the seller and buyer. An example of this is what’s known as a sale leaseback transaction.
What Happens in a Sale Leaseback Transaction?
In a commercial real estate sale leaseback transaction, there are two things happening at once:
- The property owner is entering into an agreement to sell a property to a buyer, and
- The seller executes a simultaneous agreement to lease that property back from the new owner
Most sale leaseback transactions are for properties like office buildings or warehouses where the current owner is already occupying and using it. Some other common locations where sale leaseback transactions may occur include:
- Industrial facilities
- Restaurants
- Retail and service businesses
- Medical office buildings
By definition, the buyer would be buying a property as an investment and would not intend to occupy it themselves at first. The buyer would also likely hold the property for the long term, either finding a new tenant when the lease runs out or selling it. Some sale leaseback agreements allow the original owner to repurchase the property from the buyer at the conclusion of the lease term.
Owners Have Varying Motivations for a Sale Leaseback Deal
The most common example of a sale leaseback transaction is when an owner has had the property in its possession for many years. It could be a small business that has grown over the years or wants to grow, and the property has increased in value. The business owner may want to remain in the existing location but, for whatever reason, does not want to own the property anymore.
Sale leaseback transactions are popular and common for property owners who want to increase their financial flexibility and still maintain some control over a property. In some cases, property owners are far better off using the proceeds from a sale of their property to fund other acquisitions than seeking financing for those acquisitions. They can often earn a better rate of return when they are able to monetize a property and invest the proceeds elsewhere. Selling the property allows them to stay put while pulling 100% of the equity out of the property. They will not be forced to vacate the premises upon the closing of the deal because the lease will begin to run concurrently.
Sale leasebacks lead to greater liquidity for the property owners. They may have a large part of their assets tied up in the physical building, and they may want to diversify their business or invest in their operations. Some companies may be sitting on a valuable property and may simply not be in the real estate business and want to sell the property to someone else who is.
A sale leaseback transaction allows two parties to agree to a more flexible deal than if they sold the property or leased it to another party. The lease can have different terms than a more standard commercial property agreement. At the same time, the sale agreement can also be customized and could allow the buyer to receive different terms than with standard financing from a financial institution.
Why Buyers Do Sale Leaseback Deals
The buyer of the property also realizes some advantages with this kind of deal. First, having a long-term tenant in place at the time the deal is done helps a buyer begin to generate long-term cash flow immediately. The buyer gets a new asset and an immediate cash flow at the same time. They can also quickly begin to realize some of the tax benefits of property ownership, such as deducting a depreciation expense from their income taxes.
The buyer has less risk because the lease payments should help it make the financing payments on the property. It has a tenant that it knows is stable and with whom it has a business history. From a buyer’s perspective, the longer it has a guaranteed tenant and income flow, the more it may be willing to pay for the property. A tenant who has just received a large cash infusion from selling the property makes for a more creditworthy tenant. A tenant with long-term ties to the building is also likely to take better care of the property and is more likely to stay for a long time. Still, the buyer needs to do extensive due diligence on the credit of the tenant because that is what will dictate the success of this kind of deal.
The buyer is often making a pure play on the real estate market and that particular property. It is getting a package deal that caps some of its downside risk from investing in a property. However, the downside is that it cannot sell the property quickly to another buyer who wants to use the property because it is tied to a long-term lease.
The Lease Attached to a Sale Leaseback Deal
The lease agreement that is attached to this transaction is called a net lease. The tenant, in exchange for a lower lease rate, makes all the operating payments on the property. Net leases provide flexibility for the tenant and reduce some of the administrative burdens that property owners must handle. There are two different types of net leases:
- Bond leases – The tenant must perform all the obligations relating to the leased premises, no matter what. Even if it subleases the property, it remains unconditionally liable for the performance of all tenant obligations. These obligations include taxes, insurance, utilities, maintenance, and other operating expenses.
- Credit leases – Although the tenant performs most of the obligations under the lease, the landlord may be responsible for particular ones.
The robust commercial real estate market has spurred more of these types of deals in recent years. Property owners are sitting on large capital gains from their holdings, and they want to monetize these profits without having to move to new premises. In addition, undervalued real estate on the balance sheet is an invitation for an aggressive offer from a would-be buyer.
However, from a tax perspective, the most advantageous time to sell and lease back the property is when the owner has a capital loss. This way, they can take the capital loss as a deduction on their taxes without having to move.
Before deciding on a sale leaseback deal, both buyers and sellers must extensively review their own situation and do due diligence on the counterparty to make sure the transaction is right for them.
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