What is a Sale Leaseback?
Have you ever wondered what the definition of a sale leaseback is or how your business might benefit from one? If you have an operating business that owns real estate, then a sale leaseback could be a welcome option when you’re ready to raise capital for business growth, to pay down debt, or to sell real your real estate due to a business sale.
Overview
A sale leaseback in commercial real estate, also known as a “leaseback”, is a useful and creative way for operating businesses to raise capital quickly by unlocking the value they have built up in their own real estate. The business owner would start by selling their real estate to an investor and then immediately lease the real estate back from the new owner at mutually agreed terms. The business would continue to operate just like before, but they would now be the “lessee” (aka, tenant) of the property, and the buyer would be the “lessor” (aka, landlord). Businesses might choose a leaseback real estate transaction for many reasons.
Here are the top reasons why you might choose a commercial sale leaseback on your real estate:
- Your businesses is expanding and needs capital to open new locations
- Your business needs to restructure the balance sheet by freeing up the equity tied to their real estate.
- When your business is sold, you or the new business owner might want to unlock real estate equity tied to the real estate for various reasons.
To break it down, the simplest sales leaseback definition is this: a business sells their real estate and leases it back from a new owner. This way, they get access to funds and also continue to use the real estate assets just like before. A sale leaseback is typically done with commercial real estate, but there are examples where a homeowner in a residential property would be motivated to sell and then leaseback their home to an investor. But, this is fairly uncommon as homeowners have many popular options for freeing up equity in their home, such as a HELOC or traditional mortgage.
Advantages of a Sale Leaseback
If you operate a business that also owns real estate assets, there are many great advantages to pursuing a sale leaseback transaction. There are also some disadvantages too, so it’s important to understand what your business goals are, and these goals will help determine whether a sale leaseback is right for you.
In order to clearly lay out the main real estate sale leaseback benefits, here are the advantages for both the lessee/seller and lessor/buyer.
Advantages of a sale leaseback for the lessee/seller
- You could quickly unlock 100% of any equity that’s “stored” in your real estate to help grow your business faster or pay down debt.
- You decrease your overall operational risk when you no longer own the real estate and that risk now sits with the new owner
- You can improve the health of your business balance sheet by trading your mortgage (liability) for an asset (cash) and improving your debt-to-equity ratio.
- You could realize the tax benefit of being able to deduct the monthly rent payment on your taxes.
Advantages of a sale leaseback for the lessor/buyer
- You get a longterm lease that is guaranteed by the tenant business
- You get a consistent and predictable stream of income for a long period of time
- You get a fair return on your invested capital
As you can see from these benefits, a sale leaseback can be a truly win-win scenario for both the seller operating businesses and the buyer investors alike. While there are many details that both parties need to agree on, such as the lease length, monthly payments, etc, the sale leaseback transaction provides many advantages and is a useful tool you should consider if you are looking to raise capital quickly for your operating business.
Ready to unlock your real estate equity?
We give you a quick and simple offer for your real estate.
Sale Leaseback Risks
Like all transactions, there is always some risk involved and you should be aware of the common sale leaseback risks that could affect both the seller and buyer. These risks can usually be assessed and mitigated during the due-diligence phase so that both parties can be prepared to wisely complete their sale leaseback transaction.
Risks of a sale leaseback to the seller/lessee
- You could have a new investor/landlord that’s difficult to work with
- You give up the future appreciation in your real estate
Risks of a sale leaseback for the buyer/lessor
- The business could default on their lease agreement forcing an eviction
- The tenant business is in control of the real estate and could start using it in an unauthorized way.
While there are many considerations for both the seller/lessee and buyer/lessor, these common risks can be mitigated by each party before entering into an agreement. For example, if you are a business that is considering selling your real estate and immediately leasing it back, it would be worth your time to get to know who the investor truly is first and even talk to other tenants of the investor to get a clearer picture of how they will be as your new landlord.
For the buyer/investor, it is important to mitigate these risks by understanding the business who will become the tenant. Investors will want to know the strength of the business in terms of the following:
- Is the tenant business growing or shrinking?
- What is the gross revenue of the business for the past few years?
- What entity will be guaranteeing the lease and what is their creditworthiness?
Sale Leaseback Examples
While there are many sale leaseback examples, here are a few that should give you a clearer picture of why a business would choose to do a sale leaseback with their commercial real estate.
Example: Business Expansion
Ray owns three locations of a fast food franchise in Texas. He was offered an opportunity to purchase two nearby locations as the current owner is retiring. Ray researched what it would take to finance the purchase of the two new locations and realized that he would be able to purchase both locations without financing if he simply sold the real estate from his three current restaurants, freeing up the capital he has built up over the years. This allows him to purchase the new locations without taking on any new debt and actually improves his balance sheet in the process. He came to an agreement with an investor and sold his real estate while immediately signing a 15 year lease to remain and continue to operate his initial three locations. He was able to use the cash from the sale to expand from three to five locations all without taking on new debt.
Example: Shareholder Liquidity
Patrick now runs his family’s multi-generational manufacturing business in Ohio. The business needed new equipment and the family wanted to unlock the equity they had built up in the industrial property portfolio that they have owned for decades. They realized that by selling to an investor in a sale leaseback arrangement, they could both improve their balance sheet health, buy the new equipment, and buy out the recently retired management. Patrick identified an investor who was interested and was able to sell their property portfolio, receive the cash, and sign a 20 year lease with the investor all within 60 days. The key shareholders were happy with the outcome and the investor they sold to now has a stable real estate investment guaranteed by a leading manufacturing company.
Example 3: Debt Restructuring
A national private equity company just purchased a successful aerospace manufacturing business that has real estate located in multiple Midwestern states. The business that was being acquired owned all of its own real estate and this value was included in the acquisition. Once the sale was complete, the new management group pursued a sale leaseback on the portfolio of industrial properties in order to pay down the company debt and improve the overall health of the company as they moved forward on their plan to take the company public within a few years. They found an investor group to purchase the industrial portfolio and agreed to a long term 20 year lease.
Hopefully, these three examples give you a clearer picture into why a business would consider a sale leaseback to unlocking real estate equity.
Leaseback Agreement
While the sale of the real estate is the first half of a of the transaction, the leaseback agreement itself is equally important to both the seller/lessee and the buyer/lessor. The primary concerns in the leaseback agreement itself are the lease length, and the amount of the monthly lease payments. You can use a sale leaseback calculator to understand how the sale price and the lease length and payment amounts are related. Typically both parties start their negotiation by using a standard leaseback agreement template that includes the primary elements of duration and monthly payments, but the agreement also has many other important details related to the responsibility of each party.
Here’s a partial list of elements any leaseback agreement should have:
- Length of lease in months
- Monthly lease payment amount
- Lease renewal options
- Lease payment increases and related timing
- Entity that is guaranteeing the lease
- Consequences in the case of a late lease payment or default on lease
- Management responsibility breakdown of various elements (Insurance, taxes, maintenance, improvements, etc.)
Sale Leaseback Accounting
When considering a sale leaseback, both the seller/lessee and the buyer/lessor should be generally aware of how sale leaseback accounting works. Most sale leaseback transactions are considered just like a traditional sale of real estate, though since there is also a new lease being signed by the seller, the sale leaseback accounting treatment for both parties is more in line with how a “financing” transaction is accounted for. Simply put, the sale leaseback transaction should be treated in a similar way as if the buyer was providing financing to the seller.
The first thing that accountants for both parties will try to determine is:
- Was the sale of the real estate priced at “Fair market value”?
- If the sale price was not at fair market value, then what is the difference between the sale price and the fair market value?
1. In the case that the sale price is higher than fair market value, then the seller/lessee would record this difference as additional financing from the buyer/lessor and would adjust the interest rate on their related booked liability.
2. If the sale price is lower than fair market value, then the difference should be recorded as a “rent prepayment”.
There are other scenarios where the sale leaseback cannot be considered a traditional “sale” and the above accounting treatment won’t apply. One such case is when there is a provision in the transaction that gives the seller/lessee an option to “buy back” the real estate at a later date. You should always consult a CPA to understand how the accounting will work in each scenario as each will have its own unique sale leaseback tax implications. for a deeper dive into the tax implications, check out this article from the Journal of Accountancy.
Sale Leaseback Companies
While there are plenty of commercial real estate brokers who would offer to help when you are ready to think through a sale leaseback, there are actually few that focus specifically on being only sale leaseback companies. These select few companies, like SaleLeaseback.co work directly with operating businesses to buy real estate directly from business owners, skipping the hassle of finding and paying a broker for this same service. These specialized companies are essentially niche sale leaseback investors who have dedicated their career to knowing the options, examples, and potential pitfalls associated with a sale leaseback transaction. So, if you are considering a sale leaseback to raise funds for your business, it could benefit you to work directly with a company that specializes in commercial real estate leasebacks.
