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.
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.
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.
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.