How to Execute a Sale-Leaseback Investment Strategy
Investing in real estate is tough. Unlike stocks, bonds or mutual funds you cannot login to your brokerage account and review some reports before making a trade. Real estate investing bears more resemblance to a marathon wherein you have to look at ten’s to hundreds of properties before you can make an investment.
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Real Estate investing can seem overwhelming without the right investment strategy given the sheer amount of time and effort it takes to accomplish that marathon. Without an investment strategy, a real estate investor can feel overwhelmed in choosing between key questions as: where to invest, who to market to, and how to make a profit.
What is an Investment Strategy?
Investors, bloggers and authors speak about having an investment strategy. What is it exactly? According to Investopedia.com, an investment strategy is an investor’s plan of attack to guide their investment decisions based on individual goals, risk tolerance and future needs for capital. Simplifying that further, an investment strategy requires you to think about what your personal risk-reward ratio is and how that functions within your overall real estate portfolio goals.
I typically break real estate investing strategies into the following buckets:
- Timing Investment Strategies:
- Yield Investment Strategies
- High Cap Rate Investing
- Sale-Lease Back Investing
- Tax Lien Investing
- Low Dollar Investment Strategies
- Option Investing
- Seller-Carry Back Investing
- Back-door Investment Strategies
- Judgment Investing
- Mortgage Investing
Over the course of the next few articles, I will be addressing investment strategies that I have personally utilized over the course of my real estate investment tenure. This article we start off with a Yield Investment Strategy of Sale-Lease Back.
What is a Sale- Leaseback Strategy?
A sale-leaseback is a financial transaction in which the owner of a property sells an asset, and then leases it back from the buyer. A sale-and-leaseback is typically seen in a commercial real estate transaction, in which one party sells it’s corporate real estate assets to another party, and then leases the property back at a rental rate and a lease term that is acceptable to the new buyer.
Why would a seller want to enter into a sale-lease back?
The answer to this key question helps you figure out whom to approach so that you can narrow your prospect list better. Based on my research and experience, there are two major motivations that drive a seller to accept a sale-lease back offer:
I. Sellers needs cash from illiquid assets
II. Seller still needs to utilize the asset
These pain points typically exist more for commercial rather than residential owners so keep that in mind as you develop your target-marketing list. I have seen it done in residential transactions where the seller still loves the house and wants to stay there while still needing a lump sum of cash or a monthly cash flow.
What are the benefits to both parties?
Below are the key benefits that a seller can achieve by accepting a sale-lease back offer:
- Illiquid assets become cash.
- Any debt associated with the real estate is removed from the balance sheet.
- Lease payments are deductible as expenses.
Given these typical benefits you want to work with a seller who is financially savvy or works with an advisor who understands these benefits when presenting this offer.
The key benefits to the buyer are as follows:
- Predictable, long-term cash flow associated with lease to the seller.
- Low management requirements as leases are typically NN or NNN in nature.
These key benefits help make this a great investment strategy for passive oriented cash flow investment buyers.
Four Steps to Executing Sale-Lease Back Strategy:
I. Find the seller: Utilize services such as ListSource and Tax Records to create a trade area of sellers who you think would be likely interested in such an offer. I typically look for long term commercial retail asset owners as those types of owners typically have a great blend of the stated pain points.
II. Find the needs: Make sure to find out the needs of the seller before proposing the sale-lease back offer. You want confirmation that the seller needs both: (1) Cash (that one is easy to figure) and (2) Continued use of the space for a long-term basis. You can ascertain the needs by asking open-ended question that begin with: Why do you want to sell, What does your ideal offer look like, How would staying in the space help your wants, etc.
III. Craft the offer: Start with the lease is the best way to craft a sale-lease back purchase offer. Find out what the owner (future tenant) can afford in annual lease payments and their target lease term. Build out the rental income analysis and then finalize your purchase price based on your return needs. Below is an example to help highlight this point:
Owner-Tenant: Wants to pay $50,000 in net rent per year
Buyer-Landlord: Wish to yield 8% on your cash
Target purchase price: $50,000 / 8% = $625,000
IV. Submit the offer: Submit both your purchase and lease contracts when presenting a sale-lease back offer to the seller. As the seller/tenant needs to approve both contracts for the deal to be truly locked up.
The sale-lease back can be a great strategy that can provide long term stable cash flow yield while fulfilling seller needs. What types of asset classes can you apply this strategy towards; would love to hear your thoughts in the comments below.