Sale Leaseback Strategies and Comparison

3 Replies

Hello All ,

This will be a longer and thorough read, but hopefully the love for this business will make it a shorter read.

I am embarking on my 3rd sale-leaseback transaction in my career and my 5th 1031 (3 were pre-downturn).

This one is slightly different. The scenario is as follows:

California property and transaction.

Current realty:

Owner of building is right in between a colleague, acquaintance, friend, and business partner. (Somewhat complicated but a great relationship)

He Bought the 23k flex building for $4.3m, 10 years ago. It’s appreciated to a market value of $7.1m and both he and I believe it has peaked. Current refi from last week consolidated 3 loans to one with CitiBank; $3,900,000 @ 4.39%. 2% prepayment penalty and not assumable. Pulled $1m out to reinvest into the business.

He would like to continue to pull the appreciated equity out and roll it into a new vehicle. That new vehicle is likely to be a passive, LP position with a very strong sponsor / operator relationship I have where his money could be pulled out or reinvested after 24 months and would achieve roughly a 10% cash on cash return payable in quarterly distributions.

SaleLeaseback Scenario:

High net worth investor relationship of mine would like to buy the building, at the market valuation of; $7,100,000 however LOI / Offer has not been received as of yet.

Current tenant would leaseback the space for a period of 5 years at $1.50 / ft / Mo; 23,500 SF. NNN - I am going to negotiate a cap on the expense pass through for property taxes to mitigate the California prop 13 tax increase; ideally getting very close to what the current tax exposure is.

Commission on the sale from seller is 2% of purchase price. There will be no broker involved in the lease negotiation. It’s a very straight forward lease.

I am working through my model and the keeping the best interest for my client / friend / seller keeps popping in my head. I am close to the situation and want to see him succeed but I may be just overthinking it.

Is this a good deal for my client? His current annual debt service after refi is significantly lower than what his annual lease would be years 1-5 with 3% annual increases.

The 1031 opportunity would allow him to pull out the $2,980,000; $3,200,000 net proceeds - ($78,000 prepay + $142,000 commission). Within this 1031 structure he would reinvest in the LP position talked about above at a, let’s say conservative 10% cash on cash. No Cap Gains.

By my math it’s a good deal for him as he is essentially a wash between his lease rate and his annual distributions from reinvesting the proceeds; no capital gains exposure and has $2.98m working for him at a healthy 10%, and exposure to a sponsor relationship that has tremendous, yet intangible value.

I hope I am clear in this description and am I missing something here? Thank you fellow BP community.

@Tanner Queen , I applaud your creativity with this one.  But there's a couple snafus when you get to the 1031 side of things. 

1. He can't 1031 initially into the LP.  He can only 1031 into deeded interest in real estate.  So unless the LP is willing to go with him as a tenant in common ownership position in the new property that won't work.

2. In order to defer all tax in a 1031 you must purchase at least as much as you sell and you must use all of the proceeds.  That would require him to purchase at least $7.1 mil in real estate and use all $3.2 mil of proceeds in the next purchase.  Unless he is in a strong cash position outside the 1031 that implies that he will need to access some debt on the new property.

@Dave Foster - in the proposed situation he will be deeded interest in the upleg, and the LP will be with him as a TIC. I am working with our attorney to ensure that is truly the case.

The upleg for this 1031 will be roughly a 60M total equity position with about the same amount of debt; i.e. a total cap of $120m and will be using all of the proceeds. 

Thanks @Dave Foster but we aren't there yet! working hard to get there though. Did you have any additional thoughts on the metrics of the deal, outside of the legalities of the 1031? I value your input and am all ears! 

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