Corporate-tenant lease-back properties

18 Replies

In the commercial arena I've been seeing many listings for corporate-owed properties with lease-backs. I'm curious why a corporation would want to sell-off their property and loose control of both their rent and an appreciating asset on their books? As a buyer, it's tempting as you have a well established tenant with corporate backing, and a NNN lease. But something about it almost seems like a sucker's bet. If the property is so valuable, why wouldn't the corporation hold on to it? Granted as with any property purchase there are many variables to consider that would make a good deal vs. a bad deal (solvency of the corporation, strength of the lease, remaining term, renewal options, ease of re-purposing / placing new tenant, etc). However I'm curious to hear the 10,000 ft view on this asset class from fellow BPers.

I think I have seen this with it being a Lease-Back Option. It's a way to gain liquidity when needed, and whoever has the liquidity has the asset security in the event the corp isn't able to generate the growth they needed and also gain the financing to rebuy the property.

I am speaking from a place with little to no expertise .... So take that with a heaping grain of salt. 

I came across this while searching for information on Master Leasing a commercial complex, and the discount off of the going rental rate I should be looking for. 

Sale leasebacks are extremely common in commercial real estate. As a broker, they’re my favorite deals to do. 

The reason a company would execute a sale leaseback is because it creates a cash-out event. A company could want that cash for any number of reasons. Get the mortgage off their books, pay down other debt, use the equity for business expansion, etc. It could also be because business is bad and they need the cash to stay afloat. As a buyer, figuring out why this company is wanting to execute a sale leaseback will be an important part of your due diligence. 

Remember, not every company wants to own real estate. And not every company operates like a real estate investor. If your core business has nothing to do with real estate, then your equity and cash is usually better spent on your core business activities. Why would I want $1 million in equity in a building I own when I can use that cash to increase my revenue? It’s all about cost benefit analysis. 

@Cason Acor I would also add that a sale leaseback also offers the seller freedom to do with the proceeds as they choose, whereas a bank loan pulling equity would impose covenants on the borrower that restrict what they could do with the funds.

In effect a sale leaseback just another kind of financing. (I’m an LP and this was the best way to describe it in my opinion).

@Cason Acor Great points, thank you. Selling the property indeed gives instant cash for the investor/business owner/corporation to re-deploy elsewhere. All the while they are able to keep their current business going as a continuing source of cash flow, and as their main core focus.  

@Evan Loader Another great point. I didn't think about it in terms of "unrestricted financing" as compared to re-financing through a commercial bank or opening an LOC against it. Given the significant difference in underwriting (more daunting) for commercial loans as compared to residential, strategies to avoid going through it would definitely be worth while.

@Will Kenner There are other reasons owners choose to do a sale-leaseback. Sometimes it is a result of ignorance and sometimes it is due to their CPA/tax professional’s lack of knowledge. An owner-occupant in the first year of buying their building can “group” the building with their business and make both “active”. By doing this, the excess paper losses created by an engineering-based cost segregation on the building can be used to offset business gains. This reduces taxes owed and gives the owner an influx of cash they would have spent on federal and state taxes. This is a specialty area of tax law.

@Will Kenner Hey Will. Here is some info I have written on the topic....

To some extent, every established business owner is familiar with the concept of raising capital. From the more common ways to achieve an influx of cash are bootstrapping, crowdfunding, and you guessed it, good old conventional financing. If these concepts sound mundane and unappealing, you would not be alone in that assertion. However, there is a much more attractive alternative that I believe is significantly less pronounced and can be simultaneously more lucrative. If you have owned the facility in which your business operates for a fairly long period of time, it is likely that you have built up a considerable amount of equity from which you can execute a sale leaseback strategy.

So, what exactly is a sale lease back? A sale leaseback is a transaction in which an owner occupant sells their current location to an investor, and at the same time forms a lease to lease the space back from the new owner. For clarity, let’s use a quick example. Danielle is the owner of a successful company that manufactures 3D printing materials and supplies. She has owned the Industrial warehouse in which her business operates for the past ten years and her property has appreciated significantly over that time due to the rising appeal of Industrial real estate as an investment. Now, Danielle does not want to pick up and go to an entirely new location but she is interested in tapping into the equity she has in the property and what that injection in capital could mean for her business. In this situation, Danielle can sell her property to an investor, who agrees to lease the space back to Danielle at agreed upon terms. This allows Danielle to receive the cash from her ownership position and still continue to operate the business in the same location virtually uninterrupted.

How does the user benefit from a sale leaseback transaction? Let me count the ways. Essentially, through performing a sale lease back the user is able to not only convert their illiquid asset (real estate) into cash but is also privy to maintain their usage of the property. To add, in this situation the user avoids other more expensive forms of raising capital like conventional financing which shows up on the businesses balance sheet as a primary liability. In the same vein, if you are at a stage in your career where you are looking at a viable exit strategy, a less commonly known fact is that it is much more desirable to sell your real estate prior to you selling your business. Conducting your liquidation sequentially allows you to reap the maximum sale proceeds of each. To elucidate, your business and real estate are both taxed differently and it has been my experience that in these situations one is often forced to artificially lower the value of either to mitigate the tax impact on sale. 

Last but not least, it is very plausible that you could be receiving higher returns in your day to day business and unleashing this tied up cash can free up just the capital you need for expansion of operations.
Why would an investor decide to enter into a sale leaseback transaction? I’m sure any savvy investor reading this is thinking, “Why not”? What could be better than purchasing a cash flowing piece of real estate with a long-term tenant already in place? The tenant is obviously sold on the location, otherwise they wouldn’t have any desire to lease it back. There is no need to sell the tenant on the plethora of virtues of the facility or negotiate major TI’s. To add, it is highly likely that the tenant will be low management intensive since they have an established track record of ownership and perhaps even a non-tangible attachment to the property.

To conclude, a sale leaseback can be an optimal solution for both a business owner and commercial real estate investor. This strategy can not only provide a viable alternative to more expensive and less convenient ways to raise capital but can also open a pathway for your business to continue to grow and flourish. It is pertinent for me to mention that one of the biggest factors to quantify when considering a sale lease back is your tax impact on sale. Consulting a commercial real estate practitioner as well as a CPA will allow you properly evaluate your adjusted basis in the property so as to know whether you will have a positive gain on sale or the proceeds will be in the negative. During the disposition phase of ownership, the owner of commercial real estate has many options, one of them being a sale leaseback and it is critical to your business to ensure you are choosing the alternative that best fits your desired outcome.

Putting my lawyer hat on here (I've never done one as an investor), but I would exercise caution.  I agree with Cason Acor that every situation is different and needs to be evaluated individually.  But it seems, based only on my experience, the seller's business is usually in some sort of distress.  Growing businesses will have an array of options to extract the equity from the real estate.  Middle and small market business lenders of all shapes and sizes are very eager to extend credit to growing businesses and let them lever up their real estate to fund growth.  And if they are growing, there is some risk they may outgrow the building entirely.  

If you are going to do it, a couple techniques to mitigate the risk.  If it is a small to midsize local/regional business, try to get the principals of tenant to personally guaranty the lease.  You should try to get this anyway up to a certain level, but if there is any pushback on that front, that may be an indication of what shape the business is in.  Also ask to see the seller's financials no matter what size they are.  Again, if they hem and haw  . . .

And if you decide to go ahead, really stress test the downside of the tenant leaving because they go south in your pro forma.  Rent losses, turnover costs, carry projections, everything.  And then try to price that into your lease rate to the extent you can.  

To address Will Kenner's point, the tenant is not losing control of the rent if they have a long term lease in place. That will dictate what the new LL can and cannot do. A lot of sellers think that the RE is "overpriced" and will sell to an investor who disagrees. There are different reasons for both.

@Brett Peters You provide a nice example of pros and cons for both parties and at what stages in their investing/working career they are in. It definitely appears there can be win/win scenarios for both buyer and seller based on built up equity and the ease of tapping into that without adding to the balance sheet for the seller, and the benefits you outlined in the fifth paragraph for the investor. Thanks for the thorough explanation!

@Andrew Tripp That's valuable advice to get the principals to personally guarantee the lease, as well as thoroughly scour the seller's/business owner's financials for indications on the health of the business. Turn-over is definitely a force to be reckoned with and an important consideration in the stress testing, thanks for pointing that out. If the building is highly customized for that one particular use of the existing business, if they pull out, it's imperative to know what it will take to reconfigure the building (if it's even possible) to be attractive to as many potential new tenants as possible. 

@Ronald Rohde That's true about the lease most likely being optimized for the seller, therefore allowing the tenant to maintain control through a lease they have "stacked in their favor". Could you clarify what you mean when you said "A lot of sellers think that the RE is "overpriced"....."  

Originally posted by @Will Kenner :

@Ronald Rohde That's true about the lease most likely being optimized for the seller, therefore allowing the tenant to maintain control through a lease they have "stacked in their favor". Could you clarify what you mean when you said "A lot of sellers think that the RE is "overpriced"....."  

 Lets say the seller thinks the highest and best use for the next 15 years is as "corporate HQ" at $20/ft. If an investor wants to buy and add a hotel to the property, they may value it at $40/ft. The tenant/seller thinks an offer at $30/ft is "overpriced" but the investor thinks there's more value to unlock over time. Neither one is right....until 15 years later...

@Will Kenner It is not that the CPA/tax professional is giving incorrect information, it is that they are unaware of certain benefits available. When I give Continuing Education Classes (CPE) to CPAs/tax professionals, it is unusual if one out of ten is aware of the benefits of grouping in the first year for owner/occupants. Once it is missed, you can't go backwards to group.