Sale Leaseback, as a concept is not new – the use of SLB as a strategic financial tool has been available for businesses for many years.
It has consistently grown in numbers over the last decade and gained further prominence in the current economic environment due to the convergence of a) businesses in need of operating capital in a challenging credit market and b) investors in search of higher yield against the historically low returns from Treasuries. Data shows that the SLB transactions in the U.S. went up more than 4-fold, from around 200 in 2010/11 to around 900 in 2019/20, while the 10Y Treasury during the same period dropped from around 2.5% to below 1%.
What is a Sale Leaseback (SLB)
The basic structure of a sale-leaseback transaction is evident from its name. The sale-leaseback allows a business to improve its cash position by selling owned real estate while retaining the right to use the property through a long-term lease. The sale provides the business (now tenant) with swift liquidity which could be used to reduce debt, reinvest in its core business, acquire other businesses or just maintain adequate liquidity. Potential investors, meanwhile, are looking for quality, income- producing real estate with tenants who are willing to sign a long-term lease. A win-win for both sides!
Typical sale-leaseback leases have initial terms of 10 to 20 years with several options to extend the lease; most leases have multiple extension options in favor of the tenant (Note: State title transfer regulations will need to be considered while determining the total extension period)
While sale-leaseback properties occupied by credit tenants command the best prices on a per-square-foot/lowest capitalization basis, real property occupied by tenants with lesser or even troubled credit is also in demand in today’s economic environment.
Compared to a traditional mortgage, where the owner can expect a certain portion of property value (typically 50% to 70%) financed by way of debt, a SLB releases 100% of the property value, which at times could include a substantial capital gain as well.
Sale Leaseback transactions come in all sizes and shapes including large corporate HQ office campuses, labs, distribution centers, light industrial manufacturing facilities, big-box stores, convenient retail/ drug stores, Quick Service Restaurants (QSRs), as well as many mom-pop facilities. SLB is poised to play a larger role in M&A as well – companies like J.C Penney, Bed Bath & Beyond and Big Lots Inc. took this approach last year.
The key advantages of SLB to the seller/ business can be summarized as below:
Weigh the Rewards and Risks
While SLB has proven to be beneficial to many owner occupiers and businesses for the above reasons, one needs to evaluate the downside of such arrangements, including:
- Long term commitment – The investors in SLB expect long term lease commitment from the business. The business needs to forecast operating cash flows sufficiently into the future to determine if the future lease liabilities could be met.
- Cost benefit analysis – The valuation of the property in an SLB is determined by the rental payments. While at times, the buyer may be willing to pay a higher price for the property in return for above market rental payment, proper financial analysis in the form of Net Present Value (NPV) calculation would help determine the net benefit to the business.
- Control – While long term lease structure and extension options could provide business continuity, there are some limitation on occupancy, control, and flexibility if certain conditions of the SLB are not met. Structuring the agreement by competent professionals should help mitigate such a situation.
- Accounting and Tax considerations – While SLB may come with many financial and strategic benefits, due consideration should be given for accounting (deducing of rental payment) and tax implication (timing of gain and loss recognition, non-recognition of SLB by IRS in certain cases, loss may not be recognized etc.) to ensure that the transaction benefits are optimized.
At CFO Center, our experienced team of professionals are here to guide across all the aspects of Sale Leaseback, with particular focus on Risk Vs. Reward, so that the businesses could reap the maximum benefit of this financial tool in this challenging economic environment. Kindly reach out to us on: (800) 919 – 4022