COVER STORY, JUNE 2008

OWN TO LEASE
Sale-leasebacks can open hidden value for today's owners with cash needs.
Tony Casalena

The sale-leaseback continues to be an effective strategy for companies and business owners to free up cash that would have otherwise been locked up in real estate. A sale-leaseback takes place when a business sells the real estate it owns and then immediately enters into a long-term lease while continuing to occupy the property. As business goals and priorities change over time, many owners decide freeing up cash in the asset may take precedence over holding the real estate. All parties should consider the business and tax advantages, disadvantages and risks involved in this type of arrangement before moving forward.

The sale-leaseback strategy may be used for a number of important business advantages including: raising capital for expansion and acquisitions, buying new equipment, lowering leverage by paying down existing debt or simply to create liquidity. The sale-leaseback is also commonly used for improving a company balance sheet and increasing shareholder value. This is accomplished by the seller replacing a fixed asset (the real estate) with a current asset (the cash proceeds from the sale). If the lease is classified as an operating lease, the seller’s rent obligation is usually disclosed in a footnote to the balance sheet rather than as a liability. This results in an increase in the seller’s ratio of current assets to current liabilities, which often serves as an indicator of a borrower’s ability to service its short-term debt obligations. Also, a primary tax advantage of a valid sale-leaseback is that rental payments under the lease are fully deductible, as compared with a traditional mortgage where only the interest portion of the loan payment is deductible.

The seller’s business needs and current market conditions may influence the decision to sell and leaseback. Length of the lease, market lease rates, cap rates and investor yield expectations are also a small subset of the important factors that influence the deal terms. An experienced real estate investment firm will not only handle typical sale-leaseback transactions but will also structure transactions in a customized manner to meet the particular needs of the seller's business objectives. Structuring the transaction and lease terms that align with the sellers and investors goals can determine whether this will work for all parties.

In today’s market, investor yield expectations are increasing with today’s tighter lending standards. Therefore, the investor wants a greater return, which places a negative impact on increased selling prices and pressures the seller to lower prices. An owner may not want to try timing the peak of a particular market and lock in proceeds today with known market conditions. Federal and state laws may also influence timing to consider a sale-leaseback. For example, capital gains rates are currently at a historic low and will most likely increase.

The real estate value can be maximized by the quality of the tenant and length of the lease. Typically investors and lenders are looking for at least a 7- to 10-year lease term with renewal options, setting the starting point for favorable underwriting terms. Most sale leasebacks today include commitments between 7 and 15 years. It’s not uncommon for a strong credit tenant with a long-term lease to bring an additional 50 to 75 percent in increased value to the real estate, as compared to selling the building vacant or with a high vacancy rate. Owners not willing to remain for more than 3 years may not be a good candidate for the sale-leaseback transaction since such short terms would not maximize the value of the real estate. There are some cases, however, where the markets are so strong in demand for commercial buildings and land that selling a building vacant may command a similar or higher price to what the sale-leaseback would bring.

Any sale-leaseback strategy takes long-term planning. The more upfront planning there is, the better the owner can establish terms that are best suited for current and future strategic business goals. The sale-leaseback industry continues to enjoy robust deal flow thanks to a strong investor appetite, including institutional players, REITs, private equity, insurance funds, pension funds, private investors and high net worth individuals. Sale-leasebacks can be attractive because many are structured with long-term triple-net leases, similar to owning bonds with very little management involvement. A recent example of a sale-leaseback included Berry Plastics Corporation's sale of its headquarters and three facilities to the REIT affiliate of W.P. Carey & Company in an $87 million sale-leaseback deal. The buyer acquired more than 1.4 million square feet in flex/industrial space in Indiana, Maryland and Kansas. Berry Plastics, a plastic packaging products manufacturer, leased back all three properties on a long-term basis. According to Berry’s chairman and CEO, the sale-leaseback allowed the company to raise funds for an add-on acquisition.

Sale-leasebacks are very common across multiple real estate product types including single-tenant retail, industrial, medical, manufacturers, banks or small specialty businesses that want to raise capital. Some manufacturers use the sale-leaseback strategy to cash out of the real estate prior to moving out of an obsolete facility. When the lease expires, the company has the freedom to walk away from what may be considered an obsolete building and can then move to a more central location.

For small business owners, not qualifying for traditional bank financing or wanting to preserve their existing bank credit line, sale-leasebacks can be used to finance growth and restructure troubled financials, as an approach to raise cash. When seller and buyer objectives align, a sale-leaseback can be profitable for all parties. Typically, seller objectives include maximum price, flexible tenant friendly lease terms or an ownership exit strategies for a users unable to readliy sell the real estate. Investor objectives include yield, quality tenants with long-term leases and tenant exit plans. More companies are using sale-leasebacks as a cost-effective and efficient alternative to traditional debt in funding the costs of expansion, acquisition and construction of new facilities.

Tony Casalena is managing director of Baltimore-based Sperry Van Ness/RealSite Commercial Group.

©2008 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.