The Sale Leaseback: Combatting Common Concerns

You purchased your first commercial property 5 years ago for $1M in a prominent location. After constructing the improvements on the property you are all in for nearly $3M. Your business is thriving and you would like to take your concept to another location. Only problem? You don’t have enough cash to do so. Your first property required you to put up $600K after your conventional lender valued your limited your financing at an 80% loan to value ratio. You know the costs you have in your first property and are weary of these limitations as you look into expansion.

What solutions do you have besides getting locked into a restrictive conventional mortgage in addition to putting down another $500K+ of your own equity? Look no further than the sale leaseback— a financing solution for a property owner looking to generate cash while retaining control over its real estate.

Let’s explore the sale leaseback more, specifically from the most common concerns we hear and how the sale leaseback combats these:

CONTROL— I enjoy the control I have as a property owner today.

Most buyers in sale leasebacks are looking for a strong, predictable investment property that they can be hands off when it comes to the day to day operations. Ultimately, the goal of the transaction would be for the seller/lessee of the real estate to retain nearly all the benefits of the ownership while continuing to occupy the property as before with a fixed lease term. (Their investment is only as valuable as the long-term success of your business!) In a triple net lease structure where the tenant is responsible for paying property taxes, building maintenance and insurance in addition to base rent, this structure provides the seller/lessee with maximum control of the property despite having passed title to a new buyer.

COSTS— I’m skeptical of paying rent payments as a lessee and how this number will be evaluated.

When potential buyers value a property, they are looking in terms of cap rates and returns, similar to that of an interest rate of a conventional lender. The sale leaseback essentially is a complete cash-out refinance of 100% of the building value with interest-only payments coming in the form of rent. Because of this, what is received in cash will be a direct reflection of the rent payments to provide a buyer/lessor of the property a fair return on their investment. This price/rent payment is completely negotiable within reason, but likely as the current owner of a property this process will be advantageous for you. You can negotiate knowing you are in the driver’s seat, not competing with other tenants for a space and are less likely to have to conform to the buyer’s wants as a result.

TAXES— I’m enjoying the tax benefits of ownership including depreciation of the property’s improvements.

Yes, ownership of commercial real estate provides great tax savings— one notable thing being taking depreciation of the improvements of the property. In turn, the key tax advantage of an authentic sale-leaseback is that the rent payments under a lease are fully deductible. While depreciation deductions are limited by the cost of a property, rental deductions can be equal to the fair market value of the property and are not limited by the depreciation schedule. In addition, one of the most notable advantageous sides of executing a sale leaseback for the seller/lessee is the strength it provides to the balance sheet by reflecting a lower amount of financing.

FUTURE— How will this affect the future of my real estate and business?

Finally, a sale leaseback can provide several benefits as you look at the future of both your property and business. First off, if you already know keeping your property in the long term is not something you are looking to do, selling your property with a stable, credit-worthy business on it now is how you will ensure receiving 100% of the fair market value in the purchase price. In other words, a buyer will be far more motivated to buy your property now knowing the potential & predictable return promised with your successful business on it. In the same sense, a buyer of a sale-leaseback may not be the same buyer who would be looking to buy your business. Separating these two sales will only increase the value of both assets, allowing you to get the fair market value of the property and the fair value of your business later.

Despite having its upsides, just like any financing method, the sale-leaseback is not a one size fits all solution for all business & property owners. Taking the time to carefully review your balance sheet and financials alongside your goals and future plans for your business with a CPA or trusted advisor is always the best path. There are some great resources out there as well— we would recommend the Net Leases and Sale-Leasebacks: A Guide to Legal, Tax, and Accounting Strategies book for a deeper dive into the caveats of the implications of this type of transaction.

Comment below if your business will be taking the next steps towards a sale-leaseback this calendar year or if this is financing solution you would consider. Happy New Year!

Thirty Eight Properties LLC

Minnesota Commercial Real Estate Specialists

Contact Us: info@38properties.com or (612) 290-7195