The Four Primary Uses for Sale-Leasebacks
- Financing: Allows for off-balance sheet financing (100% of equity can be made available for investment, as opposed to 75% with traditional financing) and at a lower cost
- Improved Returns: Firms may earn a higher return on their primary business rather than in real estate, so they consider moving capital to principal business to expand operations
- Balance Sheet Improvements: Tool for improving the balance sheet which can be important for exit planning and larger corporations
- Exit/Repositioning: When a firm determines they want to exit a given market/location, they can execute SLB to cash out of a given asset in advance, and then have 5-10 years to find new location.
Sale-leasebacks are a popular means for companies to fuel growth by moving capital out of real estate and into their principal business. Often, releasing capital in real estate is more affordable and has better terms than bank financing. With bank financing, you may only be able to release 75-80% of the equity in your real estate, and that loan will likely come with a 3-year balloon payment. And often the appraised value of the building is the value of the vacant building. With a Sale-leaseback, a business owner can tap into 100% of the equity in the real estate, with no balloon payment, and often the value of the NNN lease to an investor is higher than the appraised value of the empty building (depending on the owner’s creditworthiness and balance sheet). Also, a risk of bank financing is that if the appraised value falls below the agreed-upon LTV, the loan is in default and immediately called (think 2008). The sale-leaseback puts the market risk on the new owner.
If the returns from a company’s principal business are higher than the returns on the real estate, it often makes sense to move equity out of real estate and invest it in the company’s core business. The goal is always to maximize return. For example, if the business is able to gain a 20% return from day-to-day operations, and the ownership of the real estate where the business resides is only netting an 8% return, returns would increase if the business could divest of the real estate to allow for greater investment in the core business. Through the signing of a long-term lease, the real estate can be sold, the business remains in operation in its current location, and operations could conceivably be expanded with the opening of a new location or other operational expansion.
Balance Sheet Improvements
As a seller looks to exit their business, it can become important to improve financial statements. With this strategy, the seller replaces a fixed asset with a current asset. This increases the current ratio (current assets/current liabilities). Sometimes referred to as the Working Capital Ratio, investors see this as an indication a company’s ability to service its short-term debt.
A Sale-leaseback can be a useful tool for a business that knows it wants to move from a given location into another market or trade area in the future. It can also be a means to exit from an overly specialized or obsolete building. An example could be a prison or a hospital, or a retailer realizing that growth is moving in a given direction and determining that in 10 years it will move to follow growth, or that they will centralize their operations in a new building.