When a business needs to access capital, there are a couple of options. You can elect for traditional debt financing, dilute your equity with capital raised from additional investors or you can consider a more innovative option, such as a sale leaseback transaction (often written SLB). This transaction entails selling the commercial real estate property you own (where your business operates) to an investor on the open market then leasing it back from the investor (buyer) under a long-term NNN or Absolute NNN lease agreement without ever having to relocate your business. With the right commercial broker in your corner, a sale leaseback can be a great financing tool that helps you take the right steps forward as a business. It’s important to recognize the advantages and disadvantages of a sale leaseback before embarking on this type of business decision, though. Let’s review some of the most important pros and cons of this transaction.
The Advantages of a Sale Leaseback
There are numerous advantages of a sale leaseback transaction. Most of them are related to the financial side of the business – in particular, liquid capital is made available to your business immediately at closing. There are a number of positive reasons to consider a sale leaseback, however. Let’s dive into the key benefits.
Increase Working Capital
Access to working capital is the key advantage of a sale leaseback and what makes it such a popular decision for businesses that are looking to grow. By selling the property you own (where your business operates) and leasing it back, you can gain liquidity that was previously tied up in your real estate. This transaction, when performed correctly with the help of an experienced commercial real estate broker, gives you access to 100% of the equity you have in the property.
Maintain Control of Property & Property Expenses
A big objection to selling a commercial property that is occupied by a business is the disruption to on-going operations and loss of decision-making control. Under a sale leaseback, the business / business owner will agree to a long-term (10-year, 15-year, or 20-year) NNN lease or Absolute NNN lease which allows the business / tenant to maintain 100% control of the property. Just like when the business owner also owned the commercial property, all operating expenses, under an Absolute NNN lease structure, are still paid by the business / tenant.
Capitalize On Market Conditions – Timing Matters
Buy Low; Sell High. Early in 2020, commercial real estate investors continue to pay a premium for CRE investments compared to 10-year ago. For instance, in 2010 an office or industrial CRE investment would have sold for $1.176M based upon $100,000 in NOI (Net Operating Income is equal to Base Rent under NNN lease) due to 8.5% cap rate. In 2020, an office or industrial CRE investment will likely be sold for $362,000 more = $1.538M based upon the same NOI ($100,000) due to cap rate compression between 2010 & 2020 (6.5% cap rate) which means a higher sale price can be achieved in current market environment which is near all-time highs. A business owner that also owns the commercial real estate should strongly consider striking while the iron is hot.
Eliminate Debt Financing Costs
If business owner / property owner has a mortgage prior to considering a SLB, the rent expense under a new NNN lease will likely not significantly exceed the mortgage payment. However, if business owner took out a loan (instead of performing a SLB), they would be responsible for paying the costs, fees, and interest associated with conventional debt financing.
Moreover, a sale leaseback transaction helps you improve your debt to equity ratio and provides you with the working capital you need to achieve your short-term and long-term goals such as a Merger & Acquisition (M&A) of competitor or complementary business.
The Disadvantages of a Sale Leaseback
Now, there’s no risk-free real estate transaction. While there are many advantages that may encourage a business owner to consider a sale leaseback, it’s also important to be aware of the potential disadvantages of this particular transaction.
It’s essential to work with an experienced commercial broker so you can avoid some of the potential disadvantages of a sale leaseback. One key thing to be cognizant of is the potential tax liabilities associated with capital gains that you may be responsible for after the sale of your property. Be sure to talk to your commercial real estate broker about a 1031 Exchange to defer 100% of any capital gains taxes.
Appreciation and Depreciation
Another thing to consider when looking at the potential disadvantages of a sale leaseback is what you’re giving up by no longer owning the property. You’ll no longer be able to leverage any depreciation benefits. You’ll also be forfeiting any future appreciation which why it is important to considering a SLB when the market is more robust; not at the bottom of the market cycle.
Control Of The Property
One final potential disadvantage of a sale leaseback that you’ll want to keep in mind is that by selling your property, you may be forfeiting control of the real estate without an Absolute NNN lease structure. You’ll no longer have authority over the asset but business owner (seller) can often incorporate favorable lease terms with the investor (buyer). This distinction is what makes working with a commercial real estate broker so important when it comes to a sale leaseback transaction.
Navigating The Advantages And Disadvantages Of A Sale Leaseback
A sale leaseback transaction can be highly beneficial to a business looking to increase working capital without the confines of traditional debt financing. However, the transaction can be a complicated one to execute, which makes working with an experienced commercial real estate agent an essential part of successfully leveraging a sale leaseback.
Contact our CCIM-designated commercial broker to learn more about the advantages and disadvantages of a sale leaseback and find out if it’s the right move for your business.