The rate of commercial real estate (CRE) price increases we saw in 2020 and 2021, especially in industrial properties, clearly has slowed at this time. But a CRE owner-occupant can still lock in and realize recent increases in their property’s value (without disrupting their operations at that site/facility) through a sale-leaseback transaction.
How Does a Sale-Leaseback Transaction Work?
As the name implies, a “sale-leaseback” transaction is a two-step process.
- The owner-occupant sells the commercial property to a qualified investor and receives the proceeds from the property sale.
- Simultaneously, this former owner-occupant now becomes a tenant and enters into a long-term agreement to lease the property from the investor.
Sale-Leaseback Contract Provisions
Sale-leaseback contracts typically require the seller-tenant to continue to pay real estate taxes, property insurance, and maintenance costs for the duration of the new lease, an arrangement referred to as a triple net “NNN” lease.
The new lease contract may include a lease extension option and in some cases a right to re-purchase, which allows the seller-tenant an opportunity to repurchase the property at a later date.
Advantages and Benefits of a Sale-Leaseback Transaction for the Seller-Tenant
A sale-leaseback transaction can offer significant benefits to the company in a number of areas:
- Unlocking capital that the seller-tenant can utilize to grow their business – for example funding a strategic expansion, investing in productive capital assets, and/or reducing debt.
- Ensuring the seller-tenant can continue to operate at the facility, without any disruption to day-to-day operations, after the sale for a predetermined amount of time.
- Enabling the seller-tenant to realize property value gains – again, without forfeiting the use of the property.
Advantages and Benefits of a Sale-Leaseback for the Buyer-Landlord
With a properly structured sale-leaseback contract, the new landlord can lock in a long-term return on their investment without significant risk. The contract can also insulate the landlord from market rental rate fluctuations, although the investor-landlord might not be able to adjust lease rates in order to take full advantage of market appreciations during the initial leaseback period. The triple net lease arrangement also shifts building maintenance and operational cost-inflation risks to the seller-tenant.
Sale-Leaseback Transaction Details Are Important
In theory, sale-leaseback transactions are not complex. But given that these arrangements can offer unique tax advantages to both the seller-tenant and the buyer-landlord, the IRS may carefully review a sale-leaseback transaction to ensure a transfer of property between unrelated parties has in fact taken place and that a subsequent lease renewal or repurchase by the tenant will reflect fair market value at the time those provisions are exercised.
The IRS will also want to ensure that the lease term doesn’t exceed the expected useful life of the property and that the lease rental rate can reasonably be expected to yield a profit for the investor.
Failure to adhere to these and other requirements might result in significant fines and penalties.
If you’re wondering whether a sale-leaseback is the best path forward for your business, contact our team to review the numbers and discuss the pros and cons. If you decide to move forward, we can provide planning and negotiating guidance resulting in a sale-leaseback arrangement that produces the best financial outcome for our client.