With the significant demand for the transactions, sale leasebacks create an excellent opportunity to monetize assets and free up capital for growth, says Patrich Jett, senior vice president for Colliers International, a global investment management company.
Sale leasebacks are a transaction in which you sell your office or other real estate and enter into a long-term lease with the new owner. Based on how the deal is negotiated, there doesn't have to be any change in how the property is used or what the monthly payments will be during the lease term. If the property is sold, the lease transfers to the new owner.
Capital allocation roadblocks
The demand has come as U.S.-based real estate funds and REITs seek to allocate capital but with limited places to put it. There isn’t enough investment grade product to meet demand, Jett says. Adding to the pressure are time constraints imposed on companies when the capital is from limited partnerships facing time-sensitive IRR calculations.
Sale leaseback transactions can usually be completed in 45 to 60 days, depending on size and the scope of assets or the portfolio, while the leases often are 10 to 20 years.
B+E Net Lease, a specialist in the area, has seen inbound interest in the transaction increase 20% since the fourth quarter of 2020, with most of those transactions expected to close in the second and third quarters of 2022, the company says.
In the market today, companies are using the tool to generate cash to acquire other companies or help position them to go public, says Jett. Private equity firms are also very active in the space, buying on EBITDA multiples.
The attractiveness of sale leasebacks is being spurred in part because capitalization rates are at historic lows. Some U.S. industrial markets are trending towards sub 3%, with most at sub 5%, says Jett.
Spec warehouses are particularly enticing assets, the expert points out, because while there are more facilities being built than ever, there is still not enough product to meet demand, even with the supply chain crisis.
One complexity to take into consideration when completing a sale leaseback is the new accounting regulations, which require lease liabilities that were previously reported on as operating expenses to be reported on balance sheets in the same way as capital leases. Capital leases are now rebranded as finance leases.
Interest rate environment
The window for optimizing the benefits of sale leasebacks could be closing as interest rates rise, says Jahn Brodwin, a senior managing director at FTI Consulting.
Values are based on cash flow and if interest rates rise, that reduces the cash flow available to the equity, he says.
Still, as long as cash is king, the mechanism can be a cost efficient way to raise cash and unlock equity.
“When the market is strong and the property’s value is high relative to its cash flow, this strategy allows the owner of the real estate to generate income and liquid capital — for other investments, to provide shareholder distributions, buy back stock or for other corporate business needs,” he says.
He added a sale leaseback is also advantageous because it improves the company’s balance sheet to the extent that the value of the property exceeds its book basis (typically, the property’s historical cost less depreciation taken over the years).
Higher rates of return
One of the opportunities, says commercial real estate advisors The Voitworks Group, is the way sale leasebacks can generate better returns than taking on debt.
“Because a sale-leaseback is not considered a loan, state usury laws do not apply,” the company says. “A buyer in a sale-leaseback can earn a higher rate of return on its investment than if it had made a conventional mortgage loan to the property owner.”
Overall, the firm lauds sale leasebacks for allowing a company to redeploy funds into core business activities and achieve a better rate of return.
The firm added they can also be advantageous since from a seller’s perspective, lease rate trends typically lag behind sales price trends, so factoring in favorable occupancy costs while maximizing value can provide negotiating leverage.