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Everything You Need to Know When Considering a Leaseback Transaction

Posted by Jordan Slater on Feb 22, 2013 3:23:00 PM

Sale leasebacks are popular tools for companies that own real estate and want to turn those assets into cash to support their operations. In a sale leaseback, you sell your real estate to investors and execute a long-term lease to continue occupying the property. 

 

Choosing a Rental Rate

The first decision in structuring a sale-leaseback is how much rent you want to pay. On the one hand, you want to limit your expenditures, but the more rent you pay, the higher your selling price will be. Generally speaking, you do best to choose a rent that is in-line with what the market is bearing for comparable spaces. That way, investors will not feel that your asset represents an undue risk if you move out and they have to retenant it. 

Whatever rent you choose, you should structure the transaction with a triple-net lease. First, investors expect to see a triple-net structure and will discount the pricing of your property if you do not provide one. Second, a triple-net lease gives you more control over the building while you occupy it. Taking responsibility for the building lets you manage it as if you still owned it.


Choosing a Lease and Option Term

Most sale-leasebacks have an initial lease term of at least ten years, and investors will frequently pay a premium for lease terms up to the 25-year standard set by Walgreens. The investors that buy this property typically look for long-term stable cashflow and a longer lease not only gives them stability but can also provide them with an exit strategy. When you choose a lease term, be sure that your business can stay in the building for that entire period of time, since it will be very challenging to get out of the building before then.

You can gain a great deal of flexibility by adding options to your lease. For example, if you sign a 15-year lease with six five-year options, you must stay in the building for at least 15 years but could choose to stay for as long as 45 years, and the owner cannot lease the building to anyone else. You get to decide whether you stay or go.

 

Setting a Price

The price of a sale-leaseback usually gets set on the basis of a cap rate. Simply divide the annual rent by the prevailing cap rate to find the price. If you want to pay $300,000 in rent, and the market will bear an 8.25 cap, the building will be worth approximately $3.6 million. A commercial real estate broker can help you to identify an appropriate pricing level. As you do this, bear in mind that sale-leasebacks tend to be extremely interest rate sensitive, since investors buy them for net cashflow.

 

Accounting Treatment

Engaging in a sale-leaseback can reduce your income tax bills. Instead of expensing your interest payments and depreciating the building, the IRS allows you to expense your entire rent payment and all of your occupancy costs. In addition, leases currently receive off-balance sheet treatment, reducing your company's debt and asset load and improving its operating ratios. This could change in the future, though, since the FASB 13 accounting standard is currently being revised.

 

Sale-Leaseback Pitfalls

There are two key drawbacks to a sale leaseback. The first is that you will have locked your company into making rent payments in perpetuity. The other goes back to the initial term. You could sell a building at a loss if you really needed to vacate it. With a lease, though, you are locked in to paying for the space until the lease ends.

 

View some other great Commercial Real Estate articles:

3 Keys to a Sale-Leaseback Transaction

How to Manage Your Commercial Real Estate Portfolio

Commercial Real Estate Portfolio Consolidation Strategies

 

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Topics: Leaseback