admin / February 27, 2019
Is this a viable financing option?
Our financing world was turned upside down in 2008. The “Recession”, “Too Big To Fail”, “Dodd-Frank”, “Bank Mergers” and “Tight Capital”. These were the signs of the time back then. We have come a long way from that low point in the economic cycle.
However, rules and lender requirements made underwriting loans more cumbersome and difficult to get approved.
While banks have become more aggressive in pursuing new lending opportunities, bank credit is relatively expensive and more conservatively structure than prior to the recession. This environment has made things very difficult for middle market businesses.
A company’s investment in real estate and buildings are often overlooked as possible value in financing transactions. Corporate real estate is viewed as underutilized as a financing source and most of the time is financed with a simple amortized loan. The alternative to mortgage financing, where the asset value of the business real estate can be maximized is through a sale-leaseback.
In recent years, many companies do not own the real estate, but they need the utility of the land and buildings to manufacture their products or house their services. A sale-leaseback allows a company to reduce its investment in non-core business assets so it can free up capital in exchange for a lease and paying rent which becomes a business expense.
A sale-leaseback is a transaction that can be viewed as a financing tool. The transaction takes the owner-occupant and has it become a seller of the land and building used in its business operations, sells it to an investor in exchange for a lease commitment which commences concurrently with closing of the sale escrow. The lease is usually long term, where mutually agreed upon lease terms and conditions are negotiated. The Seller negotiates directly with the Buyer/Investor to establish deal economics that allow investor a fair return and lease agreement that does not over burden the new tenant at after close.
Some of the benefits, aside from setting your own lease terms, the tenant saves costs in relocation by not having to move, redeploys capital to pay off debt or upgrade equipment. The total lease payment can be written off as an expense for tax purposes. As a result, the sale-leaseback may have a greater tax advantage.
Unlike a mortgage, a sale-leaseback can often be structured to finance up to 100% of the appraised value of the asset. As a result, a sale-leaseback more efficiently uses the real estate as a financing tool.
Sale-leasebacks are typically underwritten based on a “Cap Rate” which determines current and future rent payments. Cap Rates may be slightly higher than mortgage rates, a sale-leaseback provides cash proceeds for up to 100% of the appraised value of the property versus 60%-80% of appraised value under a typical mortgage. A sale-leaseback can be used to free up cash to grow the business through acquisition, purchase additional facilities, and upgrade equipment or technological infrastructure. If a company has reached its borrowing limit, a sale-leaseback can be used as an off balance sheet financing structure that gives seller the opportunity to turn a non-producing asset into growth capital.
Businesses that are struggling financially or are considering bankruptcy might look to a sale-leaseback for capital. Depending on equity and value the sale-leaseback can supply liquidity and be a possible solution to begin the reorganization process. If an investor can see that the sale will allow the business to reposition itself and its financial state will be much improved after the infusion of capital the investor can see the benefit and minimized risk through this financial restructure.
An investor will conduct their due diligence similar to the due diligence used in acquiring real estate. Building and land appraisals, local market research, comparable sale and lease comps data, location are just a few of the areas considered during due diligence. Tenant credit strength before and after the sale is also looked at.
The size, shape of the building will be a part of the evaluation. Functionality equation, alternate uses when tenant vacates is very important as well. These all impact the underwritten value, return and rent.
A sale-leaseback requires input from tax professionals, real estate attorneys, competent real estate agent and ultimately the right investor.
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