Your company might be sitting on a significant amount of much-needed capital, but more than likely it is tied up in your real estate. The good news is that capital may be captured through a sale-leaseback transaction. A sale-leaseback is when the building owner sells the building to an investor who in return signs a long-term lease for the entire building, typically 7 to 10 years. These types of transactions are very common in the U.S. and Canada. Before you decide if a sale-leaseback makes sense for your company, let’s consider a few pros and cons of this method of recapturing your equity.
Pro: The Market
There is ample capital and liquidity in the market that seeks to acquire real estate as an investment. However, the length of the lease and the quality of the tenants are also factors that will drive interest in the real estate investment. Investors will be most attracted to buildings that are in good cities and submarkets.
Con: Interest Rates
Interest rates remain stubbornly high and may only drop slightly in 2025, if at all. This caps the potential investment value a buyer will pay for the property because the debt service on the loan is quite a bit higher than it was five years ago. Many buyers are choosing to use more equity on transactions today to keep the debt service lower, but this also reduces the leveraged return on investment which keeps sale prices a bit capped.
Pro: Reduced Property Ownership Risks
Owning a property means that there is exposure to maintenance issues and functional obsolescence of the building and its systems, and this can take a bite out of a company’s cash flow if not managed correctly. Roofs are expensive to replace, as are HVAC systems. When you only lease the building, your business may not be exposed to some of these costs if the lease is structured to exclude these items.
Con: Specialized Facilities
Maybe your facility has extensive infrastructure that would be extremely difficult and expensive to recreate if your business ever had to relocate. This is a very valid concern that many companies have and that is why they might never consider a sale-leaseback transaction. However, a properly structured lease can provide a lessee with significant control over the occupancy and use of the facility for the long term. How the lease is structured can certainly impact the potential sale value of the property if the investment return for the buyer is limited by the tenant’s right to extend the lease. Most sale-leasebacks provide the tenant with two or three options to extend the lease term.
Pro: Controlling Your Exit Plan
One constant is that your building is likely more valuable as a sale-leaseback as compared to a vacant building. If your company has a downturn and is put into the position of needing to sell quickly, especially in a down market, that can mean selling at a steep discount. With a sale-leaseback, you are likely selling at the optimal time to achieve the highest sale price.
Con: Potential Tax Liability and Depreciation Impacts
When you sell your property for a significant profit, there will be a tax liability associated with that gain. However, it may still be your best choice depending on how your company reinvests the capital and what type of return will be generated on that capital.
It may also be possible to defer the tax via a qualified 1031 tax deferred exchange, though this could impact the benefits of depreciation. It’s highly recommended to consult with your real estate advisor and accountant to review these factors and determine the best strategy for your investment.
Is a sale-leaseback something you should consider in an effort to extract all the equity currently tied up in your building? The answer is: it depends. Every business is different, and so is the real estate it occupies¾one size does not fit all. What is known is that the current market factors today are supporting very high sale prices in sale-leaseback transactions. At a minimum, it might be a good time for your company to work with an experienced real estate advisor to evaluate whether a sale-leaseback is the right choice. Find one of our members nearest you here.
Article submitted by Wayne Teig, ITRA Global l Minneapolis-St. Paul, Minnesota USA
