John Finegan / August 31, 2020
The last five months have been challenging for businesses. In the blink of an eye, people stopped traveling, gathering, shopping in brick and mortar stores, meeting friends for a coffee or a beer, skiing, going to yoga classes and reuniting at weddings. These changes have had an impact on each of us, but they also had a big impact on businesses. For a number of industries, cash has stopped moving around, leaving a lot of businesses eating into their reserves to survive. I want to use this opportunity to write about an instrument in real estate that can help businesses build up their cash reserves with no negative impact on operations, called a Sale-Leaseback.
A sale-leaseback is relatively simple; if you operate your business from a property that you own, you sell that property and, simultaneously, agree to lease space in that same building. Your employees go to the same desk, your delivery trucks go to the same docks, and business goes on uninterrupted. You get a lump sum of cash representing the equity you have built in your property.
As the seller, what’s in it for you? The obvious and main benefit to a seller in a sale-leaseback is that it converts equity into cash. If you have been drawing from your cash reserves since the COVID-19 shutdown and need to rebuild your bank account, a sale-leaseback is an alternative to conventional financing. The cash will improve your balance sheet, your credit standing, and improve your debt ratios. And a sale-leaseback is not only for emergency situations, you can use this cash to purchase new equipment or invest in new opportunities.
From a buyer’s perspective, they get to acquire a building that has a pre-negotiated lease and sale price. If you are a real estate investor, one of the scariest unknowns about buying a property is “what happens if I can’t find a tenant?” In this circumstance, the buyer, and the buyer’s bank, know exactly how long the building will have a tenant and how much income the investment will produce.
There are advantages to both the purchaser and the seller in a sale-leaseback.
Owning a property has undeniable benefits, including the ability to build equity over time and the absolute control that ownership provides. However, having that equity tied up in bricks and not producing revenue for the business can be undesirable. As a general rule, successful operating companies earn returns substantially above the returns expected by real estate investors. If your business can earn returns on equity in the mid-teens versus having the equity tied up in real estate producing sub-10% returns, it can make a great deal of sense to unlock that equity and put it to work in the business, without putting debt on the balance sheet. It should be noted that most major companies choose to lease the majority of their facilities for this very reason; they earn better returns on the business than on the real estate.
In some instances, a lease that is associated with a sale-leaseback may include a right of first refusal or a right to repurchase the property after X years. In other words, you get the cash today, make rent payments, and then down the road you get the opportunity to buy the property back. Also, when you own the building, you are “locked-in” and do not have flexibility. A sale-leaseback can provide the opportunity to negotiate flexibility in the lease terms to give up or take more space, require certain improvements be made by the landlord or build in other desirable lease features.
A sale-leaseback can be a useful capital tool for operating businesses by unlocking equity, providing liquidity and providing flexibility in space utilization going forward. If you would like to learn more, we at The Boulos Company would be happy to have a confidential discussion with you on your specific situation and the opportunities that you may have.