Leveraging Sale-Leasebacks to Generate Extra Capital
How to Pull Liquidity Out of Your Real Estate
July 10th, 2020
Owning your real estate has often been encouraged as a way to build equity and grow your own portfolio of assets.
Especially if you and your business have been around for any serious length of time… the reasoning has always been, “why pay rent for 20 years when you can pay off a mortgage?”
While some people don’t want the added responsibility of managing and maintaining a property, and although it may not always make sense to own, having assets in hand may prove to be critical for some Owner-Occupiers hit hard by the economic shutdowns.
None of us saw it coming. And there is little recourse unless you had specifically prepared and insured against this unlikely scenario… or you stashed away a pile of cash for a rainy day.
But what if you could turn your property or a portion of your portfolio into a cash injection?
This re-allocation of capital and ‘pulling’ of liquidity may just prove to be the lifeblood you need to push through the pandemic. And this is especially true if you are deciding to rightsize your operations and liquidate any surplus real estate… or if you are taking this event as a natural transition into retirement and transfer or sale of the business.
What we are describing is simply an option, a tool in the toolbox for investors and occupiers. One that, given the state of the economy, may be worth examining to find product for investors and convert assets for owner-occupiers.
So without further ado, let’s take a look at sale-leasebacks.
A sale-leaseback is a transaction where a business owner sells it’s real estate and leases it back for a fixed term on previously agreed to terms while maintaining control of the property for the continued operation of its business.
Why are Sale Leasebacks so popular?
Because performing a sale-leaseback allows owners to get an influx of cash immediately, while also potentially getting a higher return on that capital should they reinvest it into their operations.
For example: a business running a 25% profit margin can, in theory, make a larger return than simply taking the yield from a 5 CAP.
And with CAP rates compressing further and further, that gap between yield and potential margins grows bigger and bigger. Assuming the business is confident in its ability to scale the operation and maintain margins, it would be worth considering.
In addition, the securing of a mid- to long-term lease would provide certainty and hedge against short-term risks or market happenings.
Finally, the additional leverage gained from accessing the full disposition value compared to financing received on a bank’s loan-to-value ratio means that selling the asset truly does maximize cash in the bank (without being on the hook of a financial institution).
So, What’s in it for the Seller:
- Unlock Real Estate value: For many sellers, it is an opportune time to unlock value of their real estate and allow for more efficient and effective use of capital because of the strong real estate market fundamentals, coupled with the still historically low-interest rates, have driven up property values. Consequently, Sale-leasebacks have become an important strategy to redeploy the real estate value and better position a business for growth, obtain liquid capital for other investments, to provide shareholder distributions, buy back stock, or for any other corporate business needs.
- Maintain control of an asset: A Sale-leaseback typically enables the property owner to not only continue to occupy its current space but to also retain nearly full operational control over it. While conventional mortgage financing generally requires lender approval rights and restrictions with respect to the borrower’s operation of the mortgaged property, the seller/new tenant in a Sale-leaseback generally has free rein. Restrictions typically are limited to acts or omissions that would have a material adverse effect on the value of the property, result in the violation of applicable laws or create property liens.
- Tax benefits: Under a Sale-leaseback rental payments are tax-deductible against the companies taxable income, while only the interest portion of a mortgage payment is tax-deductible.
- Improve Company’s Balance Sheet: The Sale-leaseback transaction also improves the company’s balance sheet to the extent that any debt related to a real estate asset would be retired concurrent to a sale-leaseback transaction. Thus, a company’s balance sheet will show a larger amount of current assets and larger total assets, improving the debt-to-equity ratio.
- Remove management headaches: For non-real estate businesses that currently manage their owned facilities, the ability to shift certain responsibilities for managing the property to a professional real estate owner can be appealing. By having an experienced real estate owner worry about the real estate, the tenant can focus on core operations and potentially realize significant savings in operating costs.
- Increase in stockholders equity: Stockholder equity also is increased because profits realized from a sale-leaseback result in higher retained earnings.
- Enhanced performance: Sale-leaseback transaction enhances a company’s performance by freeing up credit facilities needed to finance accounts receivables, inventory, growth, and expansion.
- Favourable Lease Structure: Property owners/sellers are in a position to create and structure the lease portion of the agreement to support specific business objectives, including rental amount, lease term, and a number of renewal options.
And, What’s in it for the Buyer?
- Steady long term yield: Buyers benefit from the steady yield of that long-term lease. This is especially attractive to institutional investors such as pension funds and insurance companies that look for long-term inflation protection and predictable ROI. With today’s low-interest rates, even a low-level yield that has inflation protection can be enticing to investors.
- Favourable Return on Investment: Sale-leasebacks usually provide higher returns than bonds for similarly rated tenants, with real estate ownership being additional security.
- Limited ongoing responsibilities: Sale-leasebacks may also appeal to buyers because of limited ongoing responsibilities if they involve “net lease” or “triple net lease” transactions with the tenant maintaining responsibility for ongoing expenses of the property, including property taxes, building insurance and maintenance.
We are all trying our best to stay afloat, and for many of us, our business means everything to us.
That being said, Owners of Commercial Real Estate in the Greater Toronto Area may or may not be well-positioned to push through the pandemic and its resulting shutdowns. Few, if any, of us could have predicted what happened, and it caught many of us by surprise.
The silver lining here is that the GTA is such a robust and in-demand market with a large ecosystem of Buyers and Sellers. And with our vacancy rates, rental rates, and valuations having hit all-time highs right before COVID-19 took place, there may be plenty of opportunities to find creative solutions; whether it be through rightsizing, refinancing, bridge financing, sale-leasebacks, or otherwise.
While there may exist challenges in execution, Buyers are ever more hungry for product. Local, high-net-worth developers and investors are often active in bottom-of-market conditions. And well-capitalized institutional investors and pension funds are still willing to take a look at a deal if the numbers make sense.
Whatever you may decide, let us know how we can help you get the solution you need to ensure you make it through.
This is a continuously evolving situation…
Whether you are an Investor or Occupier or Lender we understand that the impact of the COVID-19 pandemic on your business may be significant. All parties involved have keen issues they are focused on and potentially different priorities at this moment. Proper and transparent communication is what will sustain and strengthen the relationships that will get us to the other side… Just remember…
We are all in this together…
DISCLAIMER: All information herein is for informational purposes only. This is not intended as professional legal, insurance, tax, or accounting advice. We are not liable for any damages, real or perceived, as a result of you receiving or consuming this information. Please consult your attorney, accountant, insurance broker, or other counsel prior to making any decisions…
As we navigate through these uncertain times, rest assured that our team is working diligently to meet the needs of our clients and colleagues. The manner in which we do business is changing constantly, but our commitment to providing the best information and advice remains the same.
Cushman & Wakefield’s leadership team and research resources are committed to providing information on the overall economic and, specifically, the commercial real estate impact due to this pandemic. Please continue to check cushmanwakefield.com for the latest information regarding COVID-19 and the commercial real estate industry.
Once again, we’re all in this together, so please reach out with any needs you may have during this time.
Please stay healthy and safe.
Goran Brelih, SIOR
Senior Vice President, Broker
Cushman & Wakefield ULC, Brokerage.
Immediate Past President, SIOR – Central Canada Chapter