Why Do You Own Your Building? Monetize Your Real Estate
Many business owners also act as their own landlords. While owning one’s real estate can provide a sense of comfort, business owners are frequently at an advantage monetizing the value of their real estate and redeploying that capital into higher return opportunities such as reinvesting in their business or paying down debt. Additionally, as a company grows and becomes more valuable, a monetization of real estate assets may make sense to “take some chips off the table” or separate the full value of the real estate from that of the company.
Business owners in this situation should ask themselves whether owning their real estate is clearly strategic and if unlocking the real estate value could provide enhanced financial opportunities. If so, one tool to convert real estate into a source of revenue while retaining operational control is using a sale-leaseback structure.
In a sale-leaseback, a company sells the real estate it owns to a buyer while simultaneously signing a long-term lease to continue to use and occupy the property. Such buyers are often professionally managed real estate firms who act as stable and supportive landlords providing additional capital for upgrades or improvements. Such leases are frequently structured on a “triple net” basis so the business owner continues to retain operational control over the property.
Sale-leasebacks have occurred across nearly every industry sector, increasing in popularity over the last three decades as a crucial solution for many middle market companies. In 2017, sale-leasebacks represented almost $14 billion dollars of transaction volume, in nearly 550 deals across 41 states. The total transaction volume represents a 25% increase over 2016, indicating the continued surge in growth in the use of sale-leaseback structures.
Benefits of a Sale-Leaseback
Knowing the opportunities in the marketplace, one may ask why a sale-leaseback might be a beneficial structure for one’s business. For many middle-market firms, there are five major benefits of a sale-leaseback transaction:
- Unlocking the full value of your real estate: A sale-leaseback typically affords the seller nearly 100% of the appraised value of the real estate. Compared with a mortgage that typically nets 65-75% of the appraised value, the sale-leaseback allows for a much better net cash return to the business owner.
- Redeployment of capital from non-core to core business functions: Considering expansion? Growing a line of business? Investing in key revenue streams? A sale-leaseback allows you to convert a non-core asset (your real estate) into capital to invest in the core and growth areas of your business. These opportunities generally offer higher returns than ongoing ownership of real estate.
- Attractive rates compared to other alternative financing options: Growth financing can be very expensive for middle market companies, with some mezzanine debt requiring 10-15% interest. In a sale-leaseback transaction, a rental payment at market rates may be less than a loan payment amount and unlike loan payments, the rental payment is typically a fully deductible expense.
- Fair and customizable lease terms: In a sale-leaseback, the business owner and new landlord work together to achieve fair and reasonable lease terms. Both parties typically want the rental rates to be at or below market and the length of the lease, renewal options and other terms can be customized to meet operating needs. New landlords may also provide additional capital for improvements or additions as part of the new lease.
- Cleaning up the balance sheet: Growing a middle market business requires capital and many business owners worry about over leveraging their balance sheets. In a sale-leaseback, owners can gain liquidity from real estate assets and use these proceeds to clean up liabilities and reduce debt.
When to Consider a Sale-Leaseback Transaction?
So, when is a sale-leaseback right for you? The timing for each individual company will differ, but these four inflection points help determine one’s appetite for a sale-leaseback:
- Accessing new capital for growth
- Improving your company’s financial health and flexibility
- Packaging your business for a sale (often times the value of your business may be greater by selling the real estate and the core business separately)
- Recouping funds to pay down debt after a key acquisition
Sale-Leasebacks in Practice
As an example, consider the case of “Company A”, a mid-sized packaging and printing firm that owned and occupied a thirty-year-old, 100,000 sq. ft. facility for its headquarters and production activities. Company A was interested in starting a new line of business that would expand its product set but would require $2,500,000 for building improvements and new equipment. The owners of Company A considered taking on a mortgage, but at a valuation (based on a recent “as vacant” appraisal) of $25 per sq. ft., the proceeds for a 60% loan-to-value would only be $1,500,000. The owners were also concerned with increasing their debt on the balance sheet.
As an alternative, the owners contacted a commercial real estate firm who specialized in sale-leaseback transactions and were able to negotiate a 12-year lease at $3.00 per foot (slightly below market) and an acquisition price based on a 7.5% cap rate. The proceeds of $4,000,000 ($300,000 divided by 7.5%) were enough to pay for the needed improvements and equipment. In addition, the owners negotiated two five-year renewal options, feeling comfortable that the lease provided a stable and predictable arrangement for their operations for many years to come. The owners used the excess proceeds to pay down existing debt and reduce interest costs.
In Summary
The sale-leaseback transaction can be a very effective means for business owners to monetize real estate assets. Not only do sale-leasebacks provide sound solutions for mid-sized businesses, they also provide similar opportunities for private-equity firms wanting to dispose of real-estate after an acquisition, for larger corporations interested in buying-back stock or creating value for shareholders, and for other entities considering using non-core assets to reinvest in their business. Interested business owners should contact their Dannible & McKee advisor to discuss details.
This article was contributed by a Dannible & McKee business partner.
Daniel J. Goldstein, CPA
President & Chief Executive Officer
Royal Oak Realty Trust