As retailers and commercial real estate property owners look to increase returns on capital investments in an uncertain market, the sale-leaseback option is becoming more popular. So, what exactly is a sale-leaseback, and why is it an enticing option for retailers?
The Basics of a Sale-Leaseback
In a typical sale-leaseback transaction, a property owner (like a chain retailer) sells the real estate used in its business to a separate investor (either private or institutional) while simultaneously leasing that same property from the purchaser. The sale-leaseback transaction can include either or both the land and the improvements, and usually features a triple-net lease arrangement. These transactions also typically accommodate fixed lease payments to provide for amortization of the purchase price over the lease term, options for the seller to renew the lease and, on occasion, an option for the seller to repurchase the property at a future date.
The Benefits of a Sale-Leaseback
There are many advantages to a sale-leaseback for retailers. Gaining capital for things like adding store units or paying off business debt are just some of the many ways a sale-leaseback can provide greater return on investment. With a sale-leaseback, the seller regains use of the capital that went into the purchase of the property. The seller usually receives more cash return with a sale-leaseback transaction than through a conventional mortgage financing plan.
With a sale-leaseback, the seller is often able to structure the initial lease term for a period that meets its needs without having to worry about refinancing, balloon payments, appraisal fees and other substantial costs. For a business looking to expand its footprint, this means there would be little to no need to take out a high-interest loan in order to make improvements or open new locations. Additionally, the seller is in a better position to negotiate rental rates and renewal options at the time of sale with a new property owner. Another bonus: rental payments from the newly established lease are fully tax deductible.
Investing in a Sale-Leaseback
For the investor, a sale-leaseback transaction can offer attractive, steady returns. With a fresh lease in place at the time of the transaction, there is less risk of tenant default. Sale-leaseback transactions also typically result in lower management costs and the associated risks thanks to the longevity of the lease. Depending on the lease term and scheduled rental escalations, the sale-leaseback will likely hedge against any future inflation. Additionally, the investor can now capture any future appreciation in the real estate asset.
Things to Consider
Although a sale-leaseback transaction might at first seem advantageous, it’s important to understand both the benefits and the potential risks of such a transaction. Changes in accounting rules or tax reforms can affect the way income from a sale-leaseback transaction is reflected on a company’s balance sheet. However, the demand for single-tenant properties typically sold via sale-leaseback is on the rise. Lower cap rate trends are driving the market and could result in increased sale-leaseback activity.
Are you interested in selling commercial real estate assets? Ground + Space is a leading commercial real estate brokerage firm that specializes in single-tenant and retail NNN investments. The team at Ground + Space works to analyze current market data to offer clients best-in-class service. Contact us today to learn more about how a sale-leaseback transaction could benefit your business strategy.