Imagine this: a business that owns a nice piece of corporate real estate desires to tap into the value of their property without losing its prime location.
So, along comes a savvy investor who sees an opportunity to acquire a prime asset with an established tenant in place. The result? The sale leaseback transaction, a harmonious union of convenience and profit.
In the world of commercial real estate, it's a great strategy to have in your toolbox that combines the art of selling and leasing, creating a unique symbiotic relationship between former owners and new landlords.
The corporate property owner can free up untapped equity from their assets while maintaining presence in their property while investors who may usually shy away from speculative CRE investments right now can work around the immediate challenges of finding tenants and get right to earning.
So, let’s learn more about what the sale leaseback is, the benefits for each party, and why it may be complicated for office tenants right now.
But in the mean time, tenants looking for new space can learn all the things they need to know to find the best office for the best price and terms in the free course below.
What is the Sale Leaseback Transaction?
The sale leaseback occurs with businesses who occupy properties that they own. In the case that they want to remain a tenant yet free up tens of millions of dollars in equity, they can seek out a willing investor who will buy the property out from under them just to lease it back in a long-term arrangement.
Essentially, with the sales-leaseback, the property owner morphs into the tenant, while the buyer becomes the landlord.
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“For companies that might have invested heavily in amassing their own real estate, or even just acquiring their own headquarters building, the opportunity to offload a property and pocket some cash while staying put in your space under a lease agreement is proving to be a popular alternative in these precarious economic times." -Propmodo |
Companies who choose this option are tapping into their own resources. And rather than seeking external financing, liquidating their CRE assets frees up a lot of immediate capital. The major downside to mention is that the business owner of the property may no longer own it debt-free or have a low-interest rate mortgage on the property. Now and forever more, they will be paying rent.
On the other hand, the investor avoids pitfalls associated with finding new tenants and short-term leases. Business get an infusion of capital while retaining control over their facility and establishing stable long-term occupancy costs. On the other hand, the buyer benefits from acquiring a mission-critical, passive investment that generates a consistent long-term income.
Traditionally these agreements are long term. Because in a sale leaseback the value of the building is mostly in the value of the lease terms that the new owner can extract (in terms of rent). The only time they wouldn’t want a long term lease is if they felt that the area was up and coming, and therefore is better positioned for appreciation.
In a place like Manhattan, investors will want a long term lease because the value is most likely in the lease. But on the other hand, in a hot market, the value is in the lease but also what the property's value will appreciate to in the future. Because what the new owner is looking for a good Return On Investment (ROI).
Benefits of the Sale Leaseback
Overall, a sales leaseback arrangement often provides a win-win solution, allowing property owners to access capital while maintaining occupancy and enabling investors to acquire income-generating properties.
For Property Owners-Turned Tenants
For the original property owner, the sales leaseback offers a financial lifeline. It's like tapping into the treasure chest within their property, accessing capital that can be injected back into their business. Whether it's paying off debts, expanding operations, or investing in new ventures, the influx of funds provides a newfound sense of freedom and opportunity. It also typically yields higher proceeds than traditional financing.
For tenants who don’t want to be uprooted, it’s a great maneuver. They can continue to occupy and utilize the space, like a tenant with the security of a long-term lease. They preserve their operational control while transferring the burdens of ownership to the new landlord. Retaining the location can have huge marketing and symbolic significance. Beyond this, they can continue to benefit from any capital expenditures they put into the property.
Pros for the tenant include:
- Monetize real estate holdings and increase cash flow
- Set favorable lease terms
- Maintain physical control of property without business disruptions
- Pay down debt
- Improve financial strength and balance sheet
- Ability to invest Infrastructure upgrades, facility renovations, etc.
- Finance growth, acquisitions, etc.
For Investors- Turned Landlords
Commercial investors see the sales leaseback as an ingenious way to acquire an income-generating asset without the risk of searching for tenants or dealing with vacancies and also loss of income during the lease-up period. The property comes with a built-in tenant, providing an immediate and reliable stream of rental income. This is invaluable when traditional landlords can easily sit on a property for at least 6-9 months in a good market before a proper, credit-worthy tenant comes along. Then on top of this they're looking at several months of negotiating and building out the space for the new tenant. All the while, they're paying for the fixed costs for the building's maintenance.
By becoming the landlord in a sales leaseback, the investor can also avoid the day-to-day property management responsibilities. The tenant (former owner) often assumes the responsibility for property maintenance, repairs, and operating costs, often in the form of a Triple Net Lease, relieving the investor of these tasks.
There's also the potential for property appreciation over time. As the property value increases, the investor can enjoy capital gains upon eventual sale or refinance. The property's location, market conditions, and tenant quality can contribute to its appreciation potential, making the sales leaseback an attractive long-term investment strategy. To the new owner, it’s all about NOI-Net Operating Income that translates into ROI.
Why is the Sale Leaseback Complicated?
The sale leaseback only works if you have a willing investor. And with landlords defaulting left and right as interest rates rise and office vacancies fall, the CRE investment isn't what it used to be. Office tenants may be hard-pressed to find investors.
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“Real estate investors are generally less inclined to pursue office investments given well-known dynamics such as work-from-home and the resulting space underutilization.” -Propmodo |
The sale leaseback is not an uncommon CRE transaction, but not one you'll see every day. Albeit struggling now in the office sector, the sale leaseback saw record volumes from 2018-2022. As companies reassessed their need for office space in an oversaturated market, creative maneuvers were demanded.
The sale leaseback emerged as an unlikely solution for some when subleasing, renegotiating, etc failed. However, the number of office sale leasebacks are dropping. From 2021 to 2022, the volume dropped by 50%.
Investors are directing their attention to markets with more promise and liquidity, industrial. This year, the industrial market dominated the sale leaseback, followed by retail. This stat also represents a greater shift away from the office market as its future hangs in balance.
However, on the other hand, some see the drop in office demand as an opportunity to strike while the iron is hot. And because of this, daring investors can give the office sale leaseback a new life. According to Propmodo, “The office sector is hardly firing on all cylinders, but there are buyers out there who see the advantage of the steady cash flow from a leaseback or are eager to snap up office properties at lower prices in anticipation of the sector’s rebound.”
Is a Sale Leaseback Right for You?
In the ever-evolving landscape of commercial real estate, the sales leaseback stands out as a strong strategy that redefines the conventional landlord-tenant relationship. It's a testament to the ingenuity and adaptability of those in the industry, finding creative ways to unlock value and forge mutually beneficial relationships.
For the property owner-turned-tenant, it provides immediate access to capital by unlocking the value of the property, which can be used for various purposes such as debt reduction, expansion, or investment in core business activities. It also allows the tenant to retain operational control and use of the property while transferring ownership-related risks and responsibilities to the buyer.
On the other hand, the buyer or investor benefits from acquiring a property with an established tenant in place. The lease agreement provides a stable and predictable income stream, often with a long-term lease in place, reducing the risk associated with finding new tenants or dealing with property vacancies. It can also offer a steady return on investment, as the rental income generated from the lease provides regular cash flow.
Didn't know how strong a maneuver the sale leaseback is? That's probably because you're not working with a True Tenant Rep™. True Tenant Reps™ play a crucial role in the complex landscape of commercial real estate, including sales leaseback transactions. Their expertise and guidance help tenants navigate the intricacies of these deals and ensure their interests are protected. Tenant reps advocate for tenants, providing valuable market insights, negotiating favorable lease terms, and assisting with lease renewals, relocations, and expansions. They know all the methods that will best benefit the corporate tenant's interests.
Want to learn more knowledge from True Tenant Reps™, subscribe to our blog where we divulge all the CRE tips that landlords don't want tenants to know.
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