Sale-Leasebacks as an Engine for Growth

In a time marked by volatile markets, escalating property costs, and intensifying competition, franchisees must remain agile and adopt innovative approaches to drive growth. While owning real estate has long been regarded as a primary component of profitability, a financial strategy known as “sale-leaseback” transactions challenges this perception.

This article takes an in-depth look at the mechanics of sale-leaseback transactions, discusses the advantages and disadvantages, elaborates on the key elements and structures, delves into the triple net (NNN) lease concept, and demystifies the belief that real estate ownership is the most lucrative strategy for businesses in today’s economy.

Sale-leaseback explained

A sale-leaseback is a transaction in which a business owner sells their property and simultaneously enters into a long-term lease with the buyer. This strategy enables businesses to unlock the equity embedded in their real estate while continuing to use the property.

Key elements and structures of a sale-leaseback

1) Sale of real estate assets: The business owner sells the property to a private investor, business, or institution.

2) Lease agreement: The seller enters into a long-term lease, often a “triple-net” (NNN) lease, with the buyer, allowing them to continue occupying and using the property.

3) Lease term and renewal options: The lease term typically spans 10 to 20 years, with options for renewal at the tenant’s discretion.

4) Lease payments: The seller, now the tenant, makes regular lease payments to the buyer, who becomes the landlord.

5) Triple-net (NNN) lease: A triple net lease, also known as an NNN lease, is a popular type of lease used frequently in sale-leaseback transactions. Under this arrangement, the tenant is responsible for paying the property’s net real estate taxes, net building insurance, and net common area maintenance, in addition to rent. This shifts the burden of property management and maintenance from the landlord to the tenant, making it an attractive option for investors seeking a low-maintenance, long-term investment.

Advantages of sale-leaseback transactions

Access to capital: Sale-leasebacks enable businesses to unlock the full value of their real estate assets, creating opportunities to fund expansion plans, acquisitions, or other growth initiatives.

Financial flexibility: Converting a fixed real estate asset into a liquid asset can improve balance sheets, allowing businesses to access better financing options, decrease borrowing costs, and enhance financial ratios.

Tax benefits: Lease payments in a sale-leaseback transaction are typically tax-deductible, lowering the business’s overall tax liability. Moreover, many franchisees use ground lease structures, selling and leasing back only the land and maintaining the benefits of building depreciation.

Long-term stability: Sale-leasebacks usually involve long-term lease agreements, offering businesses the security of a stable location, enabling them to concentrate on their core operations.

Drawbacks of sale-leaseback transactions

Loss of ownership: Relinquishing control of real estate assets could prove disadvantageous if property values soar in the future.

Lease obligations: Long-term lease agreements might pose risks if businesses face financial difficulties or need to relocate.

Potential reputation impact: Some stakeholders could perceive real estate sales as a sign of financial distress, potentially damaging the company’s image.

Crafting a successful sale-leaseback strategy

Determine your objectives: Assess how capital generated from a sale-leaseback will be utilized for expansion, acquisitions, or other strategic initiatives.

Evaluate financial position: Determine whether a sale-leaseback will enhance the balance sheet and credit profile, leading to better financing options and reduced borrowing costs.

Analyze market conditions: Conduct a thorough examination of the current real estate market. Understanding the direction of cap rates and the availability of 1031 exchange buyers can help businesses make informed decisions about the timing and pricing of their sale-leaseback transactions.

Get professional advice: Consult with financial advisors, real estate experts, and legal counsel to ensure a sale-leaseback strategy is tailored to the business’s unique needs and circumstances.

Determining if sale-leaseback is for you

While sale-leaseback transactions offer numerous advantages, it is crucial to consider the potential drawbacks and risks. For example, a franchisee should carefully evaluate the terms of the lease agreement, including rent escalations, to avoid becoming overburdened by lease payments in the future. Further, businesses should consider the impact of relinquishing control over property decisions, such as the inability to sell or redevelop the property.

A well-crafted sale-leaseback strategy, however, can mitigate these risks and maximize the benefits for franchisees. By carefully analyzing market conditions, seeking professional advice, and tailoring the sale-leaseback agreement to their specific needs, businesses can harness the full potential of this powerful financial instrument.

In the words of Peter Drucker, “The best way to predict the future is to create it.” By strategically implementing a sale-leaseback strategy, franchisees can proactively shape their financial future, tapping into the immense value of their real estate holdings and transforming them into a robust engine of growth and success. As markets continue to evolve, it is essential for businesses to stay adaptable, embrace innovative financial strategies, and make informed decisions to thrive in an ever-changing landscape.

Jason Fefer is an Associate Director of Marcus & Millichap’s Net Leased Property Group on a large team alongside his partners Robert Narchi and Tyler Bindi. They structure sale-leasebacks and negotiate leases on behalf of some of the largest franchisees across all sectors including the restaurant, automotive, and retail space. He can be reached at 818-669-2388 or jason.fefer@marcusmillichap.com.