AN INTRO TO Sale-Leasebacks A Guide to Sale-Leasebacks for Small and Midsized Companies By Beau Beach, CCIM CPM A Publication of LO
INTRODUCTION How do small and midsized companies leave money on the table? Answer: By not utilizing a strategy called the Sale- Leaseback. A sale-leaseback allows a company to sell its property and immediately lease it back from the buyer, unlocking cash that can then be used in smarter ways. Put another way, this strategy allows you to use and control essential real estate without tying up your cash in an illiquid asset that earns lower returns than your business does. This is a short, concise, no-nonsense guide that will provide you with an entry level understanding of this sale-leaseback strategy and the potential benefits for your business. It s written in a relaxed, conversational style that mimics the experience of one-on-one meeting with me in my office. I hope you enjoy it. Sincerely, Beau Beach, CCIM CPM
CHAPTER 1 Big Companies Do It The sale-leaseback is a common strategy used by many of the nation s largest (and fastest growing) companies: Walgreens McDonalds Buffalo Wild Wings Starbucks Advance Auto Parts Aurora Healthcare Best Buy Whole Foods and hundreds more It s used with all different kinds of properties including warehouses, offices, stores, hotels, movie theaters, restaurants and even schools. Sizes range from a single property to a large portfolio.
That begs the obvious question: If the biggest companies are doing it, why aren t small and midsized companies? First, small and midsized companies do use saleleasebacks just not as often as they should. And when they do use this strategy these transactions don t get as much attention from the media so the average business owner doesn t really hear much about them. Second, it s my opinion that small and midsized companies often don t understand the process or the benefits of entering into a sale-leaseback transaction. Keep in mind big companies have a small army of paid consultants whose job it is to maximize their return on capital and to fuel the growth of the business. For them using the sale-leaseback tool is obvious. Let s face it small and midsized business owners have a lot more on their plate than just researching and planning their company s growth strategy. They are consumed with actually running their businesses. Their time and attention span is limited.
Furthermore, I m quick to admit that at first glance the benefits of a sale-leaseback aren t obvious to a business owner. Many owners share a somewhat old school mentality. (For the record most of the time there is nothing wrong with the old school mentality) It says: Owning is always better than paying someone else rent right? Why in the world would I sell the property I plan to operate my business out of for the next 15 years? Like I said, the answer isn t obvious to most. That s where I come in. I happen to be a business owner too. I get it. I understand your perspective. I will describe the sale-leaseback process in terms you can understand. I will present a sale-leaseback scenario that makes real world sense. Most importantly, I will show you the money! Meaning, I will show you in dollar terms the substantial amount of money a small or midsized business owner is leaving on the table by not using a Sale-Leaseback.
CHAPTER 2 The Benefits Why do smart business owners always consider the saleleaseback option? Lock in the highest sale price today Convert equity into cash to invest in your business or for personal use Improved credit standing so you can get bank financing when you need it Tax savings Retain long term control of the property Lock in the highest sale price An occupied building with a long term lease is often worth 2 to 3 times more than the same building when it s vacant. So why as a business owner would you wait to sell the building when you ve moved out and it s worth so much less?
By selling the building now and then leasing it back you are maximizing the sale price and locking in the highest return you will get from your real estate. Convert equity into cash to invest in your business or for personal use Sale-leasebacks are used as an off-balance sheet financing strategy that gives you the opportunity to turn a non-earning asset into a source of cash to invest back in your business. This includes investing in existing operations, growth or expansion plans, making an acquisition or paying down debt. 9 out of 10 business owners earn a higher return investing in their business than they do investing in their real estate. Knowing that, it makes perfect sense to cash out of your real estate and plow that money back into your business.
This becomes even more crucial for businesses that do not have access to as much credit as they need to achieve their growth objectives. The sale-leaseback proceeds can also be used for other personal purchases like a child s wedding, medical bills, retirement investments, college tuition or a vacation home. Improved credit standing so you can get bank financing when you need it If you have an existing mortgage on the property it will now be paid off. That means any ratio that involves the debt of your company will be improved making it easier to get bank loans in the future.
Also, you will be replacing a fixed asset (the real estate) with a current asset (the cash proceeds from the sale). If the lease is classified as an operating lease, the rent obligation usually is disclosed in a footnote to the balance sheet rather than as a liability. This results in an increase in your current ratio (ratio of current assets to current liabilities) which often serves as an indicator of your ability to meet short-term debt obligations in the eyes of your bank. Did you just fall asleep? Wake up! Just remember: Less debt + fewer liabilities + more cash = easier to get bank loans Tax Advantages I ve yet to meet a business owner who likes to pay taxes. For that reason, the decision to enter into a sale-leaseback frequently is based on substantial income-tax advantages. These savings are an additional source of cash that you may use in your business. The main tax advantage is that rental payments under the lease are fully deductible. With conventional mortgage financing, a borrower deducts interest and depreciation only. If the property is owned free and clear only depreciation can be deducted.
Retain long-term control of the property For most users of real estate, the control and use of a property is all that is necessary. Actually owning the property isn't always needed to achieve those goals. With leasing, users can control and use properties without actually owning them. Remember you set your own lease terms. You ll write a lease that makes sense for your business. Typical leases run 10 to 15 years with extension options that can easily take you out 30 years if you want it to. Most sale-leasebacks are structured as triple-net leases which means the tenant will be responsible for the taxes, insurance, and common area maintenance. A long-term lease of this nature provides you with control over the property similar to when you owned it. You can even include options that will provide for future expansion and sublease of the property. With a well written lease, a company can virtually control the real estate through the end of its useful life.
CHAPTER 3 The Analysis Finally we get to talk numbers! Now is when I get to prove everything that has been said so far. To demonstrate how the analysis works we re going to review a Hold vs. Sale- Leaseback Analysis for a fictitious company. Basically, this analysis tells a company if it s better to continue to own the property or to sell it and then lease it back. Here we go. The company ABC Company. ABC is a stable company in good financial standing. The property The property is 25,000SF and ABC occupies all of it. ABC bought the building 10 years ago for $2,000,000. They expect to utilize the property for at least another 15 years.
The opportunity A mentor to the owner of ABC Company suggested that ABC earns a much higher return investing in its business than it does investing in its bricks and mortar. He urged ABC to analyze whether a sale leaseback would be a smart decision. ABC sees significant growth opportunities in its business in the coming years. Conservatively, it believes it can earn a 12% return on every dollar it invests in the business up to a $5,000,000 investment. ABC also recognizes that in 15 years its property will be nearing the end of its usable life and will be worth substantially less than it is today. Today an investor would pay $3,500,000 for the property if ABC signed a long-term lease. ABC estimates if it holds the property it could sell it in 15 years when it moves out for $900,000. ABC estimates the fair market rent for the property is $13.50/SF or $28,125 per month. The tenant would be responsible for all property expenses in addition to the base rent. Here is the analysis:
Let s break down our assumptions ABC paid $2M for the property ten years ago The current market price if ABC signs a long term lease is $3.5M We are using an 8% discount rate. The discount rate allows us to analyze future cash flows in today s dollars so we can compare apples to apples. The income tax rate for ABC is 35% federal and 5% Wisconsin state tax. ABC will have to pay a 15% tax on the gain from the sale. The cost recovery recapture rate is used to calculate another tax paid on the sale.
To compare both alternatives apples to apples today we need to convert both potential cash flow streams into their Net Present Values (see giant blue arrows). When we compare these net present values it turns out ABC is $2,154,829 better off by entering into a sale-leaseback agreement today. NPV of Sale-Leaseback = +$1,523,060 NPV of Hold = -$631,769 All other things held equal, one option costs ABC money and one option makes ABC money. Better yet, the sale-leaseback NPV does not take into consideration the income tax savings the company will enjoy when their lease payments exceed their former interest and depreciation deductions! The company s tax savings are the preverbal cherry on top (and I don t care what you say you hate to pay taxes). Clearly owning is not always better than leasing but how did this happen? Let s find out. When reviewing the analysis focus on the yearly cash flows generated from both options (This is good advice for every investment type by the way). The first big advantage the Sale-leaseback has over the Hold alternative is the higher sale price today vs. the lower sale price in 15 years when the property is vacant and nearing the end of its usable life.
The second big advantage is the company now gets to invest those sale proceeds back into its business and the returns from that reinvestment offset the rental cost paid to the landlord. Third, in many cases the company will see lower income taxes paid during the term of the lease. Taxes related to business income are too complicated to analyze so those savings aren t reflected in this output. Finally, remember when we said ABC thought it could earn a 12% annual return on cash reinvested in its business up to a $5M investment? The sale-leaseback just freed up $1.7M that they reinvested. Now ABC needs to come up with another $3.3M. Now that ABC isn t showing a mortgage on its books and its liabilities are down ABC can call its bank and ask them to provide a business loan. After all, with less debt and fewer liabilities ABC is a lot easier to lend to now. We could take this a step further and project out how much more money ABC will make with that $3.3M investment and add that to our sale-leasebacks cash flows but I fear you might get to excited your head might actually explode and I don t want you to sue me. Lets now move on to challenging my analysis assumptions.
I can just hear you saying but Beau your assumptions are garbage. Garbage in garbage out. Sale price today assumption Is the market value of the property today really $3.5M? To understand the market value of a property you need to understand how commercial properties are valued. When buying a commercial property you aren t just buying bricks and mortar - you are buying the cash flow stream the property generates. In our case, the investor will receive rent of $337,500 in year one and that amount will grow by 2% for the next 14 years. Here s the part that confuses people. To establish a market value the market now applies a cap rate to that $337,500 of cash flow to the investor. The cap rate is usually between 5% and 15%. (The market cap rate depends on a number of factors that we do not need to get into here) With our asking price of $3.5M we are pricing our property at a cap rate at 10.37%. Because ABC is a stable company with the clear ability to pay rent a 10.37% cap rate is a very conservative estimate for our analysis. In reality, a 7.5% cap rate is probably closer to market which would mean a sale price of $4.5M. That of course would make our decision to pursue the sale-leaseback even more obvious.
Reinvestment rate assumption You think a 12% return on the cash you pump back into the business is high? I don t but I ll play along. Let s assume for a second the return is a measly 6% and see what happens. NPV of Sale-leaseback = +$644,926 NPV of Hold = -$631,769 That means the sale-leaseback is still a better option by the tune of about $1.27M. Next Value at the end of year #15 assumption You think the value of your property will go up every year and someone will be ready to pay up for your old, vacant building once you move out? They will have a company just like yours and realize its value. You ll laugh all the way to the bank and retire happy! Take it from a guy who owns a successful commercial real estate company in Wisconsin you are out of your mind. As soon as a property doesn t cash flow for the buyer the value drops off a cliff. Not to mention the building is now 45 years old, many of the building systems are ready to be replaced and the neighborhood may have gone down hill since you bought it. If a buyer who plans to use the property for their business really plans to pay up for a property that property is going to be new construction and it s going to be perfect for them. That of course might not be true if they can pick up an old building like yours cheap enough. Like say, $900k. And by then you ll be so ready to be done with it you ll take the their offer.
CONCLUSION What You Should Do Now By now you ve opened your mind to using a sale-leaseback. You no longer feel good about having your cash trapped in a property that will likely to go down in value. You think you might be ready to maximize the sale price of your property today, cash out, and then plow that cash back into your business or your personal life. But how? The first step is to hire an advisor (like me) to structure a deal that makes sense for you and then take that sale-leaseback package to market. Of course we ve intentionally simplified this process for the purpose of this short ebook. In reality it s more complicated. But have no fear because a good advisor will make the process easy on you and they will only be compensated if they find an interested buyer for your sale-leaseback package. A sale-leaseback won t make sense for every company or property. Sale prices can also vary substantially. The only way to find out if your property (or portfolio) is a good candidate is to schedule a time to discuss the details. To schedule that initial consultation please contact me directly at Beau.Beach@ProwessCRE.com or 414-324-4938.
ABOUT THE AUTHOR Beau Beach is President and Founder of Prowess Commercial Real Estate Services which is headquartered in downtown Milwaukee, WI (www.prowesscommercialrealestate.com). Prowess is one of the fastest growing commercial real estate firms in Wisconsin. It provides the following services: Sale-Leasebacks Sales & Leasing Brokerage Property Management Facility Maintenance
In addition to leading the growth of the company, Beau personally works with a select number of clients to broker commercial sale, lease and sale-leaseback transactions in Wisconsin and Illinois. Beau has reached the top of the commercial brokerage industry having earned the coveted CCIM Designation. He s also earned the gold standard in the property management industry the Certified Property Manager Designation from IREM. Beau earned his MBA from the Sam Walton College of Business at the University of Arkansas. He also holds a Finance Degree from the University of Iowa. Beau is an entrepreneur, investor and family man. For more information about Beau s professional achievements please Click here to view his Linkedin Page. A Publication of