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The COVID-19 pandemic has left everyone uncertain about the future, but it’s safe to say that instability in public health and the national economy will be with us for the foreseeable future. In commercial real estate, many businesses are struggling to keep the lights on. Quick, affordable access to cash is a lifeline that could save companies, from the biggest of big-box stores to the smallest mom-and-pop operations. In commercial real estate, the sale-leaseback is a transaction that may prove especially valuable to cash-strapped companies.
The sale-leaseback allows a business to improve its cash position by selling owned real estate while retaining the right to use the property through a long-term lease. Potential investors, meanwhile, are looking for quality, income- producing real estate with a tenant or tenants who are willing to sign a long-term lease. Sounds like a win-win, right? The tenant receives an influx of cash that will improve its ability to operate in the immediate future; the buyer makes a long-term investment while managing risk with an established tenant. Both sides of a deal address their priorities.
Sale-leaseback transactions come in all shapes and sizes. Recently, discount retailer Big Lots completed sale-leaseback transactions on four distribution centers with affiliates of Oak Street Real Estate Capital LLC, collecting roughly $550 million after taxes and expenses. The initial lease terms are 15 years for facilities in Columbus, Ohio, and Montgomery, Ala., and 20 years for facilities in Durant, Okla., and Tremont, Pa. Much smaller businesses, such as law firms and medical practices that own their real estate, can also benefit from sale-leasebacks.
Weigh the Rewards and Risks
The lease commitment in a sale-leaseback is usually 10 to 15 years. The seller provides cash at long-term rates while realizing 100% of the asset’s available value—compared to, say, accessing 70% of an asset’s value through bank debt. By using this available cash, the seller also preserves its borrowing limit access to the debt market for the future. The business also is able to maintain control of the facility’s operation, maintenance, and potential alterations.
Nothing is too good to be true; accordingly, sale-leasebacks come with risks. By disposing of its real estate, the selling business gives up the right to potential future appreciation. Also, the long-term lease removes the flexibility to benefit if rental rates drop. And the disposition means the seller-lessee may be subject to relocation at the end of the primary lease period.
For the investor, the sale-leaseback represents an opportunity to acquire an attractive real estate investment with a long-term income stream from a selling tenant with good credit. But the investor still carries some risk. A sale-leaseback transaction that took place in December 2019, for example, might be problematic for an investor facing current difficulty related to COVID-19.
Still, considering its appeal to businesses of all sizes in nearly all sectors of commercial real estate, the sale-leaseback will surely be discussed in corporate boardrooms and over dinner tables in the months and years to come.
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