Commercial real estate investors always need investment financing options, such as bridge, SBA, conventional, and mezzanine loans. All of this, however, can be challenging to obtain. One of the not-so-obvious financing options is a sale-leaseback transaction. In this post, we’ll look at this option, its benefits and drawbacks, and how it can be useful to you.
What Is Sale-Leaseback in Commercial Real Estate?
In commercial real estate, a sale-leaseback transaction is an arrangement in which the property owner engages in an agreement to sell the property to an investor and then leases the property back from them for a specified period.
This transaction allows the initial owner to access the sale proceeds or unlock the property’s worth while still residing there as a tenant.
How to Determine If a Sale-Leaseback Is the Appropriate Business Strategy
Companies typically compare EBITDA vs NOI to determine whether this is an optimal strategy. EBITDA (earnings before interest, taxes, depreciation, and amortization) is a popular indicator of a company’s financial health and profitability prior to deducting non-operational expenses.
On the other hand, NOI refers to profit made by a property post-deducting operating expenses and pre-accounting for financial costs. In evaluating whether it is an appropriate strategy, companies compare their EBITDA to their NOI to determine their profitability potential.
If the EBITDA exceeds the NOI, it indicates that the company is overpaying for the property or that the NOI is underperforming compared to its potential. In this situation, a sale-leaseback deal might help the business access the property’s full worth and boost its financial performance.
Like any other business transaction, using this strategy in any real estate types has benefits and drawbacks for all parties involved. Here are some perks:
Immediate Cash Flow:
Companies might utilize the money they get to fund and invest in new projects.
Potential Tax Benefit
The structure of the transaction may bring potential tax benefits for the company.
Lower Financing Cost
Since this financing method is technically not a loan, the financing costs may be cheaper than a traditional loan.
Some of the possible drawbacks include:
Higher Rental Cost:
The rent may be more than the mortgage payment if the lease has less favorable terms.
The property’s value may decrease.
Potential Credit Impact
Credit ratings might take a hit if investors observe a pattern of deals made by a firm.
How Are the Terms Determined?
Usually, lease terms are negotiated between the investor and the company. The terms of the transaction may vary based on certain factors, such as:
- Vacancy rates
- Rental rates
- The condition of the property, and
- Its location, among others.
The lease may also outline maintenance responsibilities, rent amount, insurance requirements, renewal options, and other details.
How Long Do Sale-Leasebacks Last?
The duration of this deal is generally ten to fifteen years, depending on the parties involved. A number of factors, including the buyer’s estimated rate of return on the property, the property’s expected life cycle, and the company’s desire to remain in business, can affect the time a transaction takes.
What Type Of Properties Are Appropriate?
Warehouses, storage facilities, multi-family housing, office buildings, manufacturing plants, retail malls, and other commercial and industrial assets are typically property types used in these transactions. These buildings are frequently essential to the company’s success. However, any property can be utilized in these deals as long as rent is collected on a consistent basis.
Traditional methods of financing an option might be challenging to obtain due to unfavorable transaction conditions and interest rates. With a sale leaseback as an alternate option, the transaction can benefit both the investor and the company. Ensure you hire a qualified broker to help with the process.