Creative Capital: Using a Sale-Leaseback to Fund Your Next Merger or Acquisition
A real estate sale-leaseback is a real estate transaction in which the operator of a business sells one or more properties to an investor while simultaneously leasing that property or properties back from the buyer. Real estate sale leasebacks allow business owners and operators to swap real estate for financial capital, extracting the value of the real estate to infuse back into their business. That infusion of capital can be used for mergers and acquisitions (M&A), expansion of the business into new markets, cost-intensive improvements, company restructuring, or many other things.
For the investor, the sale-leaseback transaction provides opportunities to buy fully occupied, income-producing commercial properties with long-term leases in place. The demand for sale-leaseback properties in the commercial real estate marketplace is substantial, but these can be complicated transactions.
How Does a Conventional Sale-Leaseback Differ from the M&A Model?
Is a sale-leaseback the right strategy for your business? We asked our experts to weigh in on some frequently asked questions.
For franchisees looking to grow via merger or acquisition, how can a sale-leaseback help?
Matt Lipson, Associate Director: A sale-leaseback is simply a way to generate capital, which is obviously a fundamental part of getting an M&A done. But sale-leasebacks have some unique attributes that, in many cases, make them a more appealing solution than traditional debt or equity.
What makes a sale-leaseback appealing, versus just borrowing on the new real estate or even joint venturing with a capital partner?
Matt Lipson, Associate Director: First, more proceeds than simply borrowing on the real estate. Receiving 100 percent of the market value of that real estate is not uncommon, compared to a typical bank loan of generally 65 to 75 percent of the appraised value.
Secondly, there are few, if any, covenants governing how the business operates or manages its capital. A standard triple net lease is simply a less intrusive instrument than a typical loan agreement, by its nature.
Lastly, as compared to a joint venture or even mezzanine debt, there are no new equity splits. The operator retains total control and benefit from any upside they generate, and they can use that upside for further growth or improvements, to buy back equity, or pay down debt, etc. With joint ventures and mezzanine debt, giving up equity, and therefore upside, is typically part of the program.
What are the downsides to sale-leaseback transactions?
Chris Lomuto, Associate Director: The two common objections to sale-leasebacks are the added obligation of rents, and foregone ownership of the real estate as an investment. Not unreasonable concerns, but they need to be weighed against the options.
Many operators simply do not have the capital to get a substantial deal done with cash, which leaves them seeking bank financing, having to partner with someone, or needing to pass on good deals because they don’t have the funds. This is simply not necessary. A sale-leaseback allows the acquiring operator to decouple the real estate assets from the enterprise itself and then monetize those assets in order to generate the cash to buy the business. In some ways, it actually is a partnership in the sense of a relationship between a tenant and a landlord. But rather than dividing up future profits by way of an equity agreement or saddling assets with secured debt, the two parties are simply dividing up the assets up front and then signing a lease agreement that gives the operator the use of those assets.
And while it’s true that real estate is generally a good investment, operators must remember that annual returns for passive real estate investments are in the four to six percent range. Presumably this is considerably less than the returns generated by growing the business. So, yes there is a benefit to owning real estate, but there is also a cost that should not be ignored.
Are market conditions favorable for these types of transactions, and what advice would you give a franchisee as they evaluate sale-leaseback options?
Milo Spector, Associate Director: Absolutely. Cap rates are still extremely low compared to historical averages, which means that multiples on rents are still extremely high. It’s a great time to be a seller in a sale leaseback. And the best advice is to have an experienced broker model a sale-leaseback on your next M&A opportunity and decide for yourself if it’s the right solution for you.