Sale Leaseback: Addressing Top Concerns
Restaurant operators have three big concerns when it comes to conducting sale-leasebacks – control, cost and credit. Having control to remain in a location long term, as well as exit a location are both key points for operators. Market conditions and business plans can change over time, and operators worry about being handcuffed to a store they want to sell, close or relocate during the terms of that lease.
- Control: As a result, assignment rights and master lease agreements are important points of negotiation in saleleaseback transactions. In most cases, there is flexibility with buyers to build into the lease some language related to assignment rights. For example, if an operator wants to assign lease rights to an established operator with an equivalent net worth or credit standing as the current tenant, then the assignment would automatically take place and not require landlord approval. Lease language also can be included to say a landlord cannot “reasonably withhold” an assignment. “If you build those two in, it gives the operator at least some level of flexibility if they would want to exit,” says Daniel Herrold, a senior director at the Stan Johnson Company in Tulsa. Stan Johnson Company is a brokerage firm that focuses exclusively on single-tenant net-lease properties. Under a master lease where there are multiple properties in one lease, a substitution right allows the tenant to go to the landlord and basically swap the bad one out and put another location in. “That gives the tenant the flexibility to exit out of a lease of a bad performing store so long as you have another location that you can replace it with,” says Herrold. An operator also can negotiate certain “go dark” provisions where the tenant could potentially buy back a bad location from the landlord and eliminate the lease.
- Cost: Operators need to be careful they don’t get blinded by a very aggressive sale price and end up committing to a rental rate that is equally high, and may not be sustainable if market conditions shift or the economy slows. “Occupancy expense, outside of payroll, is a very large component of a particular unit’s P&L, and so it is important to keep that in check and keep it within a relative percentage of sales for that location,” says Herrold. Typically, most operators want their occupancy costs to be in the 5% to 8% of sales range. • Credit: Sale-leaseback due diligence involves three levels of credit—unit level financials or a profit and loss statement for that location, consolidated company financials for an operating company and personal guarantees. Most investors will want a company guarantee, but depending on the situation, the personal guarantee is a point that can be negotiated. There is close scrutiny at the individual store level. If that location is profitable the institution oftentimes is comfortable in getting a consolidated credit guarantee of the operator and not requiring a personal guarantee. “That can be a big deal to a franchisee that is maybe a 15-, 20-, 50-unit operator and doesn’t want to have that personal guarantee on a property,” says Herrold. Other options would be to secure a cap on the personal guarantee or for the personal guarantee to be phased out over time, such as once an individual unit meets certain performance levels. “These agreements are not as restrictive as you think they are,” says Ackerman. There is a way to make this a “win-win” and sale-leasebacks are often more flexible than a traditional bank, because investors want to buy that hard asset with a steady income stream, he says. In addition, the investor demand and competition in the marketplace gives operators good leverage and bargaining power today to negotiate more favorable terms, adds Ackerman.