Is A Sales Leaseback Investment The Right Fit For You?

The sale leaseback investment market represents a sizable slice of the overall commercial real estate investment marketplace. According to CoStar, the transaction volume for the sale leaseback of retail properties alone topped more than $11 billion over the past five years. It’s also a sector that has proven to be lucrative for both institutions and individual investors.

So, what exactly is a sale leaseback? Much as the name suggests, a sale leaseback investment is where a commercial property owner, who also is an operator, sells the property to a third-party owner and continues to occupy the space. Effectively, the seller shifts from the role of landlord to tenant, while the buyer acquires an investment property that is leased to an operator with a proven track record in that location. Typically, sale leasebacks are structured with long-term triple net (NNN) leases where the operator (now tenant) is responsible for paying expenses, including property taxes, insurance, utilities and routine maintenance. Remember that $11 billion in transactions? The list of sellers includes a roster of big-name companies and franchise brands such as Taco Bell, KFC, Walgreens, BMO Harris Bank, and 7-Eleven to name a few.

Benefits to the seller include:

• Unlock equity tied up in the real estate to fund expansion, improve operations, pay off debt, or return cash to investors.

• Improve income and the company balance sheet. For example, the seller can eliminate the loan interest exposure of the real estate asset and deduct rent payments as a business expense.

• Continue to occupy the property with a long-term lease agreement while locking in rent as a fixed expense.

Benefits for the buyer include:

• Ownership of a stable cash-flowing asset that is backed by a long-term lease and a tenant who already has a proven operating history in that location.

• Zero landlord or management responsibility with a triple net lease.

• Gain tax and financial benefits such as depreciation expense on the property.

• The ability to use a sale leaseback as a replacement property in a 1031 exchange.

Avoiding potential pitfalls

Sale leasebacks have long been a popular investment opportunity for institutions and Real Estate Investment Trusts (REITs). REITs are usually armed with sophisticated tools and methodologies to analyze and vet deals. Individual investors often don’t have the same extensive resources to navigate potential pitfalls. One of the biggest pitfalls for investors is buying a property where the tenant ends up in bankruptcy that allows them to terminate their lease obligation. To that point, there has been a surge in private equity firms and hedge funds who have made substantial investments in major retail companies in the past decade. They have aggressive goals to deliver returns to their shareholders that has often been at the detriment of the business. In fact, 10 out of the 14 largest retail chain bankruptcies since 2012 involved private equity-acquired chains, resulting in the owners of sales leaseback net lease properties getting hung out to dry in bankruptcy proceedings.

Thus, for private investors it is critical to not only gain sufficient understanding of the mechanics of the sales leaseback transaction, but also to conduct a thorough analysis of the real estate, the business model and financials of the operator, as well as understand the nuances of macro and micro marketplace dynamics. In today’s complex market, it is more important than ever to have a trustworthy net lease advisor on your side that has proven experience executing complex deals, dissecting investment opportunities, and tackling critical issues to help create a favorable outcome for your net lease investment. To learn more about whether a sale leaseback is the right fit for your financial and lifestyle goals contact Andrew Vu at 415-539-1120 for a complimentary strategy consultation.