In the Spotlight: Should You Consider a Sale-Leaseback?

Raising capital for your organization. If a corporation or public entity needs an infusion of cash ' and who does not these days? ' a sale-leaseback is one of the quickest ways to raise money yet still retain a property for your operational needs. Whether you use the funds
to pay down debt or reinvest into the business, depending on real estate markets, the return may well be higher than that obtained from waiting for your asset value to appreciate, and the unlocked capital is more flexible.

A more attractive sale offering than a vacant building. If you intend to sell a property in the near future, it is much more attractive to a buyer if it comes with a guaranteed major tenant than if it is empty. On average, final prices are higher for sale- leasebacks than for traditional vacant sales.

Unlocking “hidden” equity on your organization's balance sheet. Your property might have value that is not reflected on your balance sheet if a property is on the books for less than its potential market value. A sale-leaseback unlocks full asset value for that piece of real estate, boosting the company's assets, equity and favorably impacting financial ratios. Additionally, depending on your lease structure, your occupancy costs might actually be lowered through a sale leaseback.

Right-sizing your portfolio. If you have more space than you need ' a frequent challenge for post-recession downsized organizations ' a sale-leaseback is a great way to align your portfolio exactly to what your operations now require. You can simply lease back as much of the facility as you want.

Alleviating the risks associated with owning property. From damage due to natural disasters to decreased value due to market downturns, to being stuck with an asset that no longer effectively supports your organizational goals, there are all sorts of residual risks to owning property. Such exposures of ownership are shed by becoming a lessee.

Potential Downsides

Despite the many advantages of sale-leasebacks, the strategy may be less favorable to the owner/seller/lessee if:

The facility is absolutely critical to your operation, and difficult to replace. If an asset is vital to your organization's success, you may not want to risk having it slipping away through non-renewal of a lease after ownership has passed from your hands. While office buildings are normally replaceable, a core manufacturing facility designed for your unique needs might not be.

The property has a physical or geographic challenge to receiving an optimum price. For various reasons, some properties may not be able to recoup their full value even in a sale-leaseback. One example is a data center. Although you may have made a significant infrastructure investment, technological needs change so quickly that anything more than a few years old will be considered outmoded, and is often seriously devalued. A less-than-desirable market location can also depress an asset's selling price versus value. If you have invested considerable money in a facility outside a major market, it might be harder to find buyers willing to pay the price to meet your financial goals for the property. In scenarios such as these, it may be more prudent to hang onto the asset or consider a different financial structure such as a Joint Venture or lease financing rather than receive an unfavorable price through a sale leaseback.

Current market conditions are not favorable. Like any other real estate deal, the success of a sale-leaseback depends on the status of many variables at any given time. Is there a glut of comparable properties on the market, or a shortage of motivated buyers? Is availability of loan money or agreeable terms for borrowers negatively affecting what buyers are willing to offer for your property? Is there a down cycle in the leasing market that currently makes a sale-leaseback less attractive to investors? Although none of these factors should rule out ever doing a sale-leaseback on your property, you might want to wait until conditions are better. In addition, if your organization intends to invest the sale proceeds in financial markets or new property, you will want to time your initiative to receive optimum value from your capital gain.

What to Keep in Mind

Every sale-leaseback is different; there are no set rules. You should carefully evaluate your organization's financial and operational goals, and negotiate a deal that best aligns with them. Here are some things to keep in mind:

Financial return or flexibility ' which is more important? You are unlikely to receive both top price and maximum flexibility as a lessee in a sale-leaseback because one directly affects the other. The more space you are willing to lease back, and the longer the lease term, the more a buyer is motivated to increase its offering price. Depending on the asset and the location, often a seller generally needs to lease back a property for at least 10-15 years to obtain favorable pricing. And of course, your bargaining clout increases if you are willing to lease back the entire space, relieving the new owner of having to seek additional tenants. Before going to market with a sale-leaseback offer, consult the stakeholders in your organization to determine the optimal, and “worst-case” acceptable metrics for both financial return and lease conditions, rather than trying to decide this in the heat of a deal.

Be picky about lease structure and terms. There are many ways to structure a lease, and you should choose the one that best suits your organization's goals. Typical lease structures include:

• Gross lease, in which you will be responsible for nothing but monthly rent and the new owner generally pays all additional costs ranging from utilities to maintenance and insurance on your space.
• Net lease, in which you will pay the cost of some or all variables including maintenance, taxes and insurance.
• Bondable lease, which binds you to pay full rent for your lease term even if the building is uninhabitable following a casualty or is otherwise condemned.

The greater your responsibility under the lease, the higher the sale price you will likely receive. Again, you need to weigh financial gain against the amount of risk your organization is willing to take. Consider also negotiating lease terms that maximize flexibility, such as automatic renewal options, expansion and contraction options, rental rate guarantees, even a right of first offer/refusal if the property is resold by the buyer.

Consider the financial impact on the affected business unit. The financial return from a sale-leaseback deal may be offset by the harm it does to occupier productivity if the impact on the business is not carefully evaluated. Sit down with appropriate business unit leaders to determine exactly what must remain in place for the arrangement to be non-disruptive to their operations, and insist on those conditions in your negotiations.

Do not try to sell a “chicken in the rain.” As noted, timing your sale-leaseback for optimum market dynamics is critical. Study conditions rigorously to make sure you enter the market when the conditions are best for a sale-leaseback in your particular market, at that particular time.

Conclusion

In general, the market for sale-leasebacks is the best it has been in many years. Capital rates are low, interest rates are very low, lenders are increasing available funds and commercial property transactions are picking up in most major markets. There is not enough sale-leaseback product to satisfy current demand, creating even better conditions than those during the previous peak for sale-leasebacks in 2006.

Elizabeth Cooper, a member of this newsletter's Board of Editors, is an International Director for Jones Lang LaSalle Brokerage, Inc. She co-chairs the company's law firm group nationally and internationally, and is also a principal broker for the company in Washington, DC. She specializes in work with law firms, government and quasi-governmental entities and non-profits. Guy Ponticiello is resident in the firm's Chicago office. He brings over 18 years of real estate transaction experience serving corporations, institutional investors, financial institutions and developer clients. Bruce Westwood-Booth serves as a Managing Director with the Corporate Finance and Net Lease Group for the Americas Region.

With increasing financial pressure on organizations, savvy real estate executives are leaving no avenue unexplored in seeking maximum real estate performance at minimum cost. Many are taking a fresh look at an option that has been around for some time: selling some or all of their owned properties and leasing all or part of the space back. Should you pursue a sale-leaseback strategy? There is no blanket answer; however, there are many reasons most organizations should at least consider the option. This article looks at some of the benefits and downsides of sale-leasebacks, and discusses some of the factors to consider to achieve optimum results in structuring one.

Many Benefits

Among the many benefits of a sale leaseback to the owner/seller/lessee are:

Raising capital for your organization. If a corporation or public entity needs an infusion of cash ' and who does not these days? ' a sale-leaseback is one of the quickest ways to raise money yet still retain a property for your operational needs. Whether you use the funds
to pay down debt or reinvest into the business, depending on real estate markets, the return may well be higher than that obtained from waiting for your asset value to appreciate, and the unlocked capital is more flexible.

A more attractive sale offering than a vacant building. If you intend to sell a property in the near future, it is much more attractive to a buyer if it comes with a guaranteed major tenant than if it is empty. On average, final prices are higher for sale- leasebacks than for traditional vacant sales.

Unlocking “hidden” equity on your organization's balance sheet. Your property might have value that is not reflected on your balance sheet if a property is on the books for less than its potential market value. A sale-leaseback unlocks full asset value for that piece of real estate, boosting the company's assets, equity and favorably impacting financial ratios. Additionally, depending on your lease structure, your occupancy costs might actually be lowered through a sale leaseback.

Right-sizing your portfolio. If you have more space than you need ' a frequent challenge for post-recession downsized organizations ' a sale-leaseback is a great way to align your portfolio exactly to what your operations now require. You can simply lease back as much of the facility as you want.

Alleviating the risks associated with owning property. From damage due to natural disasters to decreased value due to market downturns, to being stuck with an asset that no longer effectively supports your organizational goals, there are all sorts of residual risks to owning property. Such exposures of ownership are shed by becoming a lessee.

Potential Downsides

Despite the many advantages of sale-leasebacks, the strategy may be less favorable to the owner/seller/lessee if:

The facility is absolutely critical to your operation, and difficult to replace. If an asset is vital to your organization's success, you may not want to risk having it slipping away through non-renewal of a lease after ownership has passed from your hands. While office buildings are normally replaceable, a core manufacturing facility designed for your unique needs might not be.

The property has a physical or geographic challenge to receiving an optimum price. For various reasons, some properties may not be able to recoup their full value even in a sale-leaseback. One example is a data center. Although you may have made a significant infrastructure investment, technological needs change so quickly that anything more than a few years old will be considered outmoded, and is often seriously devalued. A less-than-desirable market location can also depress an asset's selling price versus value. If you have invested considerable money in a facility outside a major market, it might be harder to find buyers willing to pay the price to meet your financial goals for the property. In scenarios such as these, it may be more prudent to hang onto the asset or consider a different financial structure such as a Joint Venture or lease financing rather than receive an unfavorable price through a sale leaseback.

Current market conditions are not favorable. Like any other real estate deal, the success of a sale-leaseback depends on the status of many variables at any given time. Is there a glut of comparable properties on the market, or a shortage of motivated buyers? Is availability of loan money or agreeable terms for borrowers negatively affecting what buyers are willing to offer for your property? Is there a down cycle in the leasing market that currently makes a sale-leaseback less attractive to investors? Although none of these factors should rule out ever doing a sale-leaseback on your property, you might want to wait until conditions are better. In addition, if your organization intends to invest the sale proceeds in financial markets or new property, you will want to time your initiative to receive optimum value from your capital gain.

What to Keep in Mind

Every sale-leaseback is different; there are no set rules. You should carefully evaluate your organization's financial and operational goals, and negotiate a deal that best aligns with them. Here are some things to keep in mind:

Financial return or flexibility ' which is more important? You are unlikely to receive both top price and maximum flexibility as a lessee in a sale-leaseback because one directly affects the other. The more space you are willing to lease back, and the longer the lease term, the more a buyer is motivated to increase its offering price. Depending on the asset and the location, often a seller generally needs to lease back a property for at least 10-15 years to obtain favorable pricing. And of course, your bargaining clout increases if you are willing to lease back the entire space, relieving the new owner of having to seek additional tenants. Before going to market with a sale-leaseback offer, consult the stakeholders in your organization to determine the optimal, and “worst-case” acceptable metrics for both financial return and lease conditions, rather than trying to decide this in the heat of a deal.

Be picky about lease structure and terms. There are many ways to structure a lease, and you should choose the one that best suits your organization's goals. Typical lease structures include:

• Gross lease, in which you will be responsible for nothing but monthly rent and the new owner generally pays all additional costs ranging from utilities to maintenance and insurance on your space.
• Net lease, in which you will pay the cost of some or all variables including maintenance, taxes and insurance.
• Bondable lease, which binds you to pay full rent for your lease term even if the building is uninhabitable following a casualty or is otherwise condemned.

The greater your responsibility under the lease, the higher the sale price you will likely receive. Again, you need to weigh financial gain against the amount of risk your organization is willing to take. Consider also negotiating lease terms that maximize flexibility, such as automatic renewal options, expansion and contraction options, rental rate guarantees, even a right of first offer/refusal if the property is resold by the buyer.

Consider the financial impact on the affected business unit. The financial return from a sale-leaseback deal may be offset by the harm it does to occupier productivity if the impact on the business is not carefully evaluated. Sit down with appropriate business unit leaders to determine exactly what must remain in place for the arrangement to be non-disruptive to their operations, and insist on those conditions in your negotiations.

Do not try to sell a “chicken in the rain.” As noted, timing your sale-leaseback for optimum market dynamics is critical. Study conditions rigorously to make sure you enter the market when the conditions are best for a sale-leaseback in your particular market, at that particular time.

Conclusion

In general, the market for sale-leasebacks is the best it has been in many years. Capital rates are low, interest rates are very low, lenders are increasing available funds and commercial property transactions are picking up in most major markets. There is not enough sale-leaseback product to satisfy current demand, creating even better conditions than those during the previous peak for sale-leasebacks in 2006.

Elizabeth Cooper, a member of this newsletter's Board of Editors, is an International Director for Jones Lang LaSalle Brokerage, Inc. She co-chairs the company's law firm group nationally and internationally, and is also a principal broker for the company in Washington, DC. She specializes in work with law firms, government and quasi-governmental entities and non-profits. Guy Ponticiello is resident in the firm's Chicago office. He brings over 18 years of real estate transaction experience serving corporations, institutional investors, financial institutions and developer clients. Bruce Westwood-Booth serves as a Managing Director with the Corporate Finance and Net Lease Group for the Americas Region.