Last month, we introduced you to the concept of a sale-leaseback, which occurs when the owner of a building sells a property they currently occupy to an investor, then leases that space for an extended period.
For a successful sale-leaseback to occur, both the seller and the buyer need to benefit from the transaction. In the first of our three-part series, we highlighted the advantages to the seller. Today, we’ll explore the topic from the buyer’s perspective.
Typically, leaseback leases are constructed as a triple net lease, whereby the tenant pays the taxes and all operating and maintenance costs for the building, including repairs. Assuming the tenant continues to pay rent on what will generally be a five- to ten-year lease, the purchaser will benefit from a guaranteed rate of return on investment—higher than a conventional mortgage arrangement.
The sale-leaseback is usually put together based on the rate of return for the purchaser. Let’s say you are being offered a 50,000 sq. ft. building at a capitalization rate of 7.25%. The deal can be structured to allow the seller to receive a higher sale price of $180 per sq. ft or $9,000,000, then pay a rental rate of $13.05 sq. ft. If, on the other hand, the seller wanted to pay a lower rental rate, say $8.00 per sq. ft, the building would then sell for $5,517,240. In both cases, you’d receive an initial return of 7.25%. The capitalization rate is always the driving force in the transaction, otherwise, you’d be looking at a seller who wants the highest sale price with the lowest rent and a buyer who wants the exact opposite.
What’s more, when you purchase a building as a sale-leaseback, you get to accrue the appreciation of the space; the tenant does not share in any upside in value. If you obtain a mortgage for the building, your rate of return will increase based on the cash outlay. It should also be noted, in a sale-leaseback, if the seller defaults in making lease payments, you’ll be able to get a default judgment to evict the new tenant without having to go through a foreclosure proceeding.
A sale-leaseback with a quality tenant is generally a sound investment, providing security, positive returns and an upside in potential appreciation. However, every transaction has its disadvantages. Stay tuned for next month when we highlight some of the drawbacks.