George Marcus and William Millichap were real estate brokers of the opinion that market intelligence is the bedrock of great commercial real estate decisions. Barry Wolfe is an attorney who used his legal knowledge of real estate transactions to do much the same thing for owner-operators the likes of Panera Bread. His Wolfe Retail Group is now part of Marcus & Millichap, and he has the founders’ same ability to boil complicated retail decisions down to the basics. Just check out his video on sale-leasebacks. But first get the skinny in his 5Qs with Chain Store Age.
What is a sale-leaseback? It’s when a property owner, who is also an operator, sells his or her property but continues to operate it by leasing back the property from the new owner. It’s often done when a retailer or restaurant operator needs access to cash but wants to keep running the business. The lease agreement is executed at the same time as the sale. Typical reasons for doing an SLB are funding for expansion, remodeling, or paying down debt.
Why are we seeing an increase in sale-leaseback transactions over the past few years? The market for single-tenant net lease properties has really boomed over the past 15 years. These types of properties are extremely attractive to 1031 Exchange buyers. As a result, it’s been an excellent time to do SLB as the pricing via low cap rates has been very favorable to sellers. The low cap rate environment results in more aggressive pricing for sellers which enables an operator to access more capital by doing a SLB. Most retailers make a higher return on their equity in their operating business versus owning the real estate.
Is it viable for a tenant to do a sale-leaseback on a newly opened location? It can be. However, both the buyer and seller need an idea of how the unit is going to perform. The seller is committing to a long-term lease and wants some guarantee of success first. The buyer, too, would like to see some positive sales history at the location. If it’s a brand-new location and a new market for the tenant, we’d usually advise our client not to do an SLB until they have at least a year or two of sales history to gauge.
Is the new tax act passed in 2018 favorable or detrimental as relates to sale-leasebacks? Generally, yes, it’s favorable. For most operators, the new tax act treats more favorably expenses related lease payments as opposed to interest expense from a mortgage. The rental payments tend to be deducted at a higher rate than do interest expenses on a loan and that looks more favorable on a balance sheet by removing the interest charges.
What considerations should both buyer and seller keep in mind before executing an SLB? For the seller, what’s your strategy? Is the focus on growing unit count or reducing debt? Some retailers see the business more as a way to back into owning a real estate portfolio. If that’s the profile, then an SLB obviously is not a good option. But if it’s not and the SLB is right for them, the seller should set the rent at a level they think will allow them to operate successfully at the location for many years. The buyers, because they are dealing directly with the tenant, usually have access to more detailed tenant financials. As a result, they can have a higher degree of comfort as to the tenant’s performance and ability to thrive at the location.