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Middle-Market Sale-Leasebacks: Art or Science?

Updated: Mar 10, 2018

Sale-leasebacks transactions involve the sale of corporately owned assets that the company owns and occupies. Simultaneous with the sale, the company executes a long-term lease with the buyer.

The majority of these transactions involve properties that are owned by large publicly-traded corporations that have investment-grade credit ratings. Not only national retailers, but major, sophisticated international banks like Goldman Sachs and Credit Suisse do it, as well as many private equity firms. These are business entities that thoroughly understand such concepts as financial leverage and arbitrage.

The investment grade sale-leaseback market is relatively efficient. That is, the cap rates tend to track the yields of their corporate bonds, adjusted by such factors as the length remaining on the lease, location and the quality of the real estate.

For unrated, smaller, middle market companies the process is very different. Its inefficiency represents a very different set of challenges and opportunities. The first challenge is finding middle market CEOs and CFOs who are interested in considering a sale-leaseback. Unlike the large companies mentioned above, most smaller companies are family-owned and very private. Its owners are often the first or second generation that grew the company from the ground up. Many still retain the bias that selling their corporately owned real estate is a sign of weakness. They fear that competitors and clients will think that the company has had to resort to a last ditch effort to raise capital. If their long-time corporate attorney and corporate auditor are not familiar with sale-leasebacks, then these trusted advisors are unlikely to recommend that the company consider such a transaction.

After you find the middle market company owner who has a need for capital and is willing to sit down to discuss how a sale-leaseback might benefit his firm, the “real estate” pitch is very different from a normal broker-client presentation. In most cases, the C-office has not been involved in many corporate real estate transactions. Real estate brokers’ pitches make them uneasy. I am fortunate to have a team around me that includes a Harvard MBA who was a commercial banker and two big-four trained CPAs with backgrounds in auditing, tax planning, asset management and CFO experience of two major national development and investment firms. I make sure that one of them accompanies me to these meetings. I know a lot about real estate finance. My colleagues know a lot about company operations and corporate finance. They can speak the same language the CFO speaks. They can strike up a rapport with the CFO that I cannot. They can share common experiences and use a common vocabulary. The average real estate broker cannot. At this stage listening to the company - to its business challenges and its business objectives - is more important than expounding on your real estate company’s successes.

The reasons that a sale-leaseback might be an attractive corporate finance strategy are as varied as the number of middle market businesses that exist in the US. Each firm, each ownership, has its unique situation. Examples of uses of the capital raised from the net proceeds include: expanding the business, acquiring another company, building another company facility, providing the capital to retire a senior owner, buying-out a partner, repaying existing debt, etc.

If the company gains confidence in our team’s ability to potentially help them get closer to achieving various business goals, we offer them a no-cost analysis of how a sale-leaseback might be structured and give them an estimated range of what the net proceeds would be and what the costs would be to the company in a set of different assumptions.

To make our analysis, we need to look at its operations and various financial reports to understand how a sale-leaseback would fit into their business plan. We need to establish that a sale-leaseback is the right financial tool for them. We need to determine what level of rent payments the company can comfortably afford to pay a third party investor based on the company’s net cash flow from operations. The sale price calculated from market rents and market cap rates may generate lease payments that cannot be supported by the firm’s operations. In such situations, the team’s creativity and experience is challenged. Alternative strategies need to discussed, quantified and often the company’s “story” recast. The challenge is to balance the amount of the net proceeds desired by the company with the annual lease payments it would need to pay with the return that the sale-leaseback investor community requires.

A concern for many companies is the timing required to execute the transaction. It takes months to perform such tasks as: making the financial analyses; researching the real estate, financial and investor markets; creating the marketing and investment material; drafting the sale-leaseback lease; marketing the offering; responding to questions and showing the property; reviewing and recommending offers; negotiating a purchase and sale agreement; allowing time for the buyer to do its due diligence; creating the closing documents; and, closing the deal. Most deals have a total process time that takes between three months and a year, with 5 to 6 months being a time frame for a “typical” middle market deal to close. That said, a legal purchase and sale agreement can often be reached in 6 weeks to 3 months.

The challenges are numerous - as are the opportunities.

The benefits of infusing relatively inexpensive equity into the company are too varied to list. The market is enormous. There are hundreds of thousands of middle market companies in every corner of the country who need capital and who have never considered a sale-leaseback. It is a market that is grossly underserved. As stated above that the reasons for a company to enter into a sale-leaseback transaction span an enormous range. So too, are the reasons that investors buy middle market assets. The investor market is deep and diverse. The most obvious reason is that an investor receives a higher return that he would from a credit-rated asset. Other often stated reasons include: replacement of a 1031 exchange property; part of a portfolio diversification, or estate plan; dissatisfaction with fixed-income and equity investments; sold a company, or major property; and desire to reinvest capital from a foreign country.

Whenever a CFO is considering ways to raise equity for the company, he is doing an injustice to his firm if a sale-lease transaction is not one of the corporate finance techniques that is measured against the other corporate finance alternatives available to the company.
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