Some investors need unique ways to finance an investment. Conventional loans, bridge loans, Small Business Administration (SBA loans), and even some other alternatives that many investors aren’t even aware of. Some of these options are a great way for investors to diversify and grow their portfolio while getting rid of properties that may not serve them anymore but keep the businesses that do.
As commercial property investors look for financing options for their investment opportunities, there are some obvious and not-so-obvious options. One of the options that many investors are not aware of is called a sale-leaseback transaction. A sale-leaseback option improves cash flow without interrupting daily operations. It is a financial agreement where a seller of the commercial property is able to pay lease payments for the property from the buyer as soon as the sale is finalized.
Many sale-leaseback transactions are done when an investor tries to free up capital by untying cash in an investment without getting rid of the income-generating resource attached to it. Let’s take a closer look at sale-leasebacks and some of the pros and cons associated with them for both buyers and sellers.
Key Takeaways:
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What is the Purpose of a Sale-Leaseback?
A sale-leaseback transaction is when a real estate property owner (whether commercial or residential) sells that property to an investor who leases it back. A sale-leaseback can be a popular financing option for commercial tenants to finance expansions. They are most often used in commercial real estate with multifamily properties, office buildings, and retail properties, among other property types.
Sale-leasebacks provide economic incentive to both parties involved in the transaction. The seller sells the property to the buyer and then leases it back, typically over a long-term lease agreement.
Institutional buyers and lenders aren’t simply purchasing a building, they’re underwriting your ability to pay rent for the life of the lease. The lease itself is the primary asset being bought. As Jordan Mulloy, an Investment Sales Advisor with Sands Investment Group who specializes in fast food and restaurant investment sales, explains:
“The closer that lease reads like a stable, bond-like cash flow, the more competitive the pricing and financing you’ll see from buyers.” – Jordan Mulloy
What is a Sale-Leaseback Strategy?
A sale-leaseback can be one of the most efficient ways to fund growth without giving up the location your business depends on. Instead of taking on new debt, you convert the equity already sitting in your real estate into capital you can put toward opening new locations, funding an acquisition, or paying down higher-cost debt, all while staying in place as the tenant.
Most often, the buyer is an institutional investor or a private capital group actively looking for long-term, leased real estate; other times, it’s a smaller private investor. Either way, the goal is the same: you keep running the business, and the capital that was tied up in the building goes to work for you instead.
Is a Sale-Leaseback a Good Idea?
A sale-leaseback arrangement can be a good idea for investors in need of cash flow and capital quickly. They are often a great way for certain investors to quickly and easily make a sale of their property so they can move on to other projects while giving them the ability to hold on to the business housed in the property.
The Pros and Cons of Sale-Leasebacks
As with anything in life, there are pros and cons to a typical sale-leaseback, for both the seller and the buyer. The seller becomes the lessee, and the buyer becomes the lessor. This means they both have several things to consider when making a decision to enter into this sale-leaseback agreement. Here are several pros and cons that buyers and sellers need to consider with a sale-leaseback transaction for commercial real estate.
Pros of a Sale-Leaseback
- Cash Flow: The sale-leaseback will allow the buyer to collect rental income from the seller lessee, who maintains their business operations in that facility. It can help to strengthen the cash flow of the buyer.
- Benefits of Ownership: Once the buyer owns the property, they receive the benefits of the asset after the lease term ends. If and when the lease term ends, they can lease the property to another tenant, potentially increasing the rent and their income.
- Raising Capital: The seller can quickly collect the proceeds, which often increases the buyer’s liquidity and frees up available cash. The seller can use this money for other purposes but can still retain the use of the asset.
- Effective and Easy Financing: Buyers are pricing the income stream your lease provides, not just the real estate itself, so a well-structured sale-leaseback typically commands a higher sale price than the same property sold vacant or with only a short-term lease in place. A stronger, longer lease also gives you more room to negotiate rate and structure.
- Higher Sales Price: Many times, commercial property sale-leasebacks get a higher sale price than vacant properties might. It can also give the seller some room to negotiate in the lease structure and rates.
- No Financial Covenants: Sale-leasebacks tend not to have restrictive covenants for the seller lessee.
Cons of a Sale-Leaseback
- Market Risk: The property’s value might decrease more quickly.
- Balance Sheet: It can be unlikely that the seller lessee can carry the lease off-balance sheet because they are often too long a lease. The only off-balance sheet leases allowed these days are short-term leases of less than a year.
- Price: There may be certain characteristics of the property that are not ideal and prevent the optimum sale price. Poor market conditions can also hurt the sale price.
- Reduced Flexibility: A long-term lease can limit your ability to relocate, downsize, or repurpose the space if your business needs change. You can negotiate around this upfront: build in renewal options, subletting rights, and clear capex responsibilities, and think through where you expect the business to be in 10 years before you sign.
Once investors on both sides of the transaction have reviewed the pros and cons, if they have decided to move forward with the commercial leaseback agreement, it’s time to talk terms. Investors can often come to win-win terms for buyers and sellers, and some of the terms that a sale and leaseback agreement might involve include:
- 10-, 15-, or 20-year lease terms for sale and leaseback (shorter if needed by either or both parties)
- Annual rent increases of potentially 1 to 2 percent
- Possible sublease opportunities for sale and leaseback
Is a Sale-Leaseback a Loan?
Sale-leaseback transactions are not a loan and are not treated like a loan. It’s a real estate transaction that helps free up capital for an investor. This sale-leaseback is a financial and real estate transaction, as opposed to any type of loan. It involves a sale of a property, then the subsequent leasing of the property to the previous owner so that the owner can continue to run a business out of the property.
Is Your Property a Fit for a Sale-Leaseback?
Not every property is an ideal candidate, but many more qualify than owners realize. Lenders and buyers are generally looking for a stable operating history, a desirable location, and a willingness on your part to sign a long-term lease. If your business has been profitably operating from the location for several years and you’re comfortable staying put, you’re likely in a strong position.
Property Types That Work Best
Right now, restaurant and QSR properties are seeing some of the most active sale-leaseback volume, as operators use the structure to fund growth and clean up their balance sheets. Beyond retail and restaurants, sale-leasebacks are also common across industrial properties (including self-storage), office space (including medical office), and multi-family assets, wherever a stable, creditworthy tenant is in place.
Sale-Leaseback Example
A recent SIG transaction shows how a sale-leaseback plays out. A QSR operator in the Midwest wanted to free up cash to pay down debt, while the buyer was completing a 1031 exchange and needed long-term, dependable cash flow from a reputable tenant. By negotiating a lease structure that gave the buyer the predictable income they needed and gave the seller the operating terms they needed to keep running the business, both sides got what they were after, and the deal closed as a win-win, says Jordan Molluy.
Additional Considerations: Accounting and Tax Treatment
A sale-leaseback is a real estate and financing decision first, but it carries accounting and tax implications worth understanding before you sign anything.
Lease accounting changed meaningfully with ASC 842. Under the old rules (ASC 840), companies sometimes pursued a sale-leaseback partly to get the lease off their balance sheet. That benefit is largely gone under ASC 842, so today a sale-leaseback is best evaluated as a capital-allocation and liquidity decision, not an accounting strategy.
On the tax side, talk to your CPA before closing about capital gains tax, depreciation recapture, how the proceeds will be used to pay off existing debt, and any reinvestment opportunities that could offset the tax impact. SIG helps structure the transaction and the financing, but we’re not your accountant or tax advisor, your CPA should weigh in on your specific numbers before you sign.
Work With Experienced Professionals For Sale-Leasebacks
When an investor is looking to enter into a sale-leaseback transaction agreement for a property they currently own, then they need to find a qualified real estate broker to help with the process. A sale-leaseback transaction can seem complicated and overwhelming. Not only is there the sale of the property to handle, but there are lease terms to negotiate to retain access to the building for that side of your business. For investors looking to use a sale-leaseback strategy in a future commercial real estate transaction, Sands Investment Group can help you every step of the way.
If you are selling a property you want to lease back, Sands Investment Group can help you find the right buyer, negotiate the terms of the sale and of the lease, and help you get closer to your investment goals in the process. We succeed when you succeed, so we want to find you exactly what you need to get on to your next project or investment. To learn how we can support your next sale-leaseback, connect with a SIG Advisor.
Frequently Asked Questions
What happens at the end of the lease term?
At the end of the lease term, you and the buyer typically have a few options: renew the lease if you negotiated that right upfront, renegotiate new terms, or vacate and let the owner re-lease the space to a new tenant. This is exactly why negotiating renewal options at the start of the deal matters; they protect your ability to stay if you want to.
Can you do a sale-leaseback on a property with an existing mortgage?
Yes, in most cases. The proceeds from the sale are typically used to pay off the existing mortgage at closing, and any remaining capital is yours to redeploy. Your advisor and the buyer’s team will coordinate directly with your lender to make sure the payoff happens as part of the closing process.
What causes a sale-leaseback to fall apart during due diligence?
Deals are more likely to stall when a seller isn’t fully prepared with financials, or when the proposed lease terms don’t work for both sides. Coming in with clean financial records and a lease structure that’s fair to both parties from the start goes a long way toward keeping a deal on track.
How long does a sale-leaseback take to close?
Timelines vary by property and buyer, but a straightforward sale-leaseback can often move from initial marketing to closing in a few months once a lease structure both sides accept is in place. Properties with more complex financials or unique lease terms can take longer.
