If your business resides in a building that you own, you’ve likely received at least a few calls or letters over the years offering what’s called a “sale leaseback.” The gist of it is relatively simple. You sell the building for a lump sum with the condition that you continue operating as usual, but strictly as a tenant. Obviously, the deal has its allure, especially for an independent business owner. But if you don’t read the fine print of a sale leaseback, you could end up regretting the decision.
Start by Figuring Out the Cap Rate Being Used
When a sale leaseback is initially proposed, the negotiations usually start with the sales price. This can be further contextualized through a cap rate, using a universal formula of:
annual rent/sale price = cap rate (expressed as a percentage)
In most cases, the lower the cap rate, the higher the price for the same rent. However, this also comes at the price of more equity in relation to the income the buyer hopes to earn. Ask to see comparative recent sales in the area after you find out the cap rate being used. You want to go hyperlocal with this rather than trusting market generalizations.
Understand the Terms and Renewal Options of the Proposed Lease
Scrutinize the lease terms and renewal options. And then scrutinize them again. You can’t afford to miss any details, because sale leaseback deals frequently employ lengthy initial lease terms, commonly anywhere between 10 and 20 years. And that’s not even getting into the renewal options. Longer terms tend to benefit the buyer’s financial goals, but they also buy your business some stability. You just need to figure out whether tying your business to this location and landlord long-term is in your best interest. Therefore, it’s wise to familiarize yourself with the number of renewal periods offered, the rent, and whether renewal is automatic.
The Most Common Lease Type for Sale Leaseback Deals
The type of lease can also obviously influence how a sale leaseback works, so you need to familiarize yourself with the primary commercial lease types. In most cases, sale leasebacks will fall under the net lease family. With net leases, the tenant (your status after a sale leaseback) is responsible for at least a portion of the property taxes, insurance, and maintenance, plus rent.
However, if you’ve signed a triple net lease (NNN), then all of these costs will fall on you. Therefore, you need to have a firm understanding of these different lease types before signing anything. Ask for a clear breakdown of your quoted rent and what items will be billed separately. You may also want to request records on taxes and insurance so you’re not going into the lease blind.
Understand When Rent Increases and By How Much
Most sale leaseback deals also include scheduled rent increases. Familiarize yourself with this schedule to avoid any unwelcome surprises. You should be able to find full details in the rent escalation clause of your lease. These can manifest as annual fixed percentage increases, periodic bumps, or index-related increases. Even annual increases that seem insignificant can compound over the length of a lease. Take time to calculate what this would mean 15 to 20 years down the road.
Develop an Exit Strategy
You should also clarify your exit plan, just in case you need to get out of the lease at some point. Get to know the subletting rules, defaults, and any limitations on use of the property’s space. Might your business expand, downsize, or sell during the lease’s lifespan? Get to know how that works within the confines of the lease. Then, map out your most reasonable exit strategy, because you never know what the future holds.
Have a Professional Review Any Sale Leaseback
It also won’t hurt to get a second opinion, especially from a professional. Consider employing the efforts of a commercial real estate attorney or CPA to pore over the details of a sale leaseback before committing. Of course, it’s better if these professionals have no personal stake in the deal’s closure. Pull up the purchase agreement and the lease, so you can scrutinize them side by side.
Make Sure You Only Use a Sale Leaseback to Your Advantage
If you need to free up capital without moving your business, a sale leaseback can be a tactic worth considering. But the offer letter is just an initiation for negotiation. Don’t make the mistake of simply accepting it as a final term sheet. You have agency in this. The owners who tend to benefit the most from a sale leaseback are those who look beyond the price on the first page.
This article is for general informational purposes and is not legal, tax, or financial advice. Consult a qualified professional before entering into a sale leaseback transaction.
