In this installment of our series on real estate strategy for long-term owners, we focus on the sale leaseback. How it works, and whether it’s a good idea.
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Each alternative offers its own advantages and consequences depending on the unique circumstances surrounding each investor.
Understanding market trends and the mechanics of each of the disposition choices figure heavily into the development and execution of a real estate strategy that maximizes investor returns.
However, it is also important to keep the more qualitative aspects of investing in mind. By that we mean what you get from your investments in terms of peace of mind, enjoyment, recreation and the power of choice that we all strive for throughout our lives.
The Dickens classic A Christmas Carol wouldn’t be much of a classic if old Scrooge had not learned that there was more to life than counting his money.
Finding balance in terms of the financial performance of our investments with the pursuit of happiness our founding fathers made a central tenet of our Declaration of Independence, is delicate indeed. We are not licensed to advise on what makes people happy.
But, as fellow human beings striving for many of the same things you are, we feel okay about bringing the pursuit of happiness into the equation.
Today we look at an interesting alternative for you owner/users out there, those of you who decided that being your own landlord was a good thing and bought a building for your company to call home. Well, you were about as right as right can get, but all that equity you have built up over time remains trapped in your building, and you just might have plans that would make it come in handy.
If your company still functions efficiently in your building, and you prefer not to move, a sale leaseback could be your answer.
In this scenario, the entity that owns your building (usually your own LLC, Trust or Partnership) sells the building to an investor, while your company signs on as the tenant. You get your cash out of the building to do with as you please, the investor acquires a 100% leased building and your business gets to stay in a facility suited to its needs. Sounds like a pretty good deal all around. Everybody wins.
Not so fast. What seems too good to be true, generally is.
So, let’s dig a little deeper on this one.
Perhaps the biggest hurdle to overcome in a sale/leaseback transaction is establishing the lease rate. Since the availability of low interest loans has been the primary fuel for the prolific run-up in industrial property values, demand for lease product lagged behind demand for owner/user properties.
As a result, the rise in lease rates, while still significant, has run behind the rise in sales prices. So, when a market capitalization rate is applied to the potential net operating income from your lease, the property turns out to be worth less to the investor than it would be to another owner/user.
The idea of selling the property for less than it is “worth” to the highest bidder doesn’t seem like such a good idea to a lot of folks, resulting in very few sale/leaseback transactions taking place.
That may be changing though, as lease rates have recently spiked, due to abnormally low vacancy rates. Tenants who really need space are showing an increased willingness to pay a premium, just to be able to secure a space in their preferred market area.
Investors, hungry to acquire quality industrial assets are also willing to accept less of a return, a phenomenon known as cap rate compression. Together, these two realities put the sale/leaseback front and center as an option for owner/users, particularly for properties that have been heavily improved (think manufacturing) to meet the specific needs of the business.
Having to start from scratch to improve a different space could come at a price far more than the premium that would come from selling an empty building to another owner/user.
What do you do with your proceeds from the sale? Whatever you want.
However, if you sell outright, you’ll have to pay Uncle Sam his cut. If you exchange, Uncle Sam has to wait.
You could even do seller financing on the deal, which means you could pay your taxes over time. Most small private investors utilize loans to purchase properties anyway. You can earn a tidy return on the note you carry back, and your company pays a market rate to lease the property that still fits the use. What’s not to like! You decide, based on your preferences.
The point here is that there is more than one way to structure the sale/leaseback. And, if you are not done running your business, but you feel like it’s time to cash in your building equity chips, the Sale/Leaseback scenario just could be a great fit.
In part 5, we will wrap things up with some final thoughts on developing a strategy that works for you, the one who put his money on the table, took the risk and deserves to be the winner.
Continue to Part 5 by clicking here.