Re-Capitalize Your Enterprise with Sale-Leaseback

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Is your enterprise seeking a recapitalization event? A sale-leaseback is a useful recapitalization tool for static uses of commercial property. The net proceeds of sale (equity + principal + capital appreciation) can be substantial. Before any sale-leaseback can occur, prepare a business case to justify the project; the terms of sale and lease are discussed to identify sale value, net proceeds, where to apply the cash and how the enterprise will benefit from the sale, currently and long-term. The sales-leaseback is attractive to seller and buyer in the early stages of economic expansion and during slow growth economies. Low, predictable rent increases benefit the tenant; investors benefit from a credit-worthy long-term investment. Facilities management can be outsourced to a property management firm, bringing efficiencies of services at low predictable costs. A consensus of yes among top management prompts strategic planning to plan a sale-leaseback project (“SLp”).


return on investmentXAction Spreadsheet

A sale-leaseback is a financing tool to re-capitalize an enterprise by exchanging property value and ownership for a long-term net lease; buyers are funded privately or publicly held. It works best with established enterprises (operating from a large single facility or from many sites with the same use), is a reliable loan for a lender, and is a reliable long-term investment for the buyer; the tool is akin to a corporate bond sold directly to one bondholder. I urge the preparation of a business case to justify making the commitment; facilities operating costs are assembled with accuracy. Most planning comes from a committee assembled by top management of the seller (CEO, COO, CFO, Chairman, board of directors if any). A commercial lease is often 10-15 years pending staff count and TI involved, yet the SLp uses 20+ year lease terms.  Results are compared to the costs to sell, a lease projection, property management expectations and the cost/benefit of tenancy vs. property ownership. The SLp taps equity, principal and capital appreciation by securing a large loan using the credit of the seller and the buyer to match stringent underwriting criteria of the lender; credit quality of the lease and buyer dictate the amount of the loan and equity required by the buyer. (Note: Equity investors of the buyers are attracted to the long-term reliability of income from each lease closed vs. buying an interest-bearing corporate bond.)

NPV_IRR

MIRR & NPV vs. IRR. What are the long-term projections of economic performance for the net proceeds of sale? Financial projections should include costs to finance equity and interest received from loans made by the company; MIRR (modified internal rate of return) shows the time value of your money more accurately over the term of the net lease. NPV shows the loss or profit from your investment assuming a discount rate. Compare MIRR to 10-year treasury yields and similar fixed investments. This cost-benefit analysis is included in the business case for the SLp.

Biz Meeting

Sale criteria. Investment sale brokers consistently conduct marketing to source seller candidates for SLp’s. Buyers often create a private equity fund (with return expectations and placement criteria), placed through a mix of direct marketing and relationships with investment sale brokers. Instead of reacting to a marketing call (you’re unprepared for), prepare the business case outlined above, assuming a capitalization event. Report results will clearly show the pro’s and cons of committing to a SLp, qualitatively, quantitatively, operationally and culturally. Begin with a broker’s appraisal of the property(ies) to be sold, factor the potential net rent paid by your company’s credit score, this produces market value of the property(ies). Net proceeds of sale are the amount left from gross sale proceeds, less closing costs, less mortgage due, less capital gains taxes. A choice to pursue a SLp creates a steering committee to assemble the criteria for sale, guiding a project manager to source prospective buyers. The end goal is to select the most compatible business partner to purchase your property(ies). (Caveat: 20+ years represents a notable period of time in an enterprise’s life; seamless daily operations must continue.)

return on investment

Use of Sale Proceeds. Using sale-leaseback funds to improve a firm’s financial health fine sometimes, analysts say the best use is to reinvest the funds to support the company’s core business operations. “Sale-leaseback deals are definitely a higher-cost form of growth capital,” Ackerman says, emphasizing that companies should have a plan to use at least some sale-leaseback proceeds for expansion (Mitchell, NREI online, 2015).

Equity Investing

The U.S. is still perceived as a very stable economy abroad, and foreign cap rates are traditionally lower than those in the U.S., making the yields more attractive. Banks typically limit loan-to-value (LTV) on financing agreements to 80 percent, but sale-leasebacks allow a company to access the full amount of a property’s value. Firms can use the funds to expand their lines of business, invest in new equipment or even maximize returns after a merger or acquisition, according to net lease broker specialist Stan Johnson Co of Tulsa, OK (Mitchell, NREI online, 2015)

Corp Advisor

To recap, sale-leasebacks are prevalent in low interest rate economics; they tap the value of a property, secure fixed rents/increases, tenant retains daily facilities management; buyer takes title to the land and building, responsible for the physical integrity of the building shell. An established business with a long-term future can attract a high price for their property(ies); returns from the rent income stream are similar to a long-term corporate bond. If your enterprise is considering a sale-leaseback project, please ask your CFO or COO to fill out “Request a Consultation” at the base of About Me in this website. Enter “capitalization” in the subject line, then paste the email signature of their executive assistant the message body. I reply within 24hrs to arrange an exploratory conference call within their calendar. ###

Buy Property

CONSIDERING TO BUY A PROPERTY vs. LEASE FOR YOUR BUSINESS? If you’re considering to own the space your business operates from, have you identified how financial benefits can lower your cost of occupancy? Imagine the lift to your P&L… Financial planning is as important as preparing the building for use. The goal is keeping space costs known, predictable and low while adding property value to the value of your business.

The physical and financial aspects of the buy can be plugged into transaction software that changes with scenario models. A comparative quantitative analysis helps to reveal your cost of occupancy. The final transaction model will serve as a guide to negotiate the closing terms of the buy as well as drive the project management of the build.

I’ll show you how a mortgage, tax, utility and economic development benefits will help lower your acquisition, development and operating costs of the property. We’ll review each scenario to the extent you need to create options to focus on. Our review of options will include how we’ll respond if the seller (and other players) cannot meet your transaction or development needs.

Five (5) Key Factors affect a property purchase:

  1. Physical building and location. What kind of building and layout does your business need? Where should it be located?
  2. Development. Does the building need retrofitting, rehab or is land development your best option?
  3. Financing (including IDA financing). Your credit status will dictate the lending terms you can secure.
  4. Economic Development benefits from utilities, job creation, construction. Location of the business, employees relocated, new hires and how you power/light your property will all help identify the economic development benefits available to you to lower your cost of occupancy.
  5. Tax benefits (mortgage interest, depreciation, property tax abatements, effective tax rate). Property tax abatements, plus tax deductions for interest will be factored into the transaction to show its financial effects on your cost of occupancy.

Considering to buy a property requires quantitative and qualitative analysis. I discuss the report with you in layman’s terms to make a choice giving a predictable outcome. The financial and physical outcome of acquiring commercial real estate requires some degree of predictability to focus on operating and improving the performance of your business. This consulting service is available for an hourly fee or is included in the commission fee [I’m paid by the seller of the property].

If you agree that this analysis service would be useful to you, please click “Request A Consultation” link in the upper right of the screen. Enter “Acquisition Modeling” in the subject line; please include your name, email address and telephone number in the message body; I reply within 24 hours. Thanks for reading and listening. ###

Real Estate Investment Valuation: Few Comps

If your property is located a bit off the beaten path and sale comps are few, how do you value your investment for loan or sale? Don’t guesstimate by market conditions; capitalize Net Operating Income (NOI). Here’s how:

ADD

Rent. Every space has a rent value, there are enough properties near yours competing for tenants that offer rent comps. Identify the accurate rent value of your space (adjust rents for plans to rezone a part of your property. For example, converting unfinished storage space into workspace supported by adequate parking and/or elevators.)

Land Value. If your building has substantially more land than building, with air rights for more than 3-4 floors, add land value to identify the property’s market value. How? All land can be rented. Land is typically 22% of the market value of a property; land rent is capped at 10%. (This rate assumes all public utilities are installed to develop the land.) For land with air rights of more than 3-4 floors, air rights are a commodity, market conditions dictate value; demand with low supply drives up value; add land and/or air rights to market value.

SUBTRACT

Operating Expenses. What’s does it cost to run your building every month? Assure to add a % of gross operating expenses as buffer for unexpected maintenance needs.

Capital Expenses. Costs to improve efficiencies of building operations; not subject to depreciation.

Capital Improvements. Investments to physically improve the building, subject to depreciation (after NOI).

Tenant Improvements. Costs to build tenant space, recaptured in rent over life of lease.

Brokerage Commission. Like TI, brokerage fees, recaptured in rent over life of lease.

NET OPERATING INCOME

Result. (Existing rent + rent from rezoned space) – Operating Expenses – Capital Expenses – Capital Improvements – TI – Brokerage Commission = Net Operating Income.

Cap Rate. A divisor that leads to Market Value. The capitalization rate (cap rate) is directly affected by the term of the lease, the integrity of collecting rent from leases, the credit quality of tenants, and sometimes the use of space.

Market Value. Adjust sale comparables to the capped NOI of your property, the result equals the market value of your property.  This case study is about a property sold for mixed-use redevelopment.  Add the capitalized value of land and/or market value of air rights [per buildable foot] to this result.

Uses of Market Value. Use market value to secure a mortgage, a take-out or sell the property. Confirm the market value with a commercial appraisal; no one can dispute a reasonable appraisal approved by an M.A.I.

Hire Me. If you’re planning to sell your property or need to identify its market value for a transaction, I can perform the analysis to identify its market value.  In the past, my results came within 5% of an M.A.I’s appraisal or the sale price.  Please fill out the form in Request a Consultation with your information; I’ll reply within 24 hours.  Until the next post…

Pricing Property to Sell

As the economy improves incrementally, commercial real estate is regaining attention as a stable, reliable investment [vs equities or bonds]. Its published knowledge that American businesses (including private equity) kept over $1 trillion in cash profit from sales since the depths of the [Great] Recession; currently cash is king. Banks are lending cautiously, yet in measured amounts. Investors are searching for choices that offer a mix of stable cash flows and future upside. Complete rehabs of functionally obsolescent buildings are an alternative investment, if handled shrewdly.

Plan and Prepare Basics

If you’re considering to sell a property you own, strategy and planning are key to a successful sale and use of proceeds. Stick to your plan; leave a bit of room for flexibility. Recruit multiple offers to assure the sharpest sale terms; have alternate buyers ready to fill sales that break up unexpectedly.

Seasoned, experienced, savvy service providers to process the transaction include a real estate analyst, Public Engineer, CPA and attorney.

a.  Real Estate Analyst. This knowledge worker, whether support staff or private contractor, will project an opinion of value of the property from accurate income and expense figures. (This is my service niche.)

b.  Pre-Inspection. Its to your benefit to hire an engineer (P.E) or commercial inspector to report on the physical condition of the property before bringing it to market. Leaving the inspection report up to the buyer could put you in a materially weak negotiating position, creating a lower perception of value by the buyer.

c.  MAI Appraisal. Order a professional appraisal of the property before sale, approved by an MAI; scrub the results against the opinion of value from your analyst. No buyer can argue with the results of an appraisal from a licensed appraiser and MAI.

d.  Legal. Assure the contract of sale fairly protects you and the buyer; read a sample copy from your attorney before they customize it to your transaction.

Four Essential Questions

Prior to bringing your property to market, ask yourself:

  1. What’s it worth?
  2. Where to place the sale proceeds?
  3. If you make a like-kind, tax-free exchange, identify the replacement property (ies) before bringing your property to market.
  4. Paying capital gains taxes on the sale proceeds? Talk with your CFO or CPA about profits’ affect on your P&L before bringing the property to market.

These preparatory steps include expenses and time worth investing in to avoid losing a sale, or negotiating unexpected material hurdles of sale that could lower the closing price you envisioned. These steps map a path to a smooth close, with flexibility as needed.

1.  What’s it Worth?

These facets of value, some of which are severable from the whole, work in-unison to generate an accurate value for the property:

  • Integrity of income (eg. rent from tenants, billboards and antennas, parking income)
  • Projected rents from lease renewals and potential vacancies
  • Does rent from long term leases (10yrs or more) sustain, lock or step-up revenue?
  • Does the building operate efficiently?
  • Is maintenance effective and costs sharp?
  • Is the assessed value of the property reasonable?

Additionals:

  • Are there hazmats behind walls needing abatement at relet?
  • Do floor plate sizes help/inhibit lease up?
  • Could select floors be re-positioned for better uses at higher rents or sold as condo?

The tangible and intangible variables of a property directly affects the capitalization rate applied to NOI to produce an accurate property value. Some are:

  • Building features (common area cosmetics, telco wiring, green skin and mechanicals)
  • Property’s ability to compete in the community for tenants.
  • Does the legal ease of your lease help, hurt or inhibit property value?
  • Credit of larger tenants

Uses for Sale Proceeds

Sale proceeds are substantial, you’ve agreed with your senior staff about where to place them (i.e. re-invest, pay debts, fund new development, etc). If you’re a single user of owned property, is this sale a leaseback to free-up cash? Proceeds may be divided among facility expenses, short term rent and to fund growth.

Like-kind Exchange. If you’re planning a like-kind, tax free exchange of properties, identify a list of replacement properties that meet your investment goals and core portfolio. Hire an experienced, neutral agent to handle the exchange of properties.

Capital Gains Taxes. If capital gains taxes are to be paid from sale proceeds, have a detailed discussion with your CFO or CPA about how the net profit will affect your P&L.

My Services

If your real estate investment business needs a savvy analyst for a sale project, who can also present the results with charisma, please contact me to discuss your specific needs.  If my skills fit the needs of your sale project, my hiring terms are: