Sale-Leaseback - Unfreeze Your Credit Now

A sale/leaseback transaction, in its simplest form, is a method for a business to raise immediate cash. When a business owns its real estate (and generally has substantial equity in the real estate) it can gain a new source of cash which it can then invest back into the business, payoff partners, etc. It generally has positive effects on the balance sheet and by leasing the property for a substantial period of time; the business retains control of the property.

During this credit crunch, more and more companies are using a sale/leaseback transaction as the preferred method of obtaining additional cash for operating expenses.

Generally, a buyer looks at three main items in considering the transaction:

1. The market value of the property being sold, including consideration of the condition of the property.
2. The fair market rent the property may yield — the rental income stream is used to calculate the potential value of the property being sold.
3. The credit worthiness of the seller.

The first two calculations must yield similar results — that is the value of the property based on the rental income must be close to the market value of the property. The reason for this is that if the seller goes out of business, the buyer can reasonably re-rent the property and continue his/her income stream. Years ago, buyers often purchased properties solely based on the rental income stream, without due consideration to the market value of the property. Unfortunately, a number of these buyers ended up “upside down” when the seller went out of business. “Upside down” means the amount of mortgage the owner has on the property is greater than the current market value of the property.

Here is a simplified example: Let’s say a company owns a 40,000 square foot building and wants raise cash by using it in a sale/leaseback transaction (assuming no debt on the building). If the market value of the building is $50.00 per square foot (equaling $2 million) and the buyer wanted to buy the building at a rate of return of 10%, the seller would have to sign a lease paying approximately $200,000 per year, net, for at least 10 years. That amount equals $5.00 per square foot as a rental rate [$200,000 divided by 40,000 sf]. In evaluating this potential deal, if $5.00 per square foot was indeed the going rental rate, and $50.00 per square foot was a reasonable sale price in the area, then the buyer could reasonably expect that $2 million was a fair sale price. Using this formula, the buyer and seller are generally able to come to a reasonable conclusion as to the value of the building and the lease.

Naturally, this is only a very brief overview of the sale/leaseback process, for more details; speak with your attorney, accountant and broker.

I am a Senior Vice President with Preston Partners Real Estate in Baltimore, MD and have 20 years of commercial real estate experience in industrial sales and leasing. My unique perspective has helped both major corporations and small businesses alike. Call me at (410) 296-3800 x 4137 or visit my web site http://www.michaelspedden.com

Michael Spedden
Preston Partners Commercial Real Estate, Inc.
(410) 296-3800 x 4137
http://michaelspedden.com