Sale-Leasebacks Are Back, Baby
The sale-leaseback transaction, nearly dormant in 2020, is coming back in vogue as investors search the pandemic-riddled landscape for yield while cash-strapped tenants hunt for capital infusions.
Often parties with these two convergent interests find a solution in sale-leaseback transactions, or deals where businesses sell off properties to commercial real estate investors and then lease the same spaces back as tenants.
"I would say the current backdrop is incredibly conducive for sale-leasebacks right now," SLB Capital Advisors Managing Partner Scott Merkle said. "I would go as far as to say the market is really on fire."
Sale-leaseback activity picked up in the past several months after declining during the coronavirus pandemic. The deal type reached a trough in the third quarter of 2020 and then rose again with data from SLB Capital showing there was $3.1B worth of sale-leaseback activity nationwide in the fourth quarter of 2020, up from just shy of $2B in Q3 and $2.7B in Q2 2020.
Deal flow has a ways to go to get back to prior peaks for dollars spent — SLB Capital data shows $11.1B worth of sale-leaseback deals in Q4 2019. But those numbers were skewed by high prices and large deals in late 2019, and 2021 has come out strong for number of transactions.
SLB Capital reported 160 completed sale-leaseback transactions nationwide in the first quarter of this year, up from just over 150 deals in the same quarter of 2020 and roughly 145 in Q1 2019.
Experts say this is likely just the beginning of a wave of deals, especially since they can be beneficial to both buyer and seller.
Business owners may consider sale-leasebacks to remove debt obligations from their balance sheets in rough economies, in this case particularly if they have been hit hard by the pandemic, said Dallas real estate attorney Camisha Simmons, managing member of Simmons Legal PLLC.
In the past year, several major retailers in DFW, including Tuesday Morning and Havertys, offloaded commercial real estate in sale-leaseback deals. In both cases, the firms entered into sale-leasebacks after experiencing substantial drops in traffic and sales during the early days of the pandemic.
"When a company is experiencing a liquidity crisis, or they are having problems with cash flow, they will often try to restructure their balance sheets to monetize whatever assets they may have in order to increase cash to use in operations or increase company profit," she said.
Businesses are most likely to consider selling and leasing back their properties in low-interest-rate environments like today with ongoing cap rate compression because they can get competitive rates, Edge Realty Partners Senior Associate for Capital Markets Nicolas Elwood said.
It's all about pricing and value.
"More and more property owners/users [are] putting their self-occupied facility on the market to capture price appreciation," Henry S. Miller Director of International Business Angela Chen said. "It’s an ideal deal for 1031 exchange buyers and investors; usually they are willing to pay a little premium for a long-term leaseback as long as the company is in good financial condition."
Merkle sees two primary drivers of sale-leaseback activity in today's market: a sharp divergence in the value of a business when compared to the appreciation of its underlying property and an increase in merger and acquisition activity, which tends to drive sale-leasebacks.
"If you look across the wide swath of middle-market businesses, there continues to be a delta between what the underlying business is worth compared to the effective real estate multiple, so a lot of companies and private equity firms look to do sale-leasebacks to capture that value arbitrage," Merkle said.
Essentially, investors can get more bang for their buck on these deals than out in the middle-market sphere. Merkle also is watching the resurgence of net-lease REITs, which were on the sidelines in 2020 but are now actively deploying capital again, as they are typically major buyers of sale-leaseback assets.
Newmark Executive Managing Director Ken Hedrick worked on a team in March that finalized a $109.4M sale-leaseback transaction in Hawaii that involved a 21-property gas station and convenience store portfolio with assets located across the state.
Hedrick saw this type of transaction gain in popularity in late 2020 and demand for it has bled over into 2021, he said.
"From a tenant's perspective, the positives in utilizing a sale-leaseback is in unlocking 100% of the value of the real estate through a sale-leaseback transaction versus carrying the property where they may be leveraged at 70% or 65%," Hedrick said.
And with interest rates remaining low and demand for single-tenant essential retail spaces (such as grocery stores and pharmacies) and industrial spaces still high, it's the perfect time for tenant-owners to cash in on these types of spaces, Hedrick added.
He said there is another benefit for businesses that is sometimes overlooked in these deals — the company becomes a tenant but often has the ability to set its rents, negotiating pricing based on how individual units are performing.
"They can set rents at or below market while still maximizing the value of the real estate," Hedrick said.
The sale-leaseback spaces investors want the most are industrial assets and essential retail concepts, such as quick-service restaurants with drive-thrus, Edge Realty Senior Vice President Bill Pyle said. These concepts remain creditworthy and strong, but their owners may also want new capital of their own to deploy.
"The majority of them never shut down, or they may have closed down their dining areas, and shifted to delivery and drive-thru only," Pyle said of restaurants. "I think they are trying to capitalize on the demand and it's difficult when you are an owner and builder of your property and also an operator to have that kind of capital tied up in a location versus getting it off the ground, signing the lease and selling the real estate to redeploy the capital into opening more locations."
Smaller mom-and-pop retail tenants can also benefit from sale-leasebacks in today's environment where it's now much harder to access traditional lending solutions, Weitzman Associate Cameron Mai said. And when partnered with an investor who trusts the tenant's underlying concept, restaurants and retailers can simply cash out on their underlying real estate and keep operating as a tenant.
"It's a risky business too because restaurants right now are uncertain still," Mai said. "There has to be both trust between the investor and the tenant together. It's not like they can do an easy leaseback to any tenant. You have to know each other."
The positives aren't only for the sellers. Some of the main beneficiaries of sale-leasebacks are investors who cannot create quality yields in today's low-interest-rate banking environment and retailers who need cash flow, Mai said.
"I am working with an investor who told me he has some cash sitting in the bank," Mai said. "He is losing money, so basically, he asked me to help him look for a restaurant building."
The investor created a deal where he will own a building that is leased out to a creditworthy Tex-Mex concept that is considered a quality tenant long-term.
"We are seeing more and more of these concepts roll their units out, especially the ones that have fared very well during Covid and that continued to perform very well especially with the additions of double drive-thrus for these restaurants," Elwood said. "You can continue to increase the price, lower the cap rate or compress the cap rate, thus incentivizing more of these operators and groups to continue doing sale-leasebacks."
That is especially true in the retail market, with essential products in high demand and market fundamentals making it extremely valuable to sell and lease back key spaces. And the success businesses and investors alike can find in these deals may spur them to seek out more sale-leaseback opportunities.
"Sale-leasebacks are just a great opportunity to free up your capital and you can roll that money into all aspects of your operation," Elwood said. "You can pay off existing debt, fund more developments, acquire more sites, acquire more existing assets. There are a lot of different things you can do with it. I see there being a continued increase in the sale to leaseback space."