How Much Cash Can a Sale-Leaseback Raise?

A lender does not advance the full value of a building. It lends a portion of the appraised value and keeps the rest as a cushion in case it ever has to foreclose and resell. The owner's equity above the loan stays locked in the property.

A sale-leaseback works differently because the investor is buying the building, not lending against it. The investor pays a purchase price for the whole asset, and your company signs a lease and stays in place. Published explainers from the advisory firm Stout and the law firm Mintz both describe a typical mortgage as advancing roughly 70% to 80% of appraised value, while a sale-leaseback can be structured for up to 100% of it. Treat those figures as the authors' general descriptions, not as a quote for your property or for today's lending market.

The trade is plain. A loan leaves you as owner with a debt to repay. A sale-leaseback gives you more cash today and ends your ownership, replacing it with a rent obligation for the length of the lease.

In a sale-leaseback the investor is mostly buying a stream of rent, backed by your company's ability to pay it and by the building itself if you ever leave. Three things drive the number.

• The rent you agree to pay. Price and rent move together. A higher starting rent supports a higher price, and you pay for it every month afterward.
• The return the investor requires. Investors accept a lower return, and therefore pay more, when the tenant is financially strong, the lease is long and the building would be easy to re-lease.
• The real estate itself. Location, condition, functionality for other users and any environmental history all affect how much risk the investor sees.

Because rent is an input, the largest possible price is not automatically the right answer. A price built on rent your business cannot comfortably carry is borrowed from your own future operating budget.

Owners are often surprised by how many lines sit between the contract price and the wire that lands in the company's account. Work through each one before deciding whether the transaction meets your goal.

1. Start with the contract price, less any credits the buyer negotiates during due diligence for repairs or other issues.
2. Subtract the payoff of any mortgage or other debt secured by the property, including accrued interest. Ask your lender for a payoff letter early.
3. Subtract any prepayment charge, yield maintenance or defeasance cost in your loan documents. These can be material on fixed-rate loans.
4. Subtract transaction costs: brokerage, legal fees, title and escrow charges, survey, environmental and property condition work you pay for, and state and local transfer taxes.
5. Subtract any money you must spend to close, such as agreed repairs, environmental cleanup or a security deposit under the new lease.
6. Estimate income tax on the gain with your CPA and set that cash aside. It is usually paid later, but it is not yours to spend.

What remains is the cash actually available for the purpose that prompted the transaction.

Many owner-occupied buildings were bought years ago and have been depreciated on the company's tax returns ever since. That matters because of how the IRS measures gain. Under IRS Publication 544, gain is the amount you realize from the sale that exceeds the property's adjusted basis, and adjusted basis is your original cost, increased by improvements and decreased by items such as depreciation.

In other words, depreciation that lowered your taxable income in past years also lowered your basis, which increases the taxable gain when you sell. A building with a low remaining basis can produce a large gain even if the price is close to what you paid.

Publication 544 also explains that real property used in a business and held more than one year is generally Section 1231 property, that a net Section 1231 gain is generally treated as long-term capital gain except to the extent of certain prior-year Section 1231 losses, and that separate depreciation recapture rules can treat part of a gain as ordinary income. Corporations have an additional rule of their own. How those rules apply depends on your entity type, your depreciation history and your state.

Ask your CPA for an after-tax proceeds estimate before you sign a letter of intent. A sale-leaseback should be judged on what you keep, not on the contract price.

The numbers below are round, invented figures chosen to show the arithmetic. They are not market data and do not predict what any building would sell for.

• Hypothetical contract price: $5,000,000
• Hypothetical mortgage payoff: $1,500,000
• Hypothetical prepayment charge: $50,000
• Hypothetical closing costs of all kinds: $250,000
• Hypothetical cash at closing: $3,200,000
• Hypothetical income tax on the gain, estimated by the owner's CPA: $600,000
• Hypothetical cash the owner can actually deploy: $2,600,000

In this illustration, roughly half of the headline price reaches the purpose the owner had in mind. A different owner with no mortgage and a high tax basis would keep far more of the same price. That spread is why two owners with similar buildings can reach opposite conclusions about the same structure.

The fair comparison with borrowing is not sale price against loan amount. It is the net cash each route produces, set against what each route costs you afterward.

• ✓After paying off the existing mortgage, how much new cash would a refinance produce, and how much would a sale-leaseback produce after tax?
• ✓What would the annual loan payments be, and what would the annual rent be, including scheduled increases?
• ✓Does the loan come with financial covenants or a personal guaranty, and what would the lease require?
• ✓At the end of the loan you still own the building. At the end of the lease you do not. How much is that worth to you?
• ✓Is the amount of cash you need closer to what a loan can provide or to what a sale can provide?

If a loan covers the need, selling the building to raise more than you can use is rarely the efficient answer. If the need is larger than a lender will fund, or debt is not available on workable terms, the sale-leaseback becomes the real alternative.

When TAG evaluates a property for a sale-leaseback, we work from the owner's cash target backward to the rent and lease terms that would support it, and we coordinate with the owner's CPA and attorney so the estimate reflects payoff, costs and tax.