How Does Your Company's Credit Affect Sale-Leaseback Pricing?

When a vacant building is sold, the buyer evaluates the real estate: location, condition, and what it could lease for. In a sale-leaseback there is a second subject, and it is you. The building arrives with a tenant and a long lease already in place, and the buyer's income depends on that one tenant paying every month.

Investors therefore look at a leaseback from two directions. One is the tenant's ability and likelihood to pay for the whole term. The other is what the building would be worth, and how quickly it could be re-leased, if the tenant failed. A strong answer on one side can make up for a weaker answer on the other. A company with modest financials in a versatile, well-located building may attract as much interest as a stronger company in a highly specialized one.

Privately held companies usually have no public credit rating, so investors build their own view from the information you give them. Expect requests along these lines.

• Several years of financial statements, plus year-to-date results. Audited statements carry the most weight, reviewed statements less, internally prepared statements least.
• Revenue and earnings trends, and an explanation for any year that breaks the pattern.
• Existing debt, its maturity dates and what the sale proceeds will repay.
• Rent coverage: how comfortably the company's earnings cover the proposed rent along with its other fixed obligations.
• Customer concentration and the length of key customer relationships or contracts.
• Ownership, management depth and any succession or sale plans.
• Industry outlook and how the business performed in past downturns.
• How important this specific building is to the operation.

The last item is sometimes called criticality. An investor takes comfort when the building houses equipment, licenses, workforce or customer access that would be expensive to replicate elsewhere, because a tenant in that position is likely to keep paying rent even in a hard year.

Credit quality does not appear as a line item, but it runs through almost every term of an offer.

• Price: for the same rent, an investor who sees less risk will accept a lower return, which translates to a higher price. More risk means the opposite.
• Number and type of bidders: some investors only buy leases backed by large or rated companies. Others specialize in middle-market and privately held tenants. Your credit profile determines which groups will look at the deal.
• Credit support: weaker or less transparent credit leads to requests for guaranties, larger deposits or letters of credit.
• Lease terms: investors may ask for a longer term, firmer rent escalations, financial reporting or covenants to compensate for perceived risk.
• Certainty of closing: an investor who is uneasy about the credit is more likely to seek a price reduction during due diligence or walk away.

We do not quote pricing spreads between credit levels here, because they shift with the market and with each property. The direction, however, is consistent: better credit and better information produce better terms.

Many owners are uncomfortable sharing financial statements with strangers. In a sale-leaseback there is no way around it, but you control the sequence. Sensitive information should move only under a signed confidentiality agreement, and it can be released in stages: summary figures to a qualified group, full statements to a short list, and customer-level detail only to the selected buyer, if at all.

Withholding information rarely helps. Investors price uncertainty as risk. If they cannot tell why margins fell two years ago, they will assume the least favorable explanation. A clear account, offered up front, almost always does better than a surprise found in diligence.

Disclose known problems yourself, with context. A weak year that you explain is a data point. A weak year the buyer discovers is a reason to reprice.

You cannot change your financial history, but you can change how complete, credible and well organized it is. Several steps are within an owner's control.

1. Bring financial statements current, and consider whether upgrading to reviewed or audited statements is worthwhile for a transaction of this size. Your CPA can advise on cost and timing.
2. Prepare a short written explanation of unusual items: one-time costs, owner compensation, a lost customer, a plant move.
3. Show the company after the transaction: which debt is repaid with proceeds and what the financial position looks like with rent replacing mortgage payments. Have your CPA prepare or check this.
4. Decide which entity will be the tenant and whether a parent or affiliate will stand behind it.
5. Document why the building matters to the business: investment in equipment and improvements, permits, workforce, logistics.
6. State the use of proceeds. Investors react better to growth investment or debt reduction than to an unexplained cash withdrawal.
7. Choose timing where you can. Going to market on the strength of a good trailing year is easier than explaining a poor one.

A sale-leaseback is still possible for companies with thin margins, a recent loss or bank pressure, and some owners pursue one for exactly that reason. The approach changes. The buyer pool is narrower, the building's own quality and reusability matter more, and the structure does more of the work: a rent level the business can clearly carry, additional security that steps down as performance improves, or a lease term matched to a credible plan.

What does not work is setting rent higher than the business can afford in order to reach a target price. An investor focused on credit will see the thin rent coverage and discount for it, and the company will carry the burden for years.

Questions to answer honestly before approaching investors:

• ✓Can the business cover the proposed rent comfortably in an average year, and still cover it in a poor one?
• ✓Will the proceeds fix the underlying problem or only postpone it?
• ✓Is the building one that another user would want if we were gone?
• ✓What security can we offer without putting the owners at unreasonable personal risk?
• ✓Are our financial statements good enough to be believed?

Part of our work for an occupier is presenting the company to investors accurately and favorably, and directing the offering to the buyers whose criteria fit the credit, so the first round of offers reflects the real business and holds through closing.