How Long Should a Sale-Leaseback Lease Be?

A sale-leaseback investor is buying a stream of rent from one tenant. The longer that stream is contractually committed, the more certain the investment and the easier it is for the investor to finance and eventually resell. That is why offers for the same building, at the same rent, generally improve as the firm term lengthens, and why buyers push for more years.

From the seller's side each added year is a liability as well as a selling point. You are promising to pay rent on this building in a year you cannot see clearly, whether or not the business still needs the space, fits in it or exists in its current form. The extra price you receive today is real, and so is the commitment.

The useful question is not how long a lease the market wants. It is how many years your company can commit to this site with confidence, and what the market will pay for that number.

Before discussing term with any buyer, write down what you actually know about the company's future in this building.

• ✓How long has the business been at this site, and what would it cost in money and disruption to move?
• ✓Is the building the right size for the plan, or already tight or half empty?
• ✓How much specialized equipment, power, cranes, clean rooms or licensed clinical space ties us here?
• ✓Are there customer contracts, certifications or permits tied to this address?
• ✓Do the owners expect to sell the company, bring in investors or hand it to the next generation during the term?
• ✓Is the industry changing in ways that could alter our space needs, such as automation, reshoring or consolidation?
• ✓How long are the labor market and transportation access here likely to keep working for us?

A manufacturer with heavy installed equipment and a workforce that lives nearby may be comfortable committing for a long time. A professional firm whose headcount could change sharply in a few years should be more cautious. The answers set an honest range for the firm term, and the negotiation happens inside that range.

Renewal options are how a tenant keeps control of the site beyond the firm term. An option is your right, not your duty, to extend. Buyers generally value the firm term far more than options when they price a deal, because they cannot count on an option being exercised. That makes options comparatively inexpensive for a seller to ask for, and they should be in the first draft of the term sheet.

The details decide how useful an option is.

• Number and length: several shorter options give more decision points than one long one.
• Renewal rent: a continuation of the existing escalations gives certainty. Fair market rent protects you if the market falls but exposes you if it rises. If fair market is used, define how it is determined and how disputes are resolved.
• Notice window: a long advance notice requirement is easy to miss. Negotiate a reasonable window and a reminder or cure mechanism so a missed date does not forfeit the right.
• Conditions: options that vanish on any default, however minor or already cured, are weaker than they look.
• Transferability: an option that is personal to the original tenant is lost when the company is sold. Make sure options pass to a permitted assignee.

If you are the kind of occupier who cannot easily move, the options are your protection against being held up at expiration by a landlord who knows it.

If the price you need requires a longer commitment than you are fully comfortable with, the answer is not always a shorter term. Other provisions can reduce the risk of a long one.

• Assignment and subletting rights broad enough that a buyer of your company, or a subtenant, can step in.
• A release of the original tenant or guarantor when a creditworthy assignee takes over.
• A termination right at a defined point, usually in exchange for a fee. Investors resist these and price them, so use them sparingly.
• A right to give back or sublease part of the building if your footprint shrinks.
• A substitution right in portfolio transactions, allowing one property to be swapped for another.

Each of these has a cost in price or in buyer interest. The point is to compare them against simply shortening the term, and to pick the combination that fits your plan.

Term is also an input to how the transaction is reported, and two points should go to your CPA before the letter of intent is signed.

First, lease classification. Under ASC 842, a leaseback that would be classified as a finance lease prevents the transaction from being accounted for as a sale. One of the finance lease criteria is a lease term that covers a major part of the asset's remaining economic life, and renewal options the lessee is reasonably certain to exercise are included in the lease term. A long base term plus renewals priced so favorably that exercise is a foregone conclusion can therefore change the accounting result.

Second, the 30-year question. A Treasury regulation treats a leasehold with 30 years or more to run as like-kind to real estate, and legal commentary on the cases says the term is measured including renewals. A sale with a leaseback that long can raise the question of whether the seller made a like-kind exchange, which can prevent a loss on the sale from being recognized. This matters mainly to owners selling below their adjusted basis, and it is a question for a tax advisor.

Neither point should dictate the business decision by itself. Both are reasons to settle term and options with your advisors in the room.

1. Set your confident operating horizon for the site from the checklist above.
2. Ask for pricing at more than one firm term so you can see what each additional block of years is worth.
3. Add renewal options to every scenario and see whether buyers react at all.
4. Have your CPA test each scenario for lease classification, and your tax advisor for the total term with options.
5. Model total occupancy cost and covenant headroom through the end of the firm term, including escalations.
6. Choose the shortest term that achieves the proceeds you need, with the strongest options you can obtain.

We run that comparison for sellers as a matter of course. Because we represent the occupier and not the investor, our interest is in the lease you will live with after the proceeds have been spent, not only in the price on closing day.