What Is a Sale-Leaseback?

Most business owners think of selling a building and leasing a building as separate events that happen to different companies. In a sale-leaseback they happen to the same company on the same day. You walk into closing as the owner and walk out as the tenant. Nothing moves. The machines, the exam rooms, the racking and the staff stay exactly where they were.

What changes is who holds title and what your company holds instead. Before closing, your company owns a building and may owe a mortgage on it. After closing, it holds cash, has no mortgage on that property if the loan was paid off from the proceeds, and owes rent under a lease. An illiquid asset has been converted into money the business can use.

The buyer is almost always an investor, not another operating company. The investor is not buying a building so much as buying a stream of rent, and the party paying that rent is you. That is why the lease matters as much as the price, and why both are negotiated together.

A sale-leaseback is built from two contracts that depend on each other.

• The purchase and sale agreement. This covers the price, the buyer's inspection period, what the buyer may investigate, the title and survey process, what each side promises about the property, the conditions for closing and what happens if either side walks away.
• The lease. This covers how long you may stay, what rent you pay and how it rises, who pays property taxes, insurance and repairs, what you may change in the building, whether you can assign the lease or sublet, your renewal rights and the condition you must return the building in.

The purchase agreement governs a relationship that lasts a few months. The lease governs one that can last decades. Owners who spend all their energy on price and treat the lease as an attachment tend to regret it, because every dollar of rent and every obligation in the lease is something they will live with long after the sale proceeds are spent.

The lease is normally attached to the purchase agreement as an exhibit and signed at closing. Negotiate its key terms before you accept a price, not after.

The cast is small, but each party has a different interest.

• The seller and future tenant: your operating company, or a separate entity you own that holds the real estate and leases it to the operating company today.
• The buyer and future landlord: an investor that wants long-term rental income. It will study your financial statements as closely as the building.
• Your existing lender, if there is a mortgage. The loan is usually paid off at closing, and other lenders to the business may need to consent.
• The title company, which handles the closing, the payoff and the transfer of the deed.
• Your advisors: a commercial real estate broker representing you as seller and tenant, a real estate attorney, and your CPA.

TAG's role in that group is to represent the occupier. We work for the company selling the building and staying in it, not for the investor buying it.

The following is hypothetical, for illustration only. The numbers are round and invented to show the mechanics. They are not market data and say nothing about what your building would sell or rent for.

A family-owned distributor owns the warehouse it has operated from for many years. The building has a remaining mortgage balance of $1,000,000. An investor agrees to buy the building for $5,000,000 and lease it back to the distributor at $400,000 per year, with the distributor continuing to pay property taxes, insurance and maintenance as it always has.

1. At closing, the investor pays $5,000,000 to the title company.
2. The title company pays off the $1,000,000 mortgage and the closing costs, and sends the balance to the distributor.
3. The deed transfers to the investor and the lease takes effect the same day.
4. The distributor keeps operating without interruption and begins paying rent.
5. The distributor's CPA calculates any tax due on the sale, which reduces what the company keeps.

The distributor has traded a mortgage payment and an owned building for a rent payment and cash. Whether that is a good trade depends on what the cash will earn in the business, how long the company expects to need the site, and how well the lease was negotiated.

Three confusions come up often enough to clear away early.

It is not a loan. A loan leaves you as the owner and is repaid. In a sale-leaseback you give up title for good unless the lease or a separate agreement gives you a way to buy the building back, and such rights carry accounting consequences of their own.

It is not a way to make an obligation disappear from your financial statements. Under current US accounting rules, a company that leases its building back records a right-of-use asset and a lease liability for the lease. The accounting result depends on the facts of your deal, so involve your CPA early.

It is not a sale of the business. The operating company, its customers, staff and equipment are not part of the transaction. Only the real estate changes hands.

A sale-leaseback suits some companies well and others poorly. These questions separate the two quickly.

• ✓Does the company, or an entity you control, actually hold title to the building?
• ✓Do you expect to operate from this site for many years?
• ✓What specifically would the cash be used for, and what would it earn there?
• ✓Can the business comfortably carry the rent in a weak year, not only an average one?
• ✓Is there a mortgage, and does it carry a prepayment charge?
• ✓Have you asked your CPA how the sale would be taxed and how the lease would be reported?

If the answers hold up, the next step is to understand the sequence of the transaction and how price and rent are tied together.