What Types of Property Work for a Sale-Leaseback?

An investor considering your building asks two questions that pull in different directions.

Is this site essential to the tenant? Investors often use the phrase mission-critical. A company's only manufacturing plant, its main distribution center or the clinic where all of its revenue is produced is hard to walk away from. The more the business depends on the location, the more confident the investor is that rent will be paid through good years and bad.

Could someone else use it? If your company fails or leaves at the end of the lease, the investor needs to lease or sell the building to another party. A standard warehouse in an established industrial area has many possible users. A building designed around one unusual process has few.

The ideal property from an investor's point of view scores well on both: vital to you and useful to others. Most real buildings are stronger on one test than the other, and the price and lease terms reflect the mix.

Industrial buildings are a natural fit, and manufacturing and logistics are among the sectors most often cited for sale-leasebacks because companies in them have large amounts of capital in facilities.

Warehouses and distribution buildings are usually the easiest to place with investors. Their features are generic: clear height, loading docks, truck access, proximity to highways. Many tenants can use the same box.

Manufacturing plants tend to be highly critical and less reusable. Heavy power, cranes, pits, specialized ventilation and process piping make the building valuable to you and costly to convert for someone else. Investors still buy them, but they study the tenant's credit more closely and look at what the building would be without the specialized elements.

Industrial sites also carry the most environmental history. Buyers will commission an environmental assessment, and known or suspected contamination can slow or reshape a deal. It is far better to learn what the reports will say before the building is offered.

Practice-owned clinics, surgery centers, dental offices and other outpatient facilities are regularly sold and leased back. They score well on criticality: patients know the location, the build-out is expensive to replicate, and licensing or equipment can make a move slow.

Reusability depends on the building. A general medical office with exam rooms suits many practices. A facility built around a single specialty, with shielded rooms or surgical suites, has a narrower set of replacement tenants. Investors in this sector also pay attention to the practice itself: how many providers generate the revenue, how long they are committed, and who signs the lease.

When physicians or dentists own the real estate personally and lease it to their own practice, a sale changes arrangements among the partners as well. Healthcare transactions can raise regulatory questions about dealings between providers and the parties they do business with, so have healthcare counsel review the lease and the sale.

A single-tenant office building, such as a corporate headquarters, can be sold and leased back, but investors apply more caution than they do to industrial property. The question they ask is whether the company would truly have difficulty moving. Office work is easier to relocate than a production line, so the criticality argument is weaker unless the building houses something hard to move, such as a data facility, laboratory space or a large specialized build-out.

Reusability matters more here. A well-located building of ordinary size that could be divided among several tenants is easier to sell than a large, single-purpose campus in a location with few alternative users. Where the company occupies only part of a building it owns, a sale with a leaseback of that portion is possible and attracts a different kind of buyer, one prepared to lease the rest.

Freestanding retail buildings are a staple of net lease investing. Convenience stores, restaurants, auto service locations, pharmacies and similar properties are sold and leased back, frequently in groups, by operators with many locations. The appeal to investors is simple real estate that another retailer could occupy, on sites chosen for traffic and visibility.

For operators with several locations, a sale-leaseback need not include everything. A company can sell some properties and keep others, or sell a portfolio under one lease covering all of the sites. A single master lease gives the investor more security and may improve pricing, but it also ties the locations together, which limits your ability to close an underperforming one.

• Very specialized construction with little use to anyone else, which raises the risk that the building is worth much less at the end of the lease.
• A location with weak demand, where a replacement tenant would be hard to find.
• Deferred maintenance on the roof, paving or mechanical systems.
• Unresolved environmental conditions.
• Title problems, encroachments or zoning nonconformities.
• A building far larger than the business needs, or one the business may outgrow soon.

Specialization also has an accounting angle. Guidance on ASC 842 lists, among the tests that make a leaseback a finance lease, an asset so specialized that it has no alternative use to the lessor at the end of the term, and a lease term covering a major part of the asset's remaining economic life. A leaseback classified as a finance lease prevents the transaction from being accounted for as a sale. If your building is highly specialized or old, raise this with your CPA early.

• ✓Would relocating this operation be expensive, slow or disruptive to revenue?
• ✓If we left, how many other companies could use the building largely as it stands?
• ✓Is the location one where comparable buildings lease readily?
• ✓Do we know the condition and remaining life of the roof and major systems?
• ✓Is there any environmental history on the site, and do we have reports?
• ✓Is the building sized for where the business will be in ten years?
• ✓Does the operating company or a separate entity hold title?

TAG's second step in any sale-leaseback is evaluating the property on exactly these points, including location, condition and market value, so that the price and lease we pursue are ones the building can support.