Make Your Real Estate’s Equity Work for Your Business – the Sale and Leaseback

by M. Will Fischtein

A client of mine was thinking about selling his business (a mid-sized manufacturing firm) and was wondering about what to do about the real estate asset – a large factory and receiving building from which the business operated.

I told him to cash out the real estate now, but continue to run the business until it was time to hand the reins over and retire.

For secession-bound business owners, there are many reasons to consider selling real estate assets and then leasing them back to the companies they run. But the dominant reasons include financing, accounting and tax strategies.

In the commercial real estate parlance, this process is known as a sale and leaseback; whereby the owner of a property (in this case, the business) sells that property and then leases it back from the buyer at a rental rate and lease term agreed to by the new owner. In most cases, these rents are at market rates.

The seller of the real estate is the business that holds real estate assets and potential buyers can include real estate investment trusts (REITs), institutional investors, or any other individual real estate investor or group of investors.

So, why do this? If you own a business and own the premises, why not sit tight until it’s time to sell off the entire operation and then shed all the assets at once?

Simple: the process can free up a lot of capital.

While traditional mortgage debt financing rarely frees up more than 70% of the equity locked in a piece of real estate, a sale and leaseback can free up 100%. That’s a significant increase in capital for a business owner who needs it to redeploy into the core of the business, purchase new equipment, invest in new opportunities, or focus on growth strategies. And, because the leaseback agreement is in place before the sale is consummated, the business owner can make the sale while still retaining the use and control of the real estate asset.

In some circumstances, like those of my client, a sale and leaseback allows the business’s shareholders to take a few chips off the table prior to selling the business or handing it down to the next generation. It can be a smart move if real estate markets are projected to slip, or if there’s no better option for scaring up free cash to spend on improvements to the business’ operations in order to ready it for sale. Many times, a lump sum of equity reinvested into core business ends up yielding greater returns than would have been generated by the real estate asset at the time the business is sold.

And, there’s more. For accounting purposes, a sale and leaseback can help the business pay down existing debt and remove it from the balance sheet while enabling the business to maintain control of the property. Since the business will lease the property, it can defer a good chunk of the corporate tax liability caused by the appreciation of the real estate over time.

In this case, renting has its advantages. Leasing lets the business write off the full rental payment each month as a legitimate business expense on the annual tax returns, and that can contrast nicely verses only being able to write off the interest portion of a mortgage payment: When preparing the business for sale, a bigger write off can really pad up the bottom line.

My client was able to negotiate a flexible lease for ten years and three consecutive renewal options and sees himself running the business for five more years prior to selling. The buyer, meanwhile, was an institutional investor whose main objective was to see return on the investment from rental revenue. He leveraged the real estate by obtaining debt that was priced lower than the asset yield. So both my client and the investor got a great deal, a nice outcome in any industry or transaction.

– M. Will Fischtein, JD, MBA, is the President and Broker of Record of Beacon Corporation, Brokerage, a commercial real estate brokerage and a business intermediary specializing in commercial real estate combined with the sale of businesses in Toronto. Will also serves on the Board of Directors of the International Business Brokers Association – Canada Chapter.