The Perks and Pitfalls of a CRE Sale-Leaseback

an image of a handshake in front of a CRE Sale-leaseback signed document

In today’s unpredictable economic climate, investors continue to search for innovative ways to monetize assets and free up working capital. For some, a sale-leaseback agreement may be the perfect option. It allows an investor to relinquish costly assets in exchange for quick cash and continued possession and control of the asset. Let’s take a look at how a sale-leaseback works and review some of the perks and pitfalls associated with it:

What is a Sale-Leaseback Agreement?

A sale-leaseback (SLB) is a transaction where the owner of a company enters into an agreement to sell an asset to a buyer with an arrangement to lease it back to the seller, who will continue to oversee operations of the business. SLBs are used for high value fixed assets such as real estate, machinery, vehicles and land. It is customary for SLB transactions to utilize a triple net lease where the seller/tenant agrees to continue to pay operating expenses such as property taxes, maintenance, building insurance and utilities. SLBs are long-term, usually lasting between 10-15 years.

SLB Perks

Monetary benefits: The seller/tenant can gain access to capital that otherwise would have been tied up in the ownership of the asset. That money can be used to pay debts or expand the business. The buyer/landlord who purchases the property has the benefit of a long-term tenant with a cash-flowing asset, which makes an immediate good return on investment (ROI).

Customizable lease terms: The terms of a SLB are generally more flexible than a traditional lease or mortgage agreement. For instance, the buyer can secure a new lease and set annual increases at a percentage they deem profitable. The seller/tenant can maintain control of the asset during the lease term with options to repurchase the asset, relinquish it or negotiate a lease renewal.

Tax considerations: Lease payments may be tax deductible for the seller/tenant. If the business and property is located within a Qualified Opportunity Zone (QOZ), other tax benefits may also apply. The buyer/landlord may be able to take a depreciation deduction, and if the property is financed, the loan’s interest may also be tax deductible.

SLB Pitfalls:

Lack of flexibility: The seller/tenant will be locked into a rental payment that can only be adjusted with the approval of the buyer. That means even when the rental market softens, the seller/tenant will be locked into a higher rate. The seller/tenant’s desire to relocate or renovate the property will have to be negotiated with the buyer/landlord.

Risk of losing asset: An option to repurchase the asset is oftentimes included in the terms of the sale-leaseback. Otherwise, the buyer/landlord can relinquish that opportunity from the seller/tenant. If the seller/tenant defaults on the lease, it could leave the buyer/landlord without a tenant. If the seller/tenant files for bankruptcy, the buyer/landlord may run into a problem trying to secure a new tenant.

SLBs are complex transactions that can be structured in many different ways. It’s important to understand the terms and weigh all the perks and pitfalls before purchasing an asset or committing to a lease. Consulting with a tax attorney is prudent in calculating the risks and benefits, as SLB transactions could present unpredicted tax consequences, including being characterized as a tax-deferred exchange or a mortgage rather than a SLB.

When you’re ready to make the investment leap, Old Republic Title is here to help with all your title and settlement needs. We have an extensive network of commercial branch offices across the nation. For more information, and to find a branch office near you, visit our Commercial Services webpage.