Sale-Leasebacks During COVID and Beyond
More companies are looking at sale-leaseback as an alternative source of financing, as other financing markets are trending back.
This story originally appeared in the Winter 2021 print edition of the Middle Market Growth Outlook Special Report. Read the full report in the archive.
Sale-leasebacks have long been an effective capital solution for private equity groups, operators, franchisees and franchisors in many industries including restaurants, industrial and manufacturing facilities, general retail and medical properties. With the debt market being more conservative during the pandemic, the financing options have become limited. Many companies are increasingly looking at sale-leaseback as an alternative source of financing, as other financing markets are trending back.
The sale-leaseback market continues to remain strong during the pandemic. For 70-80% of the property types, cap rates have been consistent to what they were pre-COVID. The cap rates have improved for manufacturing and distribution facilities, as well as many other businesses that have proven to operate strongly or thrive during the pandemic. We have also seen cap rates tightened in sectors like automotive services, gas stations, convenience stores and QSRs during the pandemic. The sale-leaseback market for the hospitality sector and for some of the big box retailers has suffered, but the transactions are still getting done at higher cap rates.
Getting a sale-leaseback valuation from a credible real estate advisory firm that understands the market is usually as easy as getting a traditional debt quote and there is no charge to get a general market assessment. If a PE firm or an operating company wants to get a sale-leaseback valuation for the real estate in their portfolio, a real estate advisor can usually provide the valuation within a week. Typically, the information required for the pricing assessment would be the current financials of the company including income statement and balance sheet, the basic real estate fundamentals like address of the property/ies, building size in square foot and land in acres. If the firm decides to move forward with the sale-leaseback, then the entire process can be completed as quickly as 30 days, but usually within 60 to 90 days, which is not different than a typical financing.
Another important thing to note is that the appraised value of the property is not necessarily the sale-leaseback value. Based on historical transactions, companies have completed sale-leaseback transactions for anywhere between 20% to 100% more than the traditional appraised value. Comparatively, traditional real estate financing only yields proceeds between 60% and 80% of the appraised real estate value, which is usually tied to replacement cost. In several instances, sale-leaseback value of the real estate can be greater than the purchase price of the operating business and the underlying real estate.
In several instances, sale-leaseback value of the real estate can be greater than the purchase price of the operating business and the underlying real estate.
The survey results show that almost 80% of the PE firms have not conducted a sale-leaseback in the past. Interestingly, 60% of the respondents have owned real estate in their portfolio companies. This may be the result of other forms of debt being more easily available during the past few years. Many of them most likely did not even explore a sale-leaseback as a viable option. As more than 25% of the PE firms have changed their financing strategies due to the pandemic, sale-leaseback activity could increase among sponsor companies as a viable alternative.
As the demand to own commercial properties for the long term has increased for both institutional as well as private investors over the past few years and especially during the pandemic, the supply and demand curve will most likely be in tenant and operating companies’ favor and it will continue to compress cap rates. Sale-leasebacks will continue to be a useful tool for sponsors and tenants to finance M&A transactions, reduce debt and fund capital expenditures.
