investment bank logoinvestment bank logoinvestment bank logoinvestment bank logo
  • ADVISORY
    • BUY SIDE M&A
    • SELL SIDE M&A
    • CAPITAL RAISE
    • BUSINESS VALUATIONS
  • DEALS
  • ABOUT
  • CONTACT

Real Estate Sale-Leasebacks – The Benefits of Various Leaseback Structures

This article is one in a series covering commercial real estate investment banking. For more information on our real estate investment banking services, click here.

A large number of business owners want to own their real estate, from office space to factories. Although this choice can help strengthen your balance sheet, and give you increased control; it’s not the only way to achieve these goals. Leasing, if structured correctly, can also provide this control and use without the risks associated with ownership.

For the most part, property owners tend to favour sale-leaseback transactions and enter into net lease arrangements. Sale-leaseback transactions allow the property seller to transform illiquid assets into cash while maintaining use of the property.

What is a net lease agreement?

A net lease agreement is an agreement, on a property, where the tenant agrees to pay additional fees, over and above the normal fees which include rent and utilities. These additional fees can include, but are not limited to; real estate taxes, building insurance, and maintenance of the property. Because the typical duration of these lease agreements is long, the landlord generally receives a fixed rental payment, net of all property expenses. A net lease is the opposite of a gross lease, in which the lessee makes a single rental payment and the lessor pays all of the property’s operating expenses.

The two primary classifications of net leases are; bond leases and credit leases.

  • Bond Leases – requires the lessee to complete all obligations related to the leased premises. The lessee is required to pay these regardless of what occurs with the leased premises and is obligated to continue to pay rent. Therefore, the focus is on the lessee’s credit, not the property characteristics of the premises.
  • Credit Leases – these agreements differ from a bond lease as there might be a small set of landlord obligations or real estate risks, rather than the entire risk falling onto the lessee. In a credit lease, the lessee is still responsible for most of the obligations related to the leased premises. However, the lessee may have limited rights to offset or abate rent related to casualty or condemnation or to the landlord’s failure to perform roof, structural, or parking obligations.


What are the benefits to the lessee?

It does not seem intuitive that a creditworthy company would choose to lease. But there are many benefits to this strategy.

1. Matching Assets with Liabilities

A net lease can allow a company to match a long-term real estate asset with a long-term liability. What this means is that a company gets long-term financing, by way of lease terms that typically range from 15 to 25 years, and also renewal options equal to the initial term. This is important for less mature companies or those that do not have an investment-grade credit score. Additionally, this lease structure could suit a company that is expanding rapidly and opening new stores. For example, if a fast food chain is opening 30 new stores, real estate costs of $5 million per store could require as much as $250 million in additional capital just to finance the real estate. Net leasing each location would satisfy that financing need with long-term capital.

2. Classifaction

A lessee can classify a lease as either a capital lease (reported on the balance sheet) or an operating lease (off-balance-sheet). A net lease is an off-balance-sheet financing transaction if it is structured as an operating lease in accordance with the Financial Accounting Standards Board’s (FASB) 13 rules for operating leases and capital leases. Off-balance-sheet items help with a company’s leverage, which can impact your credit rating. If a lease meets any one of the following criteria, however, you must classify it as a capital lease:

  • the lease transfers ownership of the property to the lessee by the end of the lease term;
  • the lease contains an option to purchase the property at a discounted price;
  • the lease term is at least 75% of the estimated economic life of the leased property; or
  • the present value of the lease payments is at least 90% of the fair market value of the leased property.


  • A lease that does not meet any of these criteria is an operating lease, and can, therefore, be an off-balance-sheet item. The main benefit of this classification is reducing your debt-to-equity ratio, which will ultimately impact your cost of debt and is core to your day to day operations (interest payments) and the valuation of your business (impacts the discount rate).

    3. Capital Deployment

    A net lease allows a company to deploy its capital for more profitable investments. Owning a property will not afford you immediate gains, even if you see a capital gain (unrealised). In general, a company should expect to pay rent equivalent to 10% of the cost of the property. The target for capital projects, in particular for growth companies, should be anywhere from 15-20%, if not more. Therefore, if you adjust these gains for the rent you pay (10%) you are netting a 5-10% gain by choosing to rent and deploy your cash elsewhere. In fact, owning real estate can be a long-term distraction from your core business activity. You are not a property investor, you are running a business. Sale-leaseback transactions can enhance the value of stockholders’ equity, reducing risk through more equity and less debt.

    What are the benefits to the lessors?

    Lessors of net-leased properties benefit from having a stable, creditworthy, lasting tenant. Because the net lease provides for the lessee to pay all operating expenses, rental increases flow directly to the bottom line. Although other lease structures may afford a larger increase in rental rates, after adjusting for the corresponding increases in operating costs, often NOI growth is no greater than a net lease. Due to the increased risk, through exposure to vacancy and variable operating expenses, a net lease is generally the safer choice. In addition, the lessor can often obtain more favourable financing for the property than the lessee, because the lessor can pledge the lease income stream toward repayment of the debt.

    Win-Win

    A sale-leaseback coupled with a net lease can benefit both buyers and sellers. The lessee, the sale-leaseback’s seller, receives long-term control and property use without a balance sheet impact (off-balance-sheet transaction). The lessor, the sale-leaseback’s buyer, receives a stable income stream, no operating expense variation and reduced vacancy risk. These benefits can also appreciate the real estate asset.

    • Author
    • Recent Posts
    Nate Nead
    Nate Nead
    Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC, a middle-marketing M&A and capital advisory firm. Nate works with corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He holds Series 79, 82 & 63 FINRA licenses and has facilitated numerous successful engagements across various verticals. Four Points Capital Partners, LLC a member of FINRA and SIPC. Nate resides in Seattle, Washington. Check the background of this Broker-Dealer and its registered investment professionals on FINRA's BrokerCheck.
    Nate Nead
    Latest posts by Nate Nead (see all)
    • Covid-19 Impact on US Private Capital Raising Activity in 2020 - May 27, 2021
    • Healthcare 2021: Trends, M&A & Valuations - May 19, 2021
    • 2021 Outlook on Media & Telecom M&A Transactions - May 12, 2021
    Nate Nead
    Nate Nead
    Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC, a middle-marketing M&A and capital advisory firm. Nate works with corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He holds Series 79, 82 & 63 FINRA licenses and has facilitated numerous successful engagements across various verticals. Four Points Capital Partners, LLC a member of FINRA and SIPC. Nate resides in Seattle, Washington. Check the background of this investment professional on FINRA's BrokerCheck.

    Related posts

    May 27, 2021

    Covid-19 Impact on US Private Capital Raising Activity in 2020


    Read more
    May 19, 2021

    Healthcare 2021: Trends, M&A & Valuations


    Read more
    May 12, 2021

    2021 Outlook on Media & Telecom M&A Transactions


    Read more

    Looking to sell your business? Let's discuss. Contact us today!


    investment banking Logo

    Services

    • M&A Advisory
    • Sell-Side M&A
    • Buy-Side M&A
    • Raise Capital

    About

    • About Us
    • Our Deals
    • M&A Blog
    • Contact Us

    © Copyright Deal Capital Partners, LLC.

    Privacy Policy | Terms of Service | Listing Agreement

    This does not constitute an offer to sell or a solicitation of an offer to buy any securities and may not be used or relied upon in connection with any offer or sale of securities. An offer or solicitation can be made only through the delivery of a final private placement offering memorandum and subscription agreement, and will be subject to the terms and conditions and risks delivered in such documents.

    M&A advisory services offered through MergersandAcquisitions.net. Securities transactions are conducted through Four Points Capital Partners, LLC (4 Points), a member of FINRA and SIPC. Deal Capital Partners, LLC and 4 Points are not affiliated. Check the background of this Broker-Dealer and its registered investment professionals on FINRA's BrokerCheck.

    An Invest.net Partner