The continued challenges of supply-chain backlogs, material price increases and labor difficulties are extending the time it takes for projects in the industrial real estate market to get started. And now a series of rapid interest rate increases are driving up the cost of construction and renovation projects even more.
But the tight industrial market and the high real estate prices that brings aren’t a negative to some. For instance, Simon Caplan, a partner at Cushman & Wakefield | CRESCO Real Estate, says he’s seeing a high number of building owners use sale-leasebacks to create liquidity they’re using either to cash out or inject cash into their growing business.
Smart Business spoke with Caplan about how conditions in the industrial real estate market have made sale-leasebacks an increasingly popular choice.
How is the market affecting building owners?
Landlords who are making substantial improvements to their tenants’ buildings through large-scale renovations are adjusting rents to compensate for the costs. Given the delays in material shipping and slowdowns based on labor issues, some landlords in these situations are facing financing changes as interest rates rapidly rise. That means the deals that were negotiated months prior have potential problems for the landlords who didn’t anticipate, say, a 1.5 percent interest rate increase.
Still, the shortage of industrial properties and the historically high prices for existing buildings are creating opportunities. Business owners and companies that own their buildings are increasingly selling or doing sale-leasebacks, an arrangement that has the seller lease the same asset from the buyer they sold it to. It’s a chance, in this environment, to sell the building for top dollar, to get liquidity out of the deal as well as fixed rent, often for years.
Who can benefit most from a sale-leaseback?
A sale-leaseback is great for someone with a strong business looking to get cash out of their building while keeping their business running. It’s often a strategy for those who are nearing or contemplating a near-term retirement, especially someone who doesn’t expect to leave the real estate to family operating in the business.
For those who have family who benefit from the business, some owners choose to sell the building and distribute the money to those who are active in the business as well as those who don’t participate. It’s a way to provide an equitable benefit to heirs regardless of their involvement in the company.
It can also be a strategy to consider for a company that could use a capital boost to expand their inventory, buy new equipment or expand the current building. This is a great time to get top dollar for the building and reinvest that money back into the business to take advantage of an opportunity or accelerate growth. Also, some owners who need significant cash to invest back into the company do sale leasebacks as a financing vehicle.
This should only be a strategy if the business has a specific need for the money. Otherwise, it doesn’t make sense because, in the long run, holding the real estate asset is often the better strategy. Once the building is paid off, the former mortgage payments become an income stream, and there’s no reason to give that up. There are also other strategies to leverage the real estate — for instance, putting the building in an LLC and paying rent to the owners, creating a new personal income.
Sale-leasebacks work best when the underlying business is strong. However, often a sale-leaseback is used to help fund a struggling business to improve their situation.
A sale-leaseback also doesn’t offer much return if the seller has bad credit. It’s harder to sell the building, the return likely won’t be as much, and that business becomes a high-risk tenant. That means the seller isn’t likely to get a favorable lease rate.
Connect with a real estate adviser to discuss options. A sale-leaseback can be a great strategy, especially in this market, but it can also be a significant misstep for those using it improperly. ●
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