In California and other states, specialty manufacturing businesses and high tech firms sometimes face a difficult dilemma. In the early days of crafting their business model, they may have acquired one or more tracts of improved real estate that they utilize to produce their products or services. At the time of the acquisition, this seemed to make sense; the firms needed control over their location and processes. They likely financed the real estate purchase with an infusion of cash – obtained either through the sale of common stock, or through mezzanine financing – and a traditional mortgage.
Owning Real Estate Can Actually Be Expensive
In hindsight, they may now realize that they have too much valuable capital invested in their real estate. They find themselves in the business of owning real estate, when the original plan was to produce the high tech item or service that the public needs or wants. For such businesses, a sale-leaseback arrangement might be the answer.
Sale-Leaseback: What Is It?
Generally, a real estate sale-leaseback is a carefully crafted two-step transaction. In step 1, the owner-occupant sells the land and improvements used in its business operations to an investor. In step 2, the former owner-occupant leases the land and improvements back from the investor, under terms that are favorable to both parties.
Advantages of a Typical Sale-Leaseback
Carefully crafted sale-leaseback transactions can offer a number of important advantages:
- Costs of “financing,” i.e., the lease payments, are often considerably cheaper than mezzanine financing.
- The purchaser/lessor is usually interested in an income flow, not in being a landlord. The lease agreement is generally a net-net-net lease, with the “old owner” maintaining virtual control over the land and improvements.
- Depending on the situation, there can be considerable tax savings for the “old owner.” The full lease payment is deductible, whereas before, the interest expense and depreciation were the only available deductions. This can be particularly important when the original down payment for the real estate was provided by proceeds from common stock.
- Generally speaking, a sale-leaseback arrangement amounts to 100 percent “financing,” whereas the original transaction required that valuable capital be tied up to meet the lender’s requirements.
- Ordinarily, since the sale-leaseback transaction is not a loan, there is little need for the type of covenants that a bank or other lender would require.
- Sale-leasebacks typically free up capital for growth.
- Sale-leasebacks can be particularly helpful if the principal shareholders/owners of the former owner-occupant – now the lessee – is trying to “package” the business for sale to private equity groups. Whether they admit it or not, most private equity groups base their willing purchase price on some multiple of the business’ earnings before interest, tax, depreciation, and amortization (“EBITDA”) Generally speaking, removing the real estate from the equation – i.e., through a sale-leaseback arrangement prior to the packaging of the underlying business for sale – will improve the business’ EBITDA.
Have You Considered the Benefits of a Sale-Leaseback?
CKB VIENNA LLP has a long history of representing clients in all phases of real estate ownership, including contract negotiations and drafting original acquisition transaction, in the arranging of mezzanine financing, and in the crafting of sale-leaseback arrangements that can provide value and flexibility to any business. We would be honored to assist you. Our team makes it a point to understand your business structure, your needs, and your long-term goals. We have offices in Rancho Cucamonga, San Bernardino, and Los Angeles. Contact us by telephone at 909-980-1040, or complete our online form.