Franchising World July 2012
By: Brett Hunsaker
The current economic environment can seem daunting to small-business owners who find themselves in a growth mode. Finding lenders willing to finance expansion needs for relatively new business owners will prove challenging, but doesn’t have to be impossible. Thankfully, the retail industry is beginning to make a turnaround and the investment community is taking notice. While sale leasebacks have been around since the 1940s, the shortage of all types of real estate investments has brought renewed attention to viable sale leaseback opportunities.
In simple terms, a sale-leaseback transaction allows a franchisee to convert his real estate property into the capital he might need for growth. By selling the owner’s physical assets, typically a building, then leasing it back from the purchaser or investor, the franchisee is able to create the liquidity needed for an expansion or growth strategy. This option and all of the various consequences have to be contemplated in advance, and also negotiated or permitted in the franchise agreement.
Sales and Leaseback Strategies
From the buyer’s perspective, a sale leaseback can be an attractive investment in the real estate category as it requires less maintenance and administration than many multi-tenant real estate investments. The investor could be using the sale leaseback to diversify a larger equity portfolio or it could be a real estate investment trust specialized in sale-leaseback investments. For example, a private-equity fund recently purchased a set of approximately 50 fitness centers in the Northeast United States. The logic behind the investment is to utilize the leasing revenue and, in turn, raise additional equity for future projects. By signing a triple-net lease, it relinquishes responsibility for maintenance on the property which gives the franchise absolute control over its operations. Both sides have benefits and possible drawbacks, but when applied by small-to-medium franchisees, it can greatly impact a successful future. The impact presents a greater growth opportunity. However, credit remains scarce.
A sale-leaseback transaction allows a franchisee to convert his real estate property into the capital he might need for growth.
Sale-leaseback investments in larger public companies, such as Walgreens stores or Family Dollar locations, typically come with corporate guarantees or sponsorship, and are typically easier transactions for the investor, with less risk and thus less return. The credit-worthy company signs a long-term lease, generating a reasonable return of equity with limited risk. The company maintains balance sheet flexibility and can focus on managing its core business versus a growing real estate portfolio. These transactions are usually accomplished through a “usual suspects” list of sellers and investors.
Those investors operating in the arena where the smaller franchisee may be found will certainly require more return for the additional risk, have due diligence demands and paperwork from the initial point of introduction through the closing of the transaction, but the end result for the seller is essentially the same: The investor buys a real estate asset that typically has less management and rollover risk than other assets in the same class. However, they receive a yield that should be higher than other equity investments in the marketplace.
Sellers on the other hand might use a sale-leaseback strategy to clean up balance sheets, enhance financing options or manage tax considerations related to their core businesses. Larger companies that execute sale leasebacks might do so to avoid the cost and expense of having internal facilities management staffs. On a smaller basis, this is one of the benefits to the franchisee when doing a sale leaseback, he can shed the responsibility of maintaining the physical property, paying or appealing taxes, negotiating property insurance, and so forth, as well as being able to focus on the core business and operations needed to expand the business. A well-structured sale leaseback can, however, still leave the franchisee in control of the property’s physical condition by requiring certain standards of maintenance, rights of ways, easements and so on; all while accomplishing the franchisee’s main objective of raising capital needed to grow when opportunities present themselves.
An Existing Strategy in Selling the Business
Another advantage to a sale or sale leaseback is for the retailer looking for an existing strategy in selling the business. If the operator currently owns the real estate prior to the selling the business, consult with a commercial real estate professional who specializes in triple net or sale leasebacks to determine the best way to structure the sale of the asset either to the buyer of the business or to an investor. There are typically four options:
1. Outright sale of the asset to the buyer.
2. Outright sale of the asset to an investor.
3. Complete a sale leaseback to an investor with the existing operation with assignment to a new buyer.
4. Set up a sale leaseback pre-negotiated for the buyer of the business.
All options have different advantages. Once they are understood, then discuss with the business broker, CPA or financial planner for the option that works best with selling the business.
Before entering a sale-leaseback transaction, the franchisee should consult with his real estate attorney and or tax consultant.
When looking at outright sale or sale leaseback, investors want credit, lease term (at least 10 years, but prefer 15), market rents with escalations. To determine the way to structure a lease for a possible sale or sale leaseback, consult with a commercial real estate agent in the local market for market terms. These professionals can advise you with the terms you have agreed on to present/list the value of your property, but remember your business is your top consideration. Don’t let the real estate deal and the value drive your decision or it could be a burden on your operations and cash flow to run the business.
The success of a franchisee will always be determined by the core business strategy, but can be enhanced and more profitable if he learns creative ways to manage the assets and liabilities on his balance sheet. This option for financing the physical plant should be taken into consideration when the need for capital presents itself. With the current economic climate and unfriendliness of the credit markets, a sale-leaseback transaction could provide an efficient and effective means to generate equity for company expansion. As with any financing strategy, before entering a sale-leaseback transaction, the franchisee should consult with his real estate attorney and or tax consultant.
Brett Hunsaker is executive vice president, regional managing director of Newmark Grubb Knight Frank. He can be reached at 770-552-2444 or firstname.lastname@example.org.