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    An Explanation of Sale-Leasebacks

    A growing number of convenience retailers are adopting a strategy of leasing new stores rather than owning.

    By Robert E. Bainbridge

    Since 2006, a growing number of convenience retailers have adopted a strategy of leasing new stores rather than owning, according to industry figures. This trend peaked in 2008 with 72 percent of all new stores being leased, often through sale-leasebacks.

    An explanation of sale-leaseback transactions is provided below by industry experts John C. Flippen Jr. and John Sartory of Petroleum Capital & Real Estate LLC.

    What is a sale-leaseback financing?
    Sale-leaseback (SLB) financing is when a company sells one or more of their single tenant owner-occupied properties to a third-party investor, usually for fair market value. The investor provides the seller with a triple-net (see next paragraph) operating lease for a period of 10 to 25 years, plus options so that the seller can continue to occupy the property. Initially, the seller/tenant usually pays the investor a negotiated annual rent equal to 8 percent to 12 percent of the contracted sale price. Most often, the rate is credit-driven and the real estate is considered to be additional collateral.

    What is a triple net lease?
    In structuring SLB financing, a prospective investor enters into a long-term lease agreement by which the property is leased back to the seller/occupier; hence a SLB. The long-term lease agreement in SLB financing is referred to as triple net lease. Under a triple net lease, the seller/occupier agrees to pay all expenses associated with the property use and occupancy, including the cost of insurance, real estate taxes, improvements, on-site property management and maintenance, in exchange for control of the property and a favorable long-term lease.

    What are the primary benefits realized by a tenant from sale-leaseback financing?
    In addition to expense reduction and the conversion of the seller/tenant's liquid real estate assets to capital, a SLB structured properly with an operating lease can provide the seller/tenant company with the following business advantages:

    • Up to 100 percent financing based on the appraised value of the property with SLB financing.
    • Operating leases that do not appear on the tenant's balance sheet as debt or as a long-term lease obligation with SLB financing.
    • Full control of the tenant's real estate under lease provisions with SLB financing.
    • Tax-deductible lease payments with SLB financing.

    Cash realized from the SLB transactions can be used to enhance liquidity, expand operations, acquire other businesses, reduce debt, invest in 1031 exchanges and make other investments.

    What are the primary drawbacks realized by a tenant from sale-leaseback financing?
    The tenant:
    • Will no longer own the property fee simple.
    • Cannot participate in the potential real estate appreciation.
    • Will no longer be able to use the fee-simple value of the property as collateral for further financial leverage.
    • Cannot leave the property to his or her heirs.

    What are some of the requirements of SLB financing providers?
    The SLB provider will first look for a strong operator with experience in the convenience store and gas station industry. The SLB provider will look at both the appraised value of the property and the historical cash flow available to service the lease expense. Typically, SLB providers will provide up to 100 percent of appraised value, excluding business value, or a debt service coverage ratio from 1.50 to 2.25, whichever is lower.

    Many times, SLB providers will not finance transaction costs, standby letters of credit and lines of credit. These items will have to be financed with either cash or other real assets that are available to use as collateral. If there is a remaining portion that needs to be financed, the lender may offer a tranche of mezzanine for the remaining balance. Sometimes, the tenant can structure an option to buy the property back at a fixed price and/or the current appraised value times some pre-determined multiple during the life of the agreement.

    What about obtaining the best SLB financing?
    Petroleum Capital & Real Estate LLC recommends clients chose a sale-leaseback (SLB) financing option when the client either does not have the required equity to facilitate a traditional senior debt option and/or the client does not think that the property will materially increase in value over the next 20 years and thus believes their investment capital would have a higher return in other parts of its business.

    Robert E. Bainbridge is an author, instructor and expert witness in the appraisal and valuation of convenience stores and gas stations. He can be reached at [email protected] or (541) 823-0029. Find more valuation information at www.cstorevalue.com.

    Editor's Note: The opinions expressed in this column are the author's, and do not necessarily reflect the views of Convenience Store News.

    By Robert E. Bainbridge
    • About Robert E. Bainbridge Robert E. Bainbridge is an author, instructor and expert witness in the appraisal and valuation of convenience stores and gas stations. He can be reached at [email protected] or (541) 823-0029. Find more valuation information at www.cstorevalue.com.

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