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As an owner and operator, I've spent the past four years researching, pursuing, negotiating and closing on sale leasebacks for our properties. The key to using this financial vehicle really lies in your future business strategy, but let's first define a sale leaseback. A sale leaseback is essentially a bond that generates a steady return (rent) to a real-estate investor.
For the real-estate investor to buy your property and building, they consider its location and operating history; your ability to comfortably pay rent for the next 20 years; your market position; comparable rents in the event of a lease cancellation; and ultimately, your management expertise.
The two primary drivers of yielding value from your property are the cash flows (earnings before interest, taxes, depreciation – amortization – generated by your specific stores and the quality of the real estate. In underwriting your cash flows, the investor will want to be comfortable that your EBITDA can consistently pay the monthly rent, thus they discount your EBITDA and give you credit for 50 percent to 80 percent of that performance. Like a bank, they want some cushion to know you are good for the rent.
Next, they look at the quality of real estate, the market and its expected rate of appreciation. As an example, California and New York real estate has historically had higher appreciation rates than Iowa or Arkansas. This leads them to a capitalization rate, which is divided into your annual rent payment. Because of the demand for California and New York real estate, properties "trade" at lower cap rates in these states than the rest of the country. Within these real estate markets, certain classes are more favorable than others, and unfortunately, convenience stores are less desirable than a corporate office.
Executing a sale leaseback can often be a cheaper form of financing than with a traditional bank, and you can use the cap rate as an index. Sure, you give up the real estate now, but through your lease, you still have the site for 20 to 40 years depending upon how many options you wish to exercise. If you are paying an annual rent that approximates 8 percent of the sale price, the theory is you can invest the proceeds into a higher performing asset – your business! Your inventory generates 15 percent to 30 percent returns, and you can build a new store with the proceeds in that growing market. Or, if you are a stock investor, you can match the S&P or NASDAQ returns.
A sale leaseback almost always requires your continued participation in the management of your business. The real-estate investor underwrites you, gets comfortable with you, and wants to believe you are the best operator in your market. If you are growing through new builds or acquisition, that's even better. But it is much harder for the real-estate investor to get comfortable with someone stepping in your shoes, whether at closing or a few years down the road.
There are cases where you can achieve an exit from your business with sale-leaseback financing. An example of that would be Circle K or The Pantry buying your business through an assumption of your long-term lease. Generally, this only works when the assignee (in this example Circle K), has a much better credit rating and balance sheet than you do as an operator.
So, as a growing entity, if you decide to seek this form of financing, what's next?
You can pursue institutional real-estate buyers, either public or private, or you can enter the "retail" market with real-estate brokerage firms that attempt to sell your properties directly. These two channels offer different levels of restrictions, sophistication and value. Additionally, you'll have to get comfortable with how your future landlord will treat you and your business in a long-term relationship.
P.A. (Andy) Weber III is founder of Corner Capital Partners, LLC, an investment bank specializing in recapitalizations, capital raises, and mergers and acquisitions in gasoline and convenience retailing. Most recently, he spent 10 years at Roundtree Capital, a private equity group in Santa Barbara, where he served as president with primary responsibility of building and managing its investments in convenience retailing.