By Lynn Koller
Reprinted from: Florida Real Estate Journal - April 15, 2004
The appeal of single-tenant properties -- offering investors stable income with negligible operating expenses -- is making sale-leaseback transactions sought-after investment vehicles.
Low cap rates and tougher accounting rules make sale-leasebacks popular for retail businesses. Moreover, companies often find that owning their property is not integral to achieving their business goals. Scott Farb, principal-in-charge of the national real estate group at Rothstein, Kass & Co. in Beverly Hills, estimates the sale-leaseback real estate market in the U.S. will increase by $10 billion to $15 billion in 2004.
Pier One Imports, Burger King and Michael's Crafts are notable examples of the many national companies that use sale-leaseback transactions. Steve Ekovich, regional manager for Marcus & Millichap in Tampa, says that his firm has many single-tenant, triple-net leased properties for sale in Florida, including CVS in Port Orange, Eckerd in Deltona, Cracker Barrel in Bradenton, and Hughes Supply in Miami.
"From an investor's perspective, the hottest things on the market are sale-leasebacks," Ekovich says. "Since 9-11, there's been a real flight to safety."
Why would a solid company want to pay rent? Cynthia Shelton, vice president of development at Orlando-based Commercial Net Lease Realty, says that businesses are freeing assets, cleaning up their balance sheets, taking advantage of market hunger for single-tenant properties, and generating cash for expansion projects.
"One way to generate cash is to start selling off real estate. That's not their business anyway," Shelton says. "They're saying, 'Real estate isn't our core business, so why not dispose of those assets and clean up our balance sheet.'"
Shelton estimates that a company would expect to pay rent, before taxes, of between 7% and 9% of the sale price. With average return on investment targets for growth companies ranging north of 15%, Shelton figures that a tenant may net between 5% and 10% on capital that is now available for more profitable investments, such as those related to the company's core business.
Shelton predicts the popularity of sale-leasebacks will continue, as long as the interest rates remain low. Ekovich adds that tougher accounting rules have also swelled the popularity of sale-leasebacks. In the past, synthetic leases were instruments that allowed businesses, in effect, to keep their real estate ownership off the books.
"Companies are rushing to make sure that they're properly holding ownership," Ekovich says.
Farb says that public companies generally do not want to deal with off-balance-sheet issues anymore, due to the post-Enron political climate.
"A lot of companies are evaluating their balance sheets and looking for way to monetize the value of their real estate," Farb says. "The sale-leaseback is a very good way to accomplish that objective."
The Financial Accounting Standards Board's recent adoption of Financial Interpretation Number 46 titled "Consolidation of Variable Interest Entities" provides complicated rules that curb the use of off-balance-sheet types of entities such as synthetic lease transactions.
There are, however, several governing accounting principles that sale-leaseback transactions must follow. Farb says that for a transaction to qualify as a sale-leaseback under FASB rules, the seller/lessee must actively use the property in its business, sale-leaseback payment terms must demonstrate the buyer's continuing investment in the property, and the seller/lessee must not have a continuing involvement in real estate other than the leaseback. If the transaction does not qualify as a sale-leaseback, the seller must account for the transaction as a financing, in which case the buyer is treated as a lender.
Despite strict requirements, sale-leasebacks often offer investors a way out of more work-intensive real estate investments. Ekovich says that investors that owned other types of real estate, like apartments and shopping centers, are finding that they like the relief of property management responsibility that single-tenant offers, and they are using IRS 1031 exchanges into single-tenant properties.
"The owner will say to the tenant, 'You can have use of this building, but you pay all the expenses,'" Ekovich says. "An owner can buy those things anywhere in the country, because there's no maintenance and no management, so it's not like you have to worry about going to see it."
Ekovich points out that in sale-leaseback situations, the single tenant's credit is everything. Leases can be single-, double-, or triple-net. Single means the tenant pays taxes only; double pays taxes and insurance, and a triple-net lessee pays for taxes, insurance and maintenance.
"A non-credit versus a credit tenant makes a huge difference in the value of the property," Ekovich says. "If it's pure a triple-net lease with a great credit tenant, it's like having a bond."
Sale-leasebacks may involve either bond or credit leases, depending on the landlord's obligations. Shelton explains that in a bond lease, the lessee performs all obligations related to the premises. In a credit lease, the landlord may have some obligations or risk.
Not every company wants to shed itself of real estate. Shelton says that whether a retail business decides to own all of its property, own nothing, or do a little of both depends on a variety of factors.
"It depends on the company's policy," Shelton says. "But, right now, philosophies are changing because the rates are low."