Sale-Leaseback: How Businesses Can Solve Liquidity Problems With Real Estate
Turn non-earning assets into productive ones.
Instead of keeping equity trapped in your real estate, you can better allocate your business's cash through a sale-leaseback.
Guide to the video
- Business owned real estate can provide some wonderful opportunities, especially if it's properly optimized with your operations
- A sale-leaseback can reallocate a company's cash into growth producing and investment activities
- Proceeds from a sale-leaseback are often a cheaper financing alternative to other forms of debt and equity financing
Video transcript follows
Without even thinking about it, many businesses have equity tied up in non-earning assets.
Maybe they’ve stumbled through their real estate decisions and even purchased a building that doesn’t effectively support their operations.
These sorts of real estate decisions, whether intentional or unintentional, have impacts.
An outstanding mortgage may impact their ability to secure future lending. And it may even be negatively impacting the growth prospects and the firm’s profitability.
It’s a bad situation that can get worse without careful consideration and a real strategy.
We’ll explore all that and more in this video.
Hey everyone – it’s Matt Marsh with Marsh & Partners.
Marsh & Partners is a development and national consulting firm that helps business owners and investors maximize their real estate and transform their businesses.
So don’t get me wrong – business-owned real estate presents some wonderful opportunities.
It’s an opportunity to take advantage of potentially lower monthly payments. Even with rising mortgage rates, the rental rate on a comparable space may be more expensive.
It’s also an opportunity to start growing some personal wealth outside of your business. Because if your business needs to pay rent anyway, why not pay it to yourself, right?
But it also presents several challenges that are worth considering that have major implications for a business’s liquidity.
Balance sheet considerations
So, let’s start by talking about the journey of buying a building.
You find a space that works, secure the financing, buy the building, and move into the space.
Maybe the building needs some fit-up and capital improvements, so you outlay some additional cash to make the necessary enhancements.
You now have a building sitting on your assets side of your balance sheet and the mortgage as a liability – and that means a couple of things.
The composition of your balance sheet plays an important role in how outside parties view your riskiness.
Banks will often make financing decisions based on other debt obligations you may have. If you have a big mortgage on your balance sheet, it could impact your ability to secure future financing for business growth activities.
You can think about it in terms of available cash as well.
To buy the building, you had to outlay some cash initially as a down payment. That down payment is cash that no longer can be reinvested into the company to drive growth.
So, the opportunity cost of buying a building is that you can’t use that cash in more efficient areas of the business. Equity tied up in real estate holdings may be an unproductive deployment of a company’s dollars.
But a sale-leaseback could be an opportunity to free up cash and equity to be able to allocate those dollars more effectively in the business.
It’s the king of off-balance-sheet financing because instead of adding a liability to your balance sheet, you’re actually removing one.
One of the major challenges that businesses must navigate when they take on a loan are restrictive debt covenants.
These debt covenants place guidelines on what the business can and can’t do when they’re paying back the note.
It restricts them from doing things like issuing other senior debt or may even require minimum debt to asset thresholds.
Proceeds from a sale-leaseback aren’t encumbered by any of these covenants. A business has full control over what they want to do with the capital and how they want to deploy those dollars.
The cost of financing is another factor to consider.
A business with liquidity problems may be looking for cash to help cover its liabilities or to fund growth activities.
But the question is, where does that cash come from and what’s the all-in cost to get it?
Mezzanine debt and equity sources are traditionally more expensive forms of financing than mortgages or senior debt.
Proceeds from a sale-leaseback, however, are equal to that of your building’s capitalization rate. That’s generally a less expensive means of financing and a more effective solution to liquidity challenges than alternative debt and equity issuances.
When might a sale-leaseback make sense?
There are a couple of situations where it might make sense to consider a sale-leaseback as a business owner.
First, and most practical, is the space just doesn’t work for you anymore. It’s not a liquidity consideration per say, but there is no need to fight with your real estate I you don’t have to. And if you can unlock some non-earning equity in the process, it could be a good option.
But, perhaps the most powerful reason to consider a sale-leaseback is when capital is needed for growth.
You can’t fund business growth and investment activities with a mortgage. And an equity offering is more expensive and dilutes your ownership stake in the company.
A sale-leaseback will free up non-earning equity so you can flex that cash into more productive activities.
The ability to clean up your balance sheet is another important consideration. I mentioned previously how the composition of your balance sheet plays a role in how lenders and investors look at the riskiness of your business.
Well, if you can sell the real estate and simultaneously reduce your business’s outstanding liabilities, you may be able to more easily secure financing in the future.
And finally, if you’re a high-margin business, a sale-leaseback may make sense. Even high-margin businesses may struggle with liquidity issues, especially if they can’t get their fixed costs under control.
Here’s the way I typically frame it for business owners. Commercial real estate is typically a 6-7% margin business. If you’re running a business with 15-20% margins, you may be better served to liquidate your real estate equity and instead fund your higher-margin operations.
There is no universal recommendation for when a sale-leaseback makes sense.
Real estate ownership offers a business owner the opportunity to begin growing wealth outside of the business.
It also offers diversification from your core business’s operations and may lower your overall risk profile.
But depending on your individual situation, a sale-leaseback could be a great solution for cheaper financing or to help solve liquidity issues.
If you want to brainstorm and strategize, I’d be happy to have a conversation.
Check out the video description for more resources on sale-leasebacks, and more relevant content for small business owners.
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And thanks for watching.