Q&A of the Week - 04/21/2021
DEVELOPMENT QUESTION OF THE WEEK
Q: We’ve been approached by real estate investors about a “sale-leaseback” of the manufacturing [or distribution or office or retail…] facility that we currently own and operate. What exactly does that mean, and why (and when) should we consider it?
A: In short, a “sale-leaseback” is a transaction in which the owner of a property simultaneously (1) sells a property to a buyer and (2) leases the property back from that buyer for a specified period under specified terms. In times of low interest rates and low real estate capitalization (“cap”) rates, in particular — like right now — sale-leaseback can be a very attractive option.
The sale-leaseback transaction is typically for both the land and building, but there are circumstances in which it only covers one or the other. Leases are most often triple-net (NNN), thus leaving the now-Tenant responsible for real estate taxes, maintenance, insurance, utilities, etc. The lease will typically outline future renewal terms, and may also establish options for buy-back at the end of the initial term.
Links are provided below that offer more in-depth information, and from the perspective of both Buyer and Seller. Here we will focus simply on the highest-level advantages and disadvantages for the Seller/Tenant:
Advantages of a sale-leaseback to the Seller/Tenant:
Remove debt and/or convert equity to cash. This is the most obvious and attractive benefit, particularly when cap rates are low. The lower the cap rate, the higher the sale value of the property, the more up-front capital that can be extracted and invested in your core business. This can be especially useful for ESOPs, which have unique challenges and considerations when it comes to capital and liquidity.
Maintain effective possession and continued use of the property. The Seller is typically negotiating the sale-leaseback agreement from a position of relative power, and can thus negotiate terms that provide an adequate level of control and flexibility — even though they are relinquishing actual ownership.
An alternative to traditional financing. Terms are often better than they would be if negotiating a traditional bank mortgage, you can extract 100% of the equity (i.e., not limited by loan-to-value requirements), and fees and costs are typically lower than with traditional financing.
Disadvantages of a sale-leaseback to the Seller/Tenant:
Loss of ownership and long-term control of the property. The lease term will eventually expire, and you generally have only three options at that point: renew the lease, re-purchase the property or move.
Loss of capital appreciation. Capital appreciation is obviously one of the biggest benefits to property ownership, and could be substantial under the right circumstances.
Limited rights to modify, remodel and/or expand on the property.
The significance of these advantages and disadvantages obviously depend upon the specific business and market circumstances. We would be happy to provide additional insight into your unique situation and point you in the direction of those who can offer deeper expertise in specific areas (legal, tax impacts, etc). Let us know how we can help.
Other useful links and articles about sale-leasebacks:
Middle Market Growth: “Sale-Leaseback Transactions Poised to Play a Larger Role in M&A”
Newmark: “The Value of Sale-Leasebacks During a Market Downturn”
CRE Entrepreneur: “Sale-Leaseback Transactions Explained”
Robert D. Mitchell: “Sale-Leaseback of Commercial Real Estate: Pros and Cons”
VoitWorks Group: “CFO’S Guide to Commercial Real Estate Sale Leaseback Transactions”
DESIGN QUESTION OF THE WEEK
Q: What are the most common “I wish we had thought more about that at the time” lessons that you’ve seen others learn the hard way?
A: As the saying goes, experience is the best teacher. You can study a situation, think it through, map out a strategy and thoughtfully execute your plan — only to find that “you didn’t know what you didn’t know” and fail to anticipate a potential result or side effect.
In real estate development, the people with the most “experience” with finished projects are tenants and property managers. Unfortunately, in our business those individuals are often not involved early enough — if at all — in design processes run by people without that hands-on property management insight.
For the sake of this discussion, we’re going to keep the list relatively generic and high-level. And brief. We could certainly go on much longer, and would be happy to do so in-person. In the meantime…
Some of the most common areas of insight/feedback we get from facility and property managers:
Have a plan for snow plowing. Designate large enough areas for the piles, and in reasonable quantities and locations. Make sure those areas won’t be blocked by cars, and consider what happens while/after the piles melt.
Think about heat and salt when designing landscaping and planting beds. The drawings don’t show dead plants, but that’s what you’ll have.
Consider which way the wind will typically be blowing. Can you avoid burying your docks in snow drifts? Keep the dock doors/seals from leaking? Protect your entrances and adjacent interior spaces from driving rain?
Put sidewalks where people will actually walk, not where you think they should. This is particularly important in public spaces and schools/universities, where you do not have as much control over behavior. We’ve all seen dirt paths cutting diagonally across grassed areas — accept reality and your site will look better. If you insist on a particular sidewalk layout, consider shrubs or other ways to block “shortcuts”.
How is your staff going to change that light bulb? Wash that window? Change that filter? Maintenance inconvenience is sometimes unavoidable in pursuit of a specific aesthetic or operational target, but more often than not accommodations can be made that will save time and expense — if they’re considered during design.
Don’t get too cute with your security. Employees lose their keys and leave the company. Keep your keying/locking plan as simple as possible, or consider investing in electronic systems that can be changed quickly and easily.
CONSTRUCTION QUESTION OF THE WEEK
Q: There are a lot of general contractors and construction managers out there in our market. What are the most important criteria we should consider when putting together our list of potential bidders?
A: This is obviously a question that has significant ramifications for the ultimate cost and quality of your finished project. The first step is to figure out which project delivery method best suits the needs and expectations of your firm and your project. We’ve recently posted two articles related to that topic — “The 5 Most Common Construction Project Delivery Methods” and “Questions to Ask When Selecting a PDM” — so we’ll go ahead and skip those details here.
Once you’ve determined the type of general contractor or construction manager you need, we recommend putting together a preliminary list of six or seven firms that offer the appropriate services. We would then recommend inviting those six or seven firms to your office for introductory conversations, with the ultimate goal of reducing your actual bidders’ list down to three or four finalists.
The following are some of the questions we’d recommend discussing with each of your preliminary/potential bidders:
What is their level of experience with your project type and size?
If your project is not in the immediate geographic area, do they have experience in that market?
Do they seem like a good fit with your firm and your staff who will be running the project?
Do they have experience working with your design team? Your consultants? With the relevant local authorities?
How would they typically staff a project like yours? What trades would they potentially self-perform?
Will they have adequate time, personnel and resources to dedicate to your project?
How do they tend to procure their work? Do they have many repeat clients?
What do their past clients, subcontractors and design partners have to say about them?
The details of the bid process with your three or four finalists will be heavily dependent upon the nature of the project itself, but establishing the right bidders’ list will set yourself on the path for success. We’d be happy to help — let us know how we can.
Interested in learning more? JJH3group is a commercial real estate development and design-build advisory firm based in Milwaukee, WI. The firm was founded on a core set of guiding values and principles, providing clients with quality development, design and construction services across a broad spectrum of project types. We are experienced in assembling multidisciplinary teams and partnering with public and private stakeholders to deliver well-designed, functional and efficient facilities. Let JJH3group help you plan and manage your next project. For a free consultation, please contact us at JJH3group@gmail.com or (414) 333-3430.
