A leaseback is an agreement where a business owner sells their property and then leases back the same property from the new owner.
Real estate professionals must understand how leaseback transactions work in commercial real estate. This lease type is a popular way for business owners and property investors to make extra cash. To fully understand the ins and outs of sale leaseback transactions, you need to get your information from a reliable source.
As a long-time real estate professional, I’m here to share the knowledge necessary for passing the exam and succeeding in commercial real estate.
In this post, we’ll define leasebacks, give examples of how they work, and discuss their benefits and drawbacks. Keep reading for more information!
What Is a Leaseback?
A leaseback, also known as a sale leaseback, is a financial transaction where a company sells its property and then rents it back from the new owner. The seller becomes the lessee, and the buyer becomes the lessor.
Sale leaseback transactions are prevalent in commercial real estate. Commercial real estate refers to properties used for businesses and income generation. Examples of businesses that may use a leaseback include:
- Chain restaurants
- Postal services
- Clothing stores
- Any retail spaces
What Is the Purpose of a Leaseback?
A leaseback is an excellent option for companies that need extra cash but still need their property to run the business. This lease allows them to make money from the sale without entirely losing their property.
Examples of a Leaseback in Real Estate
Betty owns a small chain of successful clothing stores. She wishes she had money for business expansion but cannot afford to buy any more real estate.
Betty seeks out a real estate investor who specializes in leaseback agreements. The investor offers to buy Betty’s existing properties and then lease them back to her.
She signs a 15-year agreement with the investor and starts making monthly rental payments. Betty profits from the sale, giving her cash to invest in her business and rent additional spaces.
As a result, Betty’s business expands and the real estate investor earns income as a landlord. This is an example of a successful sale leaseback transaction in commercial real estate.
Now let’s look at an example of a famous leaseback agreement in the real world.
The Role of Leasebacks in the Taco Bell Franchise
If you’ve ever stopped at Taco Bell for a late-night snack, then you’re already familiar with one company that uses leasebacks.
Taco Bell is one of the most popular fast-food chains today, but this was not always the case. According to The Motley Fool, Taco Bell was a small chain that desperately needed funds when it first started. Taco Bell’s owner, Glen Bell, wanted the company to grow but lacked the money necessary for business expansion.
In 1969, he signed a deal with Bill and Joan Clark, owners of a real estate company. The Clarks agreed to provide Taco Bell with the commercial real estate it needed in a 20-year lease contract. This deal allowed Taco Bell to expand its empire without paying for real estate assets.
This deal was the first-ever sale leaseback transaction. As we know, it had beneficial effects on Taco Bell, allowing the restaurant to expand and prosper.
Pros and Cons of a Leaseback
Before signing an agreement, buyers and sellers should know the benefits and drawbacks of leasebacks.
Pros for Business Owners
Sale leasebacks are beneficial for business owners who need extra cash. This deal allows them to keep using their commercial property while investing in other needs. Another benefit is that business owners can avoid the headache of traditional financing options. They can structure the agreement without worrying about balloon payments or additional fees.
A leaseback also may help to improve the lessee’s credit. Because they are renting from a lessor instead of taking out a property loan, they have less debt. Another benefit of leasebacks is that business owners do not have to worry about their lease payments increasing. Over the lease term, their rent payment will stay stable regardless of changing market conditions.
Cons for Business Owners
One con of leasebacks is that business owners no longer own the property where they run their business. This means they have less control over the changes they can make to the rental space. Another drawback of leasebacks is that business owners are only guaranteed the property during the lease term. Once the lease is up, they may have to relocate their business to a new spot.
Another issue with leasebacks is that business owners are locked into making rent payments at a specific price. If the market changes and rent prices decrease, they must keep paying the same costs. Financing costs in leasebacks are also generally higher compared to other leases.
Pros for Buyers
A sale leaseback enables buyers to own property and earn money by collecting rent. In this type of lease, the buyer becomes the lessor and can charge higher financing costs. Buyers also benefit from guaranteed residual property value at the end of the lease. This agreement is excellent for real estate companies investing in commercial properties.
Cons for Buyers
One disadvantage of a leaseback transaction is that the buyer assumes the risks of owning the property. Another issue of a leaseback is that the new lessor cannot increase rent prices for the entire agreement term. Even if market conditions push rent prices up, they have to abide by the terms of the contract.
Check out this table for a clear visual of the pros and cons of sale leaseback transactions.
|Pros of a Leaseback||Cons of a Leaseback|
How to Calculate a Sale Leaseback
There are a few steps buyers and sellers must take to calculate the cost of a sale leaseback deal.
Assess the Property Value
Before determining the price of a leaseback transaction, the value of the property must be assessed. The buyer and seller should each hire a professional appraiser to determine the property value and cap rate.
Determine the Capitalization Rate
The capitalization rate or cap rate for short is the property’s rental income divided by the property value. The lessor may offer a lower cap rate if the business owner has decent credit. The cap rate may be higher if a business owner has poor credit.
Calculate the Rental Rate
To determine the annual rental rate, multiply the cap rate by the property value. To figure out the monthly rental rate, divide the annual rate by 12.
Lessees should compare the rental rate with other rates in the same area to ensure it makes sense for that market.
Calculate Taxes and Expenses
The operating expenses that the lessee pays depend on what kind of lease agreement they have signed. Lessees must add the amount of monthly taxes and expenses to the monthly rental rate. This final number will be the total monthly cost of the sale leaseback transaction.
What Are the Tax Implications in Sale Leaseback Transactions?
Most leaseback agreements are triple net leases. This means that the lessee is responsible for paying property taxes and other operating costs.
What Happens at the End of the Lease Period?
What happens at the end of the lease term depends on how the buyer and seller structured their deal. In some cases, the lessee can regain ownership of the property. In most cases, the lessee chooses to sign a new leaseback transaction with the owner or move their business elsewhere.
Because a sale leaseback transaction is typically a long-term deal, the lessee has plenty of time to decide their next step before the lease ends.
What Are the Different Types of Leases in Real Estate?
Leasebacks are one of the many types of leases in commercial real estate. Examples of other leases include:
- Gross leases
- Net leases
- Operating leases
- Capital leases
- Sandwich leases
- Percentage leases
A leaseback often falls under the category of one of these different lease structures.
Frequently Asked Questions
Let’s discuss some frequently asked questions students have about leaseback agreements.
Is a Sale Leaseback an Operating or Capital Lease?
A leaseback typically follows the structure of an operating lease but can work as a capital lease in some cases.
In an operating lease, the lessee rents the property without getting ownership rights. Under an operating lease, the tenant must follow the agreement terms and keep the property in good condition.
In a capital lease, also called a finance lease, the lessee pays rent and gains ownership of the property at the end of the term.
Is a Sale Leaseback a Net Lease?
A sale leaseback is typically structured as a triple net lease. According to the Legal Information Institute, tenants in a triple net lease pay rent, taxes, insurance, and other operating expenses. If the lessee wishes to pay for less of these costs, they can negotiate for a single or double net lease.
What to Know Before the Real Estate Exam
A leaseback is an agreement in which a business owner sells their property to a buyer, then rents back that property from the buyer.
Because leaseback transactions let business owners earn extra cash while still using their property, they are popular in commercial real estate. As a real estate student, you must know how these leases operate before the big exam.
Of course, there are many more key terms you should study before the day of your test. Brush up on other crucial topics using our online Real Estate Flashcards!