Managing Sale-Leasebacks for Success

Atlanta, GA (July 16, 2015) – Advisors often tout the advantages of sale-leaseback financing. But operators need to go into these deals with eyes wide open to avoid potential pitfalls. With investors paying premium pricing, sale-leasebacks are garnering more attention than ever. Yet some operators are wary about how the financing structure could impact ongoing operations.

“I definitely understand the negative feelings about it, and sale-leasebacks do not work in every situation and are not the answer for every operator,” says Andrew Ackerman, a managing director at Sands Investment Group, a net-lease advisor based in Atlanta.

Some of the sale-leasebacks done in the past were not structured in a sustainable manner, perhaps because of poor advising or perhaps an operator was in a situation where they wanted to maximize proceeds, but did not plan to stay in the location long-term, he adds. Owner-operators do have valid concerns that certain lease provisions could make it more difficult for them to continue to operate their business at that location after completing the sale of the real estate. However, the main point that operators do need to keep in mind that these are not boiler plate lease agreements. Everything is negotiable and concerns can be managed as part of the saleleaseback negotiation between the buyer and seller as it relates to overall pricing, lease terms and structure of the deal.

Open to negotiation:  Investors don’t want to negatively affect the ongoing business, but they want to protect their investment and protect against potential risks if something should happen to that business, says Ackerman. “However, there are things we can do to protect you to make sure you still receive the benefits of the real estate, and you are not losing the complete value of the asset, while you are still monetizing it and growing,” he says.

“It is a negotiation, and it is a two-way negotiation,” says Ackerman. For example, if an assignment provision is important to an operator, then maybe they can live with a master lease if they get a right of substitution. So, there is some give and take in negotiations, which is why it is important to choose a buyer who is interested in being a financial partner.

“Items such as assignment and sale of the business and master leases are all things that we negotiate on every deal. The flexibility and terms are dependent upon other terms of the transaction and other financial metrics,” agrees Gregg Seibert, executive vice president and chief investment officer at Spirit Realty Capital, a net lease real estate investment trust (REIT) based in Scottsdale, Ariz.

For example, Spirit has done sale-leaseback transactions with operators who were contemplating a sale of the business in a year or two. Spirit was able to add provisions in the lease that would pre-qualify a new operator if they met certain criteria that would allow for the assignment of the lease to the new ownership entity.

Spirit typically evaluates a variety of quantitative factors that include the type of concept, size of the operator, purchase price for the asset, cash flow of the restaurant, rental rates, brand quality, unit-level performance, liquidity and financial ratios of the tenant, among others. Those factors, along with the quality of the real estate, go into a matrix that influences decision making on the lease terms. “We evaluate this information and determine the operator strength and unit performance, which in turn dictates the flexibility we will have on a new lease,” says Seibert. “If there is a below-average metrics we try to overcome this by structuring the lease appropriately.”

Addressing top concerns:  Restaurant operators have three big concerns when it comes to conducting sale-leasebacks – control, cost and credit. Having control to remain in a location long term, as well as exit a location are both key points for operators. Market conditions and business plans can change over time, and operators worry about being handcuffed to a store they want to sell, close or relocate during the terms of that lease.

• Control: As a result, assignment rights and master lease agreements are important points of negotiation in saleleaseback transactions. In most cases, there is flexibility with buyers to build into the lease some language related to assignment rights. For example, if an operator wants to assign lease rights to an established operator with an equivalent net worth or credit standing as the current tenant, then the assignment would automatically take place and not require landlord approval.

Lease language also can be included to say a landlord cannot “reasonably withhold” an assignment. “If you build those two in, it gives the operator at least some level of flexibility if they would want to exit,” says Daniel Herrold, a senior director at the Stan Johnson Company in Tulsa. Stan Johnson Company is a brokerage firm that focuses exclusively on single-tenant net-lease properties.

Under a master lease where there are multiple properties in one lease, a substitution right allows the tenant to go to the landlord and basically swap the bad one out and put another location in. “That gives the tenant the flexibility to exit out of a lease of a bad performing store so long as you have another location that you can replace it with,” says Herrold. An operator also can negotiate certain “go dark” provisions where the tenant could potentially buy back a bad location from the landlord and eliminate the lease.

• Cost: Operators need to be careful they don’t get blinded by a very aggressive sale price and end up committing to a rental rate that is equally high, and may not be sustainable if market conditions shift or the economy slows. “Occupancy expense, outside of payroll, is a very large component of a particular unit’s P&L, and so it is important to keep that in check and keep it within a relative percentage of sales for that location,” says Herrold. Typically, most operators want their occupancy costs to be in the 5% to 8% of sales range.

• Credit: Sale-leaseback due diligence involves three levels of credit—unit level financials or a profit and loss statement for that location, consolidated company financials for an operating company and personal guarantees.

Most investors will want a company guarantee, but depending on the situation, the personal guarantee is a point that can be negotiated. There is close scrutiny at the individual store level. If that location is profitable the institution oftentimes is comfortable in getting a consolidated credit guarantee of the operator and not requiring a personal guarantee. “That can be a big deal to a franchisee that is maybe a 15-, 20-, 50-unit operator and doesn’t want to have that personal guarantee on a property,” says Herrold. Other options would be to secure a cap on the personal guarantee or for the personal guarantee to be phased out over time, such as once an individual unit meets certain performance levels.

“These agreements are not as restrictive as you think they are,” says Ackerman. There is a way to make this a “win-win” and sale-leasebacks are often more flexible than a traditional bank, because investors want to buy that hard asset with a steady income stream, he says. In addition, the investor demand and competition in the marketplace gives operators good leverage and bargaining power today to negotiate more favorable terms, adds Ackerman.

Restaurant Finance Monitor, Volume 26, Number 7 ~ Beth Mattson-Teig covers real estate topics for Franchise Times magazine

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