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Friday, June 19, 2009

Sale-Leaseback is Not Dead

Source: Restaurant Finance Monitor

Starbucks decided it had too many stores in La Mirada, California and last year shut one there that was located at the end of a small strip mall. Like many of the locations the coffee chain vacated, this one didn't stay empty for long. But the ultimate occupant came as something of a surprise: Burger King.

But the way the franchisee structured the deal and financed the buildout is just as interesting. He bought the location, and then orchestrated a sale-leaseback that netted him enough proceeds to convert the location into a small, fast food restaurant. And he even had a little cash left over when it was done.

The death of the sale-leaseback has been greatly exaggerated. While the overall volume has declined precipitously in the last 18 months, those in the market say deals continue to get done, especially at the right price. "It's still a vibrant market," said John Glass of the Glass Group, part of Marcus & Millichap, the real estate investment firm. "There is a perception out there that it is so bad that everybody is staying on the sidelines. (But) assuming the sale-leaseback is properly structured, there is tremendous demand in the marketplace."

To be sure, the market is vastly different from what it was two years ago. Cap rates have risen. Buyers are fewer. And they're being more selective and demanding. They want better credit and debt coverage ratios that make more sense—which is adding up to a market that is not providing some of the value for real estate that it once did.

In simple terms: Just like the broader real estate market, and financing as a whole, the sale-leaseback market is returning to basic fundamentals after a period of investor excess. "Underwriting has changed dramatically," said Denny Ruben, of NRC Realty Advisors. "They're going back to real-estate fundamentals. The market is going to punish people that did not have good, conservative underwriting."

Between 1997 and 2007, the volume of sale-leaseback transactions in the restaurant industry boomed. Investors were eager to take advantage of 1031 exchanges and they were backed by debt from aggressive lenders. The cap rates they received from seller-tenants were often a few points higher than their borrowing rate which provided a substantial incentive to the market. As cap rates on sale-leaseback deals fell to historic lows, investors bid up properties as operators agreed to high rent-to-sales ratios.

Many 1031 buyers are now on the sidelines because tight credit means they can't b