After seeing increased popularity in the third quarter, sale leaseback deals seem poised for strong growth in the months ahead.

Real estate experts believe that sale leasebacks, in which a company sells a property and then leases it back from the new owner, will become increasingly prevalent heading into 2021 for a number of reasons.

“We anticipate an increase in sale-leaseback transactions over the next several quarters as companies continue looking for ways to raise capital for either defensive purposes or reinvesting in their business according to their individual needs,” Newmark Group Inc.’s Matt Berres said in an email.

“Experts predict there will be more sale leasebacks this year and next. These types of transactions tend to be more common in economic down-cycles as financially embattled companies may need the additional financial reserves to allow more time to restructure or reinvest in certain growth initiatives,” Berres added.

Chris Maling, a principal with Avison Young, called sale leasebacks an “up-and-coming and focused investment class that a lot of people are looking at.”

He added that there was “still a very, very robust demand and the capitalization rates are directly associated with the strength of the guarantor behind the lease and the term of the lease. It’s like buying a bond.”

There were $117 million worth of sale leaseback transactions in Los Angeles County during the third quarter, according to data from Newmark Group Inc.

The total number of sale leasebacks completed in L.A. this year is down slightly from years prior, but they account for a larger percentage of overall sales in a market that has been curtailed by the Covid-19 pandemic.

“While overall sale-leaseback transaction volume was down in the third quarter, compared both to the prior quarter and the prior year, it is more a function of a decrease in overall transaction volume for all investment types,” Berres said.

“Sale-leasebacks made up approximately 12% of all single-tenant transactions in the third quarter of 2020, which is a 50% increase from the 8% it represented in the third quarter of 2019,” he added.

Bigger piece of the pie

Nick Foster, a senior director at Jones Lang LaSalle Inc., said the volume of sale leasebacks has been consistently in the $400 million to $500 million range since 2018, and he expects a similar number again this year.

Sale leaseback transactions, he added, are usually around 2% of all sales volume in the county. Since overall sales have decreased, it will be a bigger part of the market.

“Given that sale leasebacks have fared better in this capital market’s environment than other multitenant product types, which are more difficult to underwrite or finance currently, we should see sale leasebacks take on a more significant share of that pie,” Foster said in an email.

“That’s more of a denominator effect than a trend, but we do expect that to continue in 2021 as this Covid situation continues to play out to the benefit of single-tenant acquisitions.”

There have been a handful of sale leasebacks in L.A. this year.

One of the biggest was in July, when United Natural Foods Inc. sold an industrial property in Santa Fe Springs to Brookfield Property Group for nearly $68 million.

The motivation for the seller, according to CoStar Group Inc., was to dispose of real assets.

Also in the third quarter, XPO Logistics Inc. did a nearly $37 million sale leaseback of an industrial property in Santa Fe Springs.
 
And Iron Mountain Inc. sold and leased back a building at the Pico Rivera Commerce Center to Blackstone for $62 million.

“Looking specifically at Los Angeles, it was all about industrial in the third quarter,” Berres said.
 

Increased liquidity

There are several reasons more businesses are looking to sale leasebacks, but extra liquidity is usually a key factor, especially for companies affected by the Covid-19 pandemic.

“It allows companies to convert illiquid equity tied up in their owned real estate to working capital to grow their business,” Berres said.

Sellers maintain control of the properties through a long-term lease but get a cash infusion they can invest in their business. Buyers, meanwhile, have a known tenant agreeing to a long-term lease right off the bat.

In many cases, the leases are triple-net leases in which the tenant handles everything, making it a reliable, low-maintenance income stream for the new landlord.

Foster called sale leasebacks an “opportunity to reallocate that capital from a nonincome generating asset into the core business where it’s better served. Sale leasebacks also come with limited covenants compared to corporate debt. Today, cap rates have never been more aggressive for quality long-term sale leasebacks.”

He added that the current market is the best he has ever seen for sale leaseback yields and proceeds.

“Sale leasebacks have been increasingly popular with investors given they provide certainty of income stream with minimal landlord responsibility via the typical absolute triple net lease structure. Where financing is today, buyers can find accretive levered returns without the inherent risk associated with multitenant properties,” he added.

Industrial leads the way

Stan Johnson Co.’s Michael Matter agreed that sale leasebacks were enticing to buyers and sellers now.

“The seller can remove any debt they have on the subject property they are selling and free up equity and apply that to their business and add that to their balance sheet and pay off their debts,” he said. “It makes sense to a lot of operators as real estate returns in L.A. County are pretty weak today.”

He added that there are some tax benefits for companies selling these properties.

For buyers, Matter said there are usually built-in rent increases and lots of financial transparency from tenants.

Matter said there has been a “gradual uptick in sale leaseback activity in industrial in spite of Covid,” and thinks there will be more looking forward, especially in industrial but not as many on some other properties, like casual dining establishments. Quick service restaurants could see some, though, he said.

Matter added that he has some clients who are now looking at sale leaseback opportunities.

“I think it will be a bigger part of it (overall sales) in the next year or two,” he said.

Foster agreed.

“We would expect more sale leasebacks as this situation unfolds as companies evaluate efficient ways to generate cash from dilutive assets on their balance sheets,” he said. “The low cap rate environment for single-tenant real estate will continue into 2021, maintaining a strong value proposition for corporate users.”