For companies that hold their operational real estate on their own balance sheet or through related party entities, be it retail stores, manufacturing plants, or surgery centers, real estate ownership is not the core business. Sale leasebacks (“SLBs”) can be a highly attractive capital allocation tool with many strategic and financial drivers to consider (see our Insight). When businesses make the decision to pursue a sale leaseback, the question of execution becomes an important one. Each sale leaseback situation is unique and can draw from a number of different buyer pools.
The dramatic collapse of yields around the world in fixed income markets since the Global Financial Crisis (“GFC”) had caused institutional investors to allocate more capital to yield generating assets. Income generating real estate became one of the most popular allocations for defined benefit plans. This set the stage for an active sale leaseback market with ample capital allocated to the strategy, on the part of both debt and equity investors. While rising debt costs stemming from inflationary pressures starting in 2022 have recently presented economic headwinds, NL REITs have remained active SLB investors.
This Insight reviews the main categories of sale leaseback investors.
Figure 1: Types of Sale Leaseback Buyers
| Net Lease Real Estate Investment Trusts* | Dedicated Sale Leaseback Private Equity Funds | Generalist Institutional Real Estate Investors | Private Buyers | |
|---|---|---|---|---|
| Capital Sources |
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| Cost of Capital |
| IRR and Cash on Cash Model | IRR and Cash on Cash Model | IRR and Cash on Cash Model |
Public Real Estate Investment Trusts (REITs)
In the U.S., Public REITs are investment vehicles traded on a stock exchange (most often the NYSE) that pool investor capital in order to own and manage commercial real estate, and also, increasingly other hard assets such as infrastructure. REITs are structured as tax advantaged entities that must distribute a high proportion of their rental income, making them popular dividend vehicles for individuals as well as for defined benefit plans. In the U.S., public REITs own a large segment of all U.S. institutional quality real estate, which has been growing continually since the GFC. Supported by common stock and unsecured bond issuances, U.S. REITs have been significant purchasers of real estate over the last 10 years. One of the highest growth subsectors in the REIT space has been the group focused on net lease investing.
Private Equity Real Estate Overview
While sale leaseback real estate investors make up a small portion of overall private equity firms, they represent a substantial group of investors that overlaps between general real estate funds and dedicated sale leaseback groups.
These sale leaseback groups are competitive with the REITs in execution certainty as they too have committed, dedicated capital, including commingled funds as well as lines of credit that can bridge to permanent financing after closing.
As a group, the private equity firms can be competitive on pricing, but those that heavily utilize property level leverage have been more impacted by the rise in interest rates since 2022.
Other Institutional Real Estate Investors
A third group of real estate investors are oftentimes viable partners in a sale leaseback transaction. As previously referenced, capital allocation into income producing real estate continues to be strong. There are a wide range of institutional investors such as private equity funds, fund-less sponsor-like companies that manage real estate by leveraging their expertise utilizing third party institutional capital, developers, regional real estate firms, non-net lease publicly traded REITs (i.e. healthcare, industrial and office) and other private investors.
Many from this wide swath of commercial real estate investors do not have the same business plan as dedicated net lease investors. Depending on its characteristics, however, a sale leaseback can overlap with the investment parameters of a large portion of these other institutional real estate investors.
Looking to a few examples, for a well-located industrial facility near a medium to large city, the majority of potential offers would likely draw from a broad group of buyer types. The rent from the sale leaseback would provide an attractive current income. An investor would view the downside risk of the tenant leaving, while not ideal, as a potential opportunity for a value-add conversion to capitalize on robust demand for warehousing space. In this instance, the bids from generalist real estate investors can potentially be more attractive than those from dedicated sale leaseback investors, depending on a variety of factors including the quality of the location and the building, and the credit of the tenant.
For a single tenant building in a large or growing market, there would also be significant interest from non-dedicated sale leaseback investors. There are often investors that already own properties in a given market seeking to augment their ownership and drive potential future synergies in leasing and management.
There are also dedicated specialty asset investors that focus on varying types of commercial real estate, who would be likely investors for sale leasebacks in their respective sectors. For example, corporate data centers spun out in sale leasebacks are often acquired by public or private data centers REITs or PE firms that have the operational expertise to manage those facilities as multi-tenant properties. Healthcare REITs are always adding to their relationship ecosystems by entering into sale leasebacks with the aim of making follow-on investments with that tenant as they grow.
The large universe of real estate investors that do not focus exclusively on sale leasebacks represent a vast pool of potential partners for owner-operators. Each sale leaseback situation is unique, and with that the buyer pool can vary greatly depending on the opportunity.
Private Buyers (i.e. Individuals and Small Family Offices)
While private buyers comprise the majority of real estate investors in the U.S., they are generally not as active in the sale leaseback market as the institutional buyer set. Most private buyers are not frequent participants in the market given the price point of most sale leaseback transactions. Many private buyers are only in the acquisition market once every few years. For passive investors not looking to deal with tenants, maintenance and other management issues, net lease properties leased to well-known names are the most favored investment choice. Dollar stores, drug stores, quick service restaurants, banks, gas stations & convenience stores are popular choices amongst this investor group. Due to investor demand, many of these types of properties command relatively low cap rates.
While willing to pay aggressive cap rates for well-known credit tenants, private investors tend to be less active in sale leasebacks. In the sale leaseback market, the transaction size is often larger than what a private investor can commit to a single transaction. A fast-food restaurant with a $2 million price point is much more attainable to purchase than a $7 million manufacturing or healthcare facility. Many private buyers are also dependent on debt financing, making them less appropriate in instances where a sale leaseback is utilized in an M&A situation as lenders may not be able to quickly underwrite, diligence and fund a loan under the timelines required. Lastly, the credit concentration for an investor can be a hurdle, particularly for mission critical facilities leased to profitable but below investment grade tenants.
Due to the continued fund raising from all corners of the real estate industry, real estate owner-operators that wish to access the sale leaseback market have an abundance of options in choosing an investor. In addition to the large REITs and dedicated sale leaseback private equity funds with a direct calling effort to source opportunities, there is a vast number of other real estate investors that can potentially provide an attractive transaction for an owner. By working with an advisor, real estate owners can access these other investors not only to optimize the terms and execution of their sale leaseback transaction, but also to secure the best real estate partner for the long term.