Watch Out for These Sale-Lease Back Challenges

Retail sale-leasebacks are rising in popularity this year. Retailers are looking to unlock capital tied in real estate assets, and are using the structure as a way to optimize their portfolio. However, there are some challenges to watch out for when executing a sale-leaseback strategy, for both brokers and retailers.

To start, brokers need to understand the market and the best assets to sell and those that are essential for the retailer to keep. This requires in-depth market knowledge and research. The challenge on the business end is to understand the tenant’s credit/industry and the underlying value of the real estate,” David Swartz, a partner at Crosbie Gliner Schiffman Southard & Swanson LLP, tells GlobeSt.com. “Well-located property in good markets are obviously much safer and more insulated from down side risk. Also, particularly in the case of a store located within a larger project, careful attention needs to be given to the possibility of something occurring outside the pad owned by the landlord/investor that is outside of its control but which triggers a tenant right or landlord obligation.”

On the legal side, there are challenges in reviewing the quality of the lease for an owner becoming a tenant. “From the legal end, the main risks involve the quality of the lease,” says Swartz. “These are typically long-term leases negotiated by strong tenants. As such, there are a myriad of ways that the lease may not be truly triple net or by which other risks have been allocated to the landlord. A careful review and thorough understanding of the lease terms is key. Be on the lookout for caps on pass throughs, early termination rights and landlord obligations.”

There is strong capital demand for these deals, particularly for triple-net credit tenants, and as a result, these deals can be competitive. However, the biggest challenge can actually be for investors facing inconsistencies in the lease and CC&R provisions. “CC&Rs bind the owners of the different components of a larger project,” says Swartz. “If the provisions of the lease and the provisions of the CC&Rs do not marry up in a manner that all obligations and risks are passed onto the tenant, the landlord/investor can be left with unintended liabilities and consequences.  The investor/landlord also needs to consider the ways in which the CC&Rs might restrict the value of the real estate should the current tenant exit.  Use restrictions, access, parking, development restrictions and signage rights can all affect the reuse value of the property.”