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From Site Selection magazine, May 2014

Diversified Approach to
Growth Financing

Sale-Leasebacks, Build-to-Suits, and Reverse Build-to-Suits

Glen Kunofsky
Glen Kunofsky

here are a variety of different growth models and strategies that can be utilized by companies in the net-leased sector. As business operators grow and expand their market share and footprint, their physical footprint expands accordingly. Myriad of different growth strategies are currently utilized to expand into new markets or fortify core markets. It is important to understand the alternatives available to finance this growth as a diversified strategy can be the most useful option to explore. All too often, growth is stagnated by the implementation of only one or two expansion strategies as multiple strategies are typically seen as mutually exclusive when is it exactly the opposite that proves to be true.

Traditional Sale-Leaseback

Traditionally, a “sale-leaseback” is a real estate transaction that allows an owner/user of a commercial property to sell the real estate it owns and then continue to occupy it through executing a long-term lease with a real estate investor at closing. Sale-leasebacks give business operators the ability to monetize the real estate held on their balance sheet and reinvest this new capital into their core business operations. Additionally, operators have the benefit of being able to acquire new locations to develop their own stores and then enter into a sale-leaseback post completion and recapture development costs. Rather than keeping that real estate on their balance sheets when their primary business model is not focused on real estate, they complete a sale-leaseback. Sale-leaseback transactions are equally compelling for corporate occupiers and commercial real estate investors and are viewed as an alternative corporate financing tool.

Traditional sale leasebacks have been popular among institutional investors and high net-worth individuals for a great deal of time. However, there has been a growing popularity among developers, investors, and tenants to employ different real estate strategies to promote growth and open new stores.

Build-to-Suit and Reverse Build-to-Suit Financing vs Pre-Construction Sale-Leaseback:

As companies continue to take advantage of low lease rates to expand operations, a variety of strategies can be used to develop new locations that create immediate revenue growth and long term sustainability in addition to sale-leaseback. These different strategies involve methods that allow operators to recapture development costs, construct new locations with little to no capital investment, reduce capital expenditures, and in some cases benefit from arbitrage opportunities.

In a build-to-suit transaction, a landlord or developer constructs the building at the building’s development cost. The landlord is responsible for delivering the premises to the tenant per predetermined specifications outlined in the lease. Typically, the rent and capitalization rate are also outlined in the lease. The burden of any construction costs above the budget are outlined in the lease and can either be borne by the landlord or reflected in the rent to compensate for the increased costs. For tenants, the benefits include no construction costs or responsibilities for opening a new location. For the landlord, the benefits include a newly constructed building and a lease that is custom-tailored by the landlord.

An alternative to a build-to-suit transaction is a reverse build-to-suit strategy, where the tenant constructs the entire building or a portion of the work at the landlord’s expense. In this scenario, the landlord is typically protected from additional construction costs, permitting, and any additional costs. The real estate investor would pre-purchase the land and can typically be paid on the equity provided to the tenant as it is financed for the tenant to complete the project. A reverse build-to-suit strategy provides all of the benefits as a sale-leaseback without having to secure traditional debt to finance the construction. The tenant has complete control over the construction process, the facility is custom-designed by the user, and as many not be the case with leasing an existing building, the space fits the exact needs of the operator.

An alternative to the build-to-suit and reverse build-to-suit models is a modified approach which one could call a “pre-construction, sale-leaseback”, where the tenant develops the new site and secures investor capital prior to the completion of the building. This structure is appealing to both the investor and the tenant as the investor secures a moderately discounted capitalization rate, while the tenant completely finances its new location and maintains full control over the construction.

As with any financing tool, there are positives and negatives to participating in build-to-suit and reverse build-to-suit transactions for raising growth capital. Some additional benefits to the tenant include the least upfront costs and a locked-in capitalization rate in advance of the building’s completion, protecting the operator from any potential increase in interest rates. The negative is that some investors will desire the tenant start paying occupancy costs prior to construction completion and the rate is typically higher than a traditional sale-leaseback.

Diversified Growth Strategy

The best way to truly utilize sale-leaseback and built-to-models to grow one’s business is to employ a diversified approach that employs all of the growth strategies defined above. Build-to-suit and reverse build-to-suit financing can be used in conjunction with traditional sale-leaseback financing as the concepts are not mutually exclusive options for growth. The options are unique and integrate all underlying corporate and site specific goals, lowest blended long-term rates, property accounting treatment, and operational lease flexibility.


  • Alternative financing tool – greater value to the real estate from ability to monetize 100% of the fair market value vs 50% - 80% value limitations in traditional mortgage financing. No equity dilution.
  • Retain control of the real estate – long-term, triple-net leases provides a “hands-off” approach from an investor, allowing operational control as when the tenant owned the building
  • Bargaining power in structuring the lease – increased market demand for 1031 exchange buyers translates into higher prices and more favorable rental terms
  • Improved balance sheet – long-term illiquid asset can be replaced with a liquid asset (cash). The mortgage appears on the balance sheet as a liability, while an operating lease does not.
  • Tax advantages – by leasing its facility, a firm can write off its entire rent payment rather than just the interest portion of the mortgage payment.


Sale-leaseback’s, build-to-suits, and reverse build-to-suits allow for strategic bifurcation of real estate from core businesses competencies that allows complete operational control of real estate through a long-term lease. Each structure allows a company to achieve optimal lease flexibility, while maintaining sales price and maximizing proceeds.

  • Transaction Considerations: Lease accounting strategies – On/Off Balance Sheet
  • Tax Considerations: Gain/Loss; Individual Tax Basis Asset by Asset; Corporate Offsets to Sale-Leaseback Gain or Loss
  • Lease Considerations: Master Lease vs. Individual Property Leases; Lease Term – typically 10-25 years; Rental Escalation; CAP Rate vs Proceeds.

Net Lease Marketplace

From an investor standpoint, quality net-leased assets will remain in high demand throughout the year. The perceived safety of many net-leased assets is encouraging retiring baby boomers to exchange out of management-intensive assets, like apartment buildings, and into net-leased properties secured under long-term leases. While reshuffling real estate portfolios is not uncommon, the number of investors focusing on this strategy is directing the market. As a result, cap rates for best-in-class assets have moved very little despite a 100-basis point rise in the 10-year Treasury rate since bottoming in the second quarter of last year. Although the Fed is tapering the third round of quantitative easing, first-year returns for sought-after assets will only move incrementally as baby boomers shift retirement savings from aggressive investment vehicles into less risky net-leased properties.

As financing rates start to creep upward and debt financing becomes more expensive, sale-leaseback opportunities will continue to be prevalent and allow companies to monetize 100% of real estate values. Buyers will continue to outnumber sellers, even if investment in net-leased properties slows as interest rates bring normalcy to the market, keeping cap rates at or near record lows. It is important to maintain a diversified approach to growth, especially one that equally benefits operators, developers, and real estate investors. By utilizing multiple growth strategies the net lease sector will continue to grow through collaboration from all ends.

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