A distribution company (“VDB Co.) owns and occupies an industrial building comprised of 50,000 square feet. VDB Co. has analyzed its cash flow from operations and has realized that it can afford to pay an investor a fair market rental rate of $7.00 per square foot ($350,000 annually) in rent.
VDB Co. realizes that if it went to sell its building it could pay a significant amount of money to its owners or use the proceeds from the sale to reinvest into the business and produce new cash flow more than the annual rent amount. VDB Co. hires a sale‐leaseback specialist, Fortis Net Lease, who advises and helps them draft a lease to offer to a new owner/real estate investor (“the buyer”).
Through discussion between VDB Co. and Fortis, it is determined that the best way to maximize the sales proceeds and ensure guaranteed long‐term occupancy at the building is to offer the buyer an initial lease term of 20 years with ten (5) year extension options thereafter. The starting rent is set by VDB Co. at $350,000 with 2.5% annual rent increases at the end of each lease year. VDB Co. (now “the tenant”) will also be responsible for all expenses related to operating the property including real estate taxes, property insurance, maintenance, and capital repairs to the building. The lease will be a true triple-net lease.
The building is put out on the national marketplace by Fortis and offered to our proprietary database consisting of hundreds of thousands potential sale‐leaseback buyers/investors. Multiple offers are procured by Fortis Net Lease and the best and final round of bidding is held. The highest and best offer is selected by VDB Co. to proceed. VDB Co. and the buyer enter into a traditional purchase and sale agreement that is contingent upon VDB Co. executing the above‐mentioned lease at the close of escrow.
The purchase price is a function of the length and terms of the lease as well as the starting rent. The sales price which is determined by dividing the starting rent by a percentage (a “Cap Rate”). In today’s market, cap rates and thus pricing will vary widely depending on the financial strength of the tenant that will be signing the lease. By way of example, below is a breakdown of pricing that will illustrate the difference in the tenant’s financial wherewithal with Example A being the weaker tenant & Example B being the stronger tenant.
Example A: Selling Price = Annual Rent / Cap Rate ($350,000 / 6.00% or $5,833,333)
Example B: Selling Price = Annual Rent / Cap Rate ($350,000 / 5.00% or $7,000,000)
After Escrow has closed, VDB Co. will receive the funds from the purchase price less closing costs and will then become the tenant of the property. VDB Co. will retain exclusive use of the property under the terms of the newly executed lease and can use the sales proceeds to reinvest in the business with plans to earn a return on equity well in excess of the Cap Rate (thereby making a significant spread) or VDB Co. can distribute the sales proceeds to its owners.
Note: the square footage, market rental rate and appropriate Cap Rate as shown above are hypothetical and may be different depending on your particular asset, proposed lease (longer or shorter) and the financial stability of the company (credit rating).