Equity Retail Brokers (ERB) offers a full suite of services for banking-sector clients. Our last post (“Bank Properties for Sale: Why Handling Bank Transactions Requires Flexibility and Finesse”) covered best practices around the sale of income-producing bank properties as well as the disposition of vacant branches and underperforming assets. Another ERB service — sale-leaseback transactions — often yields significant benefits for the financial institutions we work with, as well as commercial real estate investors focused on acquiring these single-tenant, net-leased properties.
Start with the balance sheet.
“Properly structured sale-leaseback transactions allow banks to convert their existing equity in fixed assets — namely, the real estate they own — into cash that can be used for acquisitions, to compensate for unrelated losses, or to otherwise advance the company’s business strategy,” said Stuart Conston, an Equity Retail Brokers Agent who frequently advises financial institutions on these transactions. “The benefits include improving the bank’s balance sheet and financial ratios because that fixed asset is now accounted for as an income-producing, current asset with an operating lease.”
Especially for smaller banks, reducing fixed assets in this way can result in a reduction of the amount of capital they are required to keep on hand. “Lowering your percentage of fixed assets can give you additional strategic flexibility,” Conston said.
Focusing On the Core Business
In our last post, we noted the national and regional trend toward bank dispositions. Nonetheless, as of 2019, FDIC-insured commercial banks still had substantial real estate operations — 76,837 branches across the United States. Despite this historic focus on real estate, bank CFOs may not always see owning properties as the best strategic option, said David Goodman, Principal.
“Sale-leasebacks can be a great way for banks to continue operating profitable, high-deposit locations in priority markets,” he noted. “Banks aren’t really in the business of being landlords. By selling those properties to professional real estate investors and leasing back the space they need, they can focus more on their core business.”
Moreover, in a sale-leaseback, the bank gets to decide on the terms of the lease it eventually will sign — everything from rental rates and renewal options to the total term length. “When you own a property, there is a risk that its residual value will fluctuate based on the conditions in that market,” Conston said. “For financial institutions interested in getting out of real estate ownership, a sale-leaseback eliminates these kinds of distractions. At the same time, signing the lease still gives the bank a high degree of control over its presence in that location.”
Many banks own plenty of real estate that could be converted into cash via sale-leasebacks. In addition, buildings constructed in the pre-Internet era may be quite a bit larger than what the bank now needs. This can create opportunities for hybrid sale-leasebacks that allow the bank to downsize while staying in the market, noted Ed Ginn, Principal, and Founder.
Industry consolidation can be a factor as well. “Let’s say a bank that has a local branch or headquarters — call it 30,000 square feet of office space in total — is acquired by another financial institution,” Ginn said. “Suddenly, you only need 10,000 square feet for personnel at that location. With a sale-leaseback, the merged bank could occupy that 10,000-square-foot space even as the new owner of the property — the real estate investor — leases the rest to other, non-bank users.”
And thanks to strong demand among real estate investors for single-tenant, net-leased properties, banks often have good prospects for closing sale-leaseback deals.
“There is quite a large market out there, not just for the sale-leaseback of bank properties, but also for drugstores, c-stores, quick-service restaurants, and others,” Conston noted. “Investors like the fact that, because it’s a net-lease deal, the bank is responsible for all operating expenses, real estate taxes, property upkeep, and so forth. The investor buys the property and the lease and, in return, gets a stable, long-term income stream in the form of that monthly rent.”
Finding the Right Balance
For a sale-leaseback transaction to be a win for the bank, it must be carefully crafted to match the financial institution’s business goals and long-term strategy, noted ERB Agent David Laiter. “For the bank, the best approach is to come to the table with a detailed understanding, not just of its current-day need for cash, but also for its plans for the next 10 or 15 years,” he explained. “Specific decisions will need to be made with respect to the many factors that go into these transactions.”
ERB’s role is to advise banks strategically, market the properties, identify buyers, and structure and negotiate these deals. “At the simplest level, the bank uses rent — low, medium, or high — and term length and optionality to affect the capitalization rate and, in turn, the price of the asset,” Goodman explains. “If the bank is looking to maximize the amount of capital it will receive from the deal, it will be more disposed to giving the investor favorable terms on those fronts.”
But there are limits to the upside that can be achieved by adjusting these variables. As noted by Conston, sellers of single-tenant, net-leased properties can scare off investors if they offer overly generous terms in a bid to maximize cash. “The rent really does need to fit the market,” he said. “If you make it too high, a savvy real estate investor is likely to say, ‘Hold on. What if the banking tenant vacates and I need to re-rent the property? Will I be able to get the same rent the bank was paying before?’ That investor could walk away.”
The main measurement used in the buying and selling of these investment properties — capitalization rate — depends on the terms of the deal. “Buyers may say, ‘I am not going to pay anything below a 5 percent capitalization rate for a single-tenant, net-leased property,’” Conston explains. “If the seller sets a rent that is too high, the deal will violate that threshold, cooling the investor’s interest.”
Analytical Services for Financial Institutions
Equity Retail Brokers frequently works with bank executives to determine sale-leaseback terms that fit their goals. “We’ll produce charts and graphs that lay out a wide array of scenarios, including different cash yields and cap rates based on the structural elements in play,” Ginn explains. Deposit histories, market conditions, and real estate quality/character are part of the analysis.
“Sale-leasebacks allow financial institutions to catalyze their business strategies in an efficient manner,” Ginn concludes. “The key is to work with experienced real estate professionals to structure a deal that maximizes your results—now and into the future.”
Equity Retail Brokers can help you increase the value of your retail assets and establish sale-leaseback terms beneficial to your goals. Please contact us today for more information.