In the summer of 2005, Meridian, Miss.-based DeweeseEnterprises Inc., owner-operator of the Super Stop! convenience store chain, completed a $30 million deal that significantly improved the company’s bottom line. Deweese sold 24Super Stop locations in Mississippi to Realty Income Corp., aNew York-based real estate investment trust. The REIT thenleased the 24 stores back to Deweese, under long-term leaseagreements.
As a result, Deweese gained the proceeds from the real estate sale, plus theearnings generated by the leased stores itwill continue to operate.
The sale-leaseback deal worked outwell for Deweese Enterprises, said CEODoug Deweese. The transaction enabledhis company to save $50,000 per month,compared to loan payments, “beforeinterest rates went from 4% to 8%, whichruns monthly savings to almost $100,000,” he said.
For c-store owner-operators hoping to maximize the earning power of their assets, the sale-leaseback can be an effectivestrategy, according to industry experts. Retailers may use sale-leaseback for mortgage refinancing, or to finance acquisitionsor new-store construction, said Denny Ruben, a vice presidentwith Chicago-based NRC Realty Advisors LLC, whichserved as Deweese Enterprise’s financial adviser.
“Sale-leaseback is an effective way to separate real estatefrom operations,” Ruben says. “Typically, the sum of the twoparts are worth more separately than they are together.”
That was the case in the Deweese sale-leaseback deal.When the deal was announced, Deweese said his companyhad originally intended to divest a small number of locationsas part of a plan to geographically centralize and focus on certain key markets. In evaluating several options presented byNRC, Deweese also considered the sale of the entire company. But the sale-leaseback proved to be the best option.
“We advised him to consider doing a sale-leaseback,”Ruben explained. While acquisition bids for the 24 storeswere in the mid-$20 million range, the sale-leaseback dealbrought $30 million. “The sale of the parts was worth morethan the whole. We were able to get more money (from theREIT) because of the earnings-history of the stores,” Rubennoted. “And he got to keep the company.”
Based on his own experience, Deweese recommended thatc-store chain owners considering the sale-leaseback strategy ask themselves the following questions:
- How important is owning “dirt”?
- What impact do underground storagetanks have on your property value?
- Is your real property appreciating invalue? Have you tried selling locationson the open market to gauge real value?
- Do you need cash now for other purposes—estate planning, buying out familymembers or partners, etc.?
- Do you prefer debt?
- Are you attempting to make profits by operating stores orby owning stores as an investment?
- Are long-term leaseholds valuable to you?
Fortunately for c-store owner-operators, “we’re seeing aninflux of investors,” in sale-leasebacks, said Mark Radosevich,president of PetroConsulting Inc. in Coral Gables, Fla.”Equity groups are getting involved, providing equity financing to back marketers in making acquisitions and taking apiece of the deals.”
One reason more equity investors are entering the c-storemarket is that “single-tenant retail boxes are very attractive tothem,” Ruben pointed out, since they tend to be in high-valuelocations. “The only ‘analog’ for that is restaurants, and thathas been a very competitive market.”
There is also interest from life insurance companies andcredit unions to underwrite traditional mortgages, Radosevichsaid. “Their terms and conditions are generally more favorable than those of banks, with interest rates from 1% to 2%less. They view the investment in more long-term fashion andwill fix a mortgage for 20 years, whereas a bank will finance a20-year mortgage, but with 5- to 7-year balloon rates.”
Sale-leaseback terms typically involve a primary lease termof 15 to 20 years, with renewal options up to 40 years.
The non-traditional lenders coming in to provide financinghave filled a need, according to Ruben, due to dwindlingsources of “securitized debt. Back in the ‘90s, we had a lot ofspecialty lenders—FMAC, EMAC, FFC and others—who wereacquiring mortgages, packaging them and selling them toinvestors. That provided a major source of financing for theindustry. Then, in 2002-2003, there was a ‘perfect storm’—numerous defaults, some lenders went out of business andthere were properties auctioned through the bankruptcycourts.” As a result, most lenders no longer securitize c-storeloans.
“There are relatively few lenders who will do c-store mortgage loans,” Ruben continued. “There are a few, larger investment banks, such as City Capital Corp. and Comerica Bank,who will, but only want larger deals.”
Under the right circumstances, sale-leaseback offers severaladvantages over long-term real estate ownership, experts said.
Real estate investors “are looking for strong operators withgood track records,” Ruben explained. “With a mortgage,[banks] look at the credit quality of the tenant’s net-worth anddebt level. With a lease, investors will look primarily at thequality of your collateral and income from the site, and secondarily will look at the credit of the tenant. In a mortgagetransaction there is more emphasis on the tenant’s credit.
“Also, in most mortgage financing, there will be two tofour loan-covenants you have to satisfy. With the lease-back,you have to pay taxes and insurance and maintain the property, but there is no requirement to meet a debt-service ratiocovenant or debt-service covenant. That’s a real advantage.”
While banks are typically willing to lend up to 80% on thevalue of bricks and mortar, 100% financing is available underthe terms of a sale-leaseback. And while mortgage lendersonly consider the real estate value of the property, non-traditional lenders also take into consideration the EBITDA (earnings before interest, taxes, depreciation and amortization) ofeach store. As a result “if the store has been profitable, youcan sell it for a considerably higher number because of theearnings potential of the site,” Ruben said.
When financing store acquisitions, “you can get investorsto fund most of the acquisition price for both the real estateand business-value of the stores, with a relatively small investment of your own capital,” Ruben added.
There is also a significant tax benefit: under IRS rules,lease payments are fully deductible, unlike mortgage payments, in which only interest is deductible. “With a mortgage,your principle payment is not tax deductible. You’re amortizing the loan over a period of time, so as you pay down themortgage you have less amount to write-off in interest payments. With a lease, it’s 100% deductible,” Radosevich noted.
Sale-leaseback isn’t for everyone, Ruben said. The strategyis “ideal for small and medium operators with good locationsand a solid track record of earnings, who want to grow byacquisition or adding new sites in existing markets,” heexplained.
“The basic issue operators need to figure out is whether itis best for them to own or lease. My view is, if you havemoney you could invest somehow, you could do betterinvesting that in your operations than holding (owning) realestate—no matter how much you think that real estate is goingto appreciate,” Ruben said. “You can develop more stores andbetter invest your capital.”
Whether a sale-leaseback is the best choice largely”depends on your business model,” Radosevich said. “It’s aviable business model for someone who is in a fast growthmode, who wants to aggregate gallons; someone who is notso inte
rested in owning real estate as in becoming a larger jobber. You can get 100% financing on the appraised value ofreal estate and don’t have to put as much money in the deal.In many cases, you can make an acquisition with little or noequity by doing a sale-leaseback and having a third-party dealer lease from you.”
Someone with a conservative growth plan would probablybe inclined to own real estate, and divest some of the marginalstores, and redeploy that cash into low-rate, fixed mortgageson good, quality acquisitions. “You need to assess the value ofsites based on their real estate value and cash flow, and rankthem, in order,” Radosevich said. He recommended “divesting 5% to 10% of your worst stores every year. It’s called evolutionary growth. You can redeploy the money into betterstores and use sale-leaseback as a financing alternative for larger transactions.”
The recent jump in petroleum prices has been one factornudging the c-store industry into consolidation mode, whichmay increase sale-leaseback activity.
“Based on the amount of work we have had lately doingbusiness valuations and evaluations, there are going to be a lotof opportunities to buy chains of stores in the next 18 to 24months,” Radosevich said. “We expect more consolidationamong salaried operators who run stores, and pure wholesalers who are looking to aggregate volume.”