Sale Leaseback Strategies and Comparison

[Tanner Queen]

Hello All , This will be a longer and thorough read, but hopefully the love for this business will make it a shorter read. I am embarking on my 3rd sale-leaseback transaction in my career and my 5th 1031 (3 were pre-downturn). This one is slightly different. The scenario is as follows: California property and transaction. Current realty: Owner of building is right in between a colleague, acquaintance, friend, and business partner. (Somewhat complicated but a great relationship) He Bought the 23k flex building for $4.3m, 10 years ago. It’s appreciated to a market value of $7.1m and both he and I believe it has peaked. Current refi from last week consolidated 3 loans to one with CitiBank; $3,900,000 @ 4.39%. 2% prepayment penalty and not assumable. Pulled $1m out to reinvest into the business. He would like to continue to pull the appreciated equity out and roll it into a new vehicle. That new vehicle is likely to be a passive, LP position with a very strong sponsor / operator relationship I have where his money could be pulled out or reinvested after 24 months and would achieve roughly a 10% cash on cash return payable in quarterly distributions. SaleLeaseback Scenario: High net worth investor relationship of mine would like to buy the building, at the market valuation of; $7,100,000 however LOI / Offer has not been received as of yet. Current tenant would leaseback the space for a period of 5 years at $1.50 / ft / Mo; 23,500 SF. NNN - I am going to negotiate a cap on the expense pass through for property taxes to mitigate the California prop 13 tax increase; ideally getting very close to what the current tax exposure is. Commission on the sale from seller is 2% of purchase price. There will be no broker involved in the lease negotiation. It’s a very straight forward lease. I am working through my model and the keeping the best interest for my client / friend / seller keeps popping in my head. I am close to the situation and want to see him succeed but I may be just overthinking it. Is this a good deal for my client? His current annual debt service after refi is significantly lower than what his annual lease would be years 1-5 with 3% annual increases. The 1031 opportunity would allow him to pull out the $2,980,000; $3,200,000 net proceeds - ($78,000 prepay + $142,000 commission). Within this 1031 structure he would reinvest in the LP position talked about above at a, let’s say conservative 10% cash on cash. No Cap Gains. By my math it’s a good deal for him as he is essentially a wash between his lease rate and his annual distributions from reinvesting the proceeds; no capital gains exposure and has $2.98m working for him at a healthy 10%, and exposure to a sponsor relationship that has tremendous, yet intangible value. I hope I am clear in this description and am I missing something here? Thank you fellow BP community.

[Tanner Queen]

@Dave Foster - in the proposed situation he will be deeded interest in the upleg, and the LP will be with him as a TIC. I am working with our attorney to ensure that is truly the case.

The upleg for this 1031 will be roughly a 60M total equity position with about the same amount of debt; i.e. a total cap of $120m and will be using all of the proceeds.