Sale-Leaseback or Refinance for an Owner-Occupant
A 60,000 SF owner-occupied industrial building appraises at $9,000,000 on a 6.75% cap rate; the owner's imputed NOI is $607,500. The owner occupies 45,000 SF and leaves 15,000 SF vacant; market rent is $13.50/SF NNN and that space could be leased within about a year. A $6,300,000 balloon matures in eight months. The bank will refinance at 65% LTV, 7.00%, 25-year amortization, with $60,000 of costs, which forces a cash injection. An investor has offered $9,000,000 for a 15-year sale-leaseback of the 45,000 SF at $13.50/SF NNN with 2% annual bumps, taking the vacant space as-is. Adjusted basis is $4,000,000, including $2,200,000 of depreciation taken; combined tax on recapture and gain runs about 25%. Selling costs are 2%, defeasance $95,000. The owner has $500,000 of cash available.
1. Compute the cash required or received under each path, including after-tax proceeds from the sale.
Read the worked answer
Refinance path
- New loan = 65% × $9,000,000 = $5,850,000.
- Cash needed = $6,300,000 payoff + $60,000 costs − $5,850,000 = $510,000.
- The owner has $500,000 - $10,000 short, which is a signal that the property is at its leverage limit for this lender.
Sale-leaseback path (pre-tax)
- Price $9,000,000 − 2% selling costs ($180,000) − defeasance ($95,000) − payoff ($6,300,000) = $2,425,000.
After-tax
- Amount realized = $8,820,000; gain = $8,820,000 − $4,000,000 = $4,820,000.
- Unrecaptured depreciation: $2,200,000 × 25% = $550,000.
- Remaining long-term gain: $2,620,000 × 25% = $655,000.
- Total tax ≈ $1,205,000; after-tax cash ≈ $1,220,000.
The headline $2.4 million of sale proceeds shrinks to about $1.22 million after tax - roughly 13.6% of the asset's value. That is the number to compare, not the gross proceeds.
2. Compare year-1 and year-15 occupancy cost under each path. What happens to the owner's equity position?
Read the worked answer
Refinance
- Annual debt service: $5,850,000 × 0.0070684 × 12 = $496,200 (fixed for 25 years).
- Add non-recoverable owner costs and reserves of about $90,000 = $586,200 of cash cost in year 1.
- Once the 15,000 SF is leased at $13.50, it contributes $202,500, dropping the net cost to about $383,700.
Leaseback
- Year-1 rent = 45,000 × $13.50 = $607,500, escalating 2% annually.
- Year 15 rent = $607,500 × 1.02^14 = about $801,600.
The comparison
- Year 1 cash cost is nearly a wash ($586,200 owning versus $607,500 leasing), with the vacant space providing all of the ownership upside.
- By year 15 the lease costs $801,600 while the mortgage payment is still $496,200 - a $305,000 annual gap that widens every year. Renting a 15-year term with 2% bumps against fixed-rate debt is the expensive way to finance occupancy.
- The owner also loses the depreciation shield: roughly $7,200,000 of depreciable basis over 39 years is about $184,600 per year, worth about $46,000 annually at a 25% rate.
- Equity position: under the refinance, the loan amortizes to roughly $3,560,000 by year 15 - about $2,290,000 of principal build-up - and the owner still holds an asset likely worth well over $9,000,000. Under the leaseback the owner holds $1.22 million of after-tax cash and no residual.
On cost and wealth accumulation, refinancing is materially better if the property is held long term.
3. Make a recommendation and list the conditions that would flip it.
Read the worked answer
Recommendation: refinance, not sell - provided the owner can close the roughly $510,000 gap and lease the 15,000 SF within 12–18 months.
Why
- The sale-leaseback converts a $9 million asset into $1.22 million of after-tax cash, gives up $2.7 million of current equity and all future appreciation, and replaces fixed-rate debt with rent that grows 2% per year for 15 years.
- The apparent cheapness of the leaseback - $607,500 of rent on $9,000,000 of value, or 6.75% - is misleading. That 6.75% buys no residual, escalates, and is paid for 15 years; the mortgage costs 7.00% but amortizes, is fixed, and leaves the owner the building.
- The 15,000 SF of vacant space is worth $202,500 per year; in the sale-leaseback the buyer captures that upside, not the owner.
What would flip the recommendation
- The owner cannot close the $510,000 gap and cannot find a subordinate lender or equity partner for it.
- The business needs growth capital now - $1.22 million of after-tax, covenant-free cash may be worth more inside the business than inside the real estate.
- The 15,000 SF cannot be leased within 12–18 months, turning the ownership case into a purely imputed-rent argument.
- Cap rates are believed to be near a cyclical low; locking a 6.75% cap on aging industrial space may beat holding through a repricing.
- The owner's realistic horizon is under seven years, where the leaseback's cost escalation has not yet compounded and the mortgage amortization has not built meaningful equity.
- Deferred capital needs exist that the owner cannot fund but the new buyer will price into the cap rate anyway.
Structural note: if the owner does sell, negotiate rent at a fixed rate for the first five years, a purchase option or right of first refusal at year 10, and a cap on the buyer's ability to finance against the lease - an all-cash buyer with a 6.75% yield requirement is a very different landlord than a leveraged one.