Sale-leaseback vs cash-out refinance on business-owned real estate

Two ways to get the equity out

A cash-out refinance replaces the mortgage on the building with a larger one and pays the difference to the owner or the business. The lender sizes the loan two ways and uses the smaller: a loan-to-value limit on the appraised value of the property, and the debt service the rent or the business's cash flow can carry. You keep title. When the loan is paid down, the equity is yours again.

A sale-leaseback sells the building to a real estate investor and signs a long lease on it at the same time. The investor prices the building on the rent it will receive and on the credit of the tenant, which is your business. You receive the sale price, pay off any mortgage, pay tax on any gain and keep operating in the same building, now as a tenant.

The trade-off in one line: a sale-leaseback maximizes liquidity, but converts real estate equity into a permanent rent obligation. For a fuller look at the leaseback on its own, see should you do a sale-leaseback.

Side by side

The same building, both ways

Take an owner-occupied building worth 3,000 with a mortgage of 800, and an operating company earning EBITDA of 1,000 before any rent. The owner wants cash to buy out a partner.

The leaseback nearly doubles the cash. It also cuts the operating company's EBITDA by the full rent, adds a fixed charge larger than the refinance's debt service, a charge that builds no equity and keeps rising, and hands the building's future value to the investor. Whether that is a good trade depends on what the cash is for. Money that buys out a partner or funds an acquisition earning more than the rent costs can justify it. Money that sits on the balance sheet cannot.

How lenders to the operating company read each one

This is the part owners most often miss. After a sale-leaseback the operating company carries no mortgage, so it can look less indebted. Lenders do not read it that way.

• Rent is a fixed charge. A fixed charge coverage test counts rent alongside principal and interest. A long lease is as fixed as a loan: the company cannot skip a payment in a bad year. See DSCR vs FCCR.
• EBITDA falls by the rent. Rent runs through operating expenses, so the EBITDA that leverage is measured on shrinks. Some lenders look at EBITDA before rent and add a multiple of the rent to debt, to put owners and tenants on the same footing.
• The lease is on the balance sheet. Under current US GAAP, a long lease appears as a lease liability. Credit agreements often keep operating leases outside funded debt, but lenders underwrite the obligation all the same.
• The collateral is gone. A building is often the best collateral a business owns. Without it, a future term loan or line of credit leans harder on cash flow, receivables and equipment.

A cash-out refinance is plainer: more debt, measured by the usual debt service coverage and leverage tests. Conventional bank lenders commonly look for debt service coverage of at least 1.25x. If the building sits in a separate real estate company that leases to the operating company, the mortgage sits there and the operating company pays rent either way; lenders then underwrite both sides, usually with guarantees across them. See holding real estate separately.

A sale-leaseback does not remove an obligation from the business. It swaps a mortgage that ends for rent that does not, and lenders count both.

What the lease will say, and what to negotiate

In a sale-leaseback the lease is the deal. The investor is buying a stream of rent, and the price rises with the rent and the length of the commitment. That creates a trap: an owner can raise the sale price by agreeing to a higher rent, which is simply borrowing against the business's future cash flow at the investor's rate. Negotiate these terms with the business's next ten years in mind, not the closing check.

• Initial term and renewals. Investors want a long initial term. Renewal options at your choice protect the location after it ends.
• Rent escalations. Fixed annual increases compound. Model them over the full term against realistic growth.
• Triple-net obligations. Taxes, insurance and repairs usually stay with you, including major items such as the roof and structure unless the lease says otherwise.
• Assignment and subletting. If you may sell the business, the lease must be assignable to a buyer on reasonable conditions. An acquirer's lender will require it; see why the lease matters when a business is sold.
• Buyback rights. A purchase option or right of first refusal keeps a path back to ownership.
• Guarantees and reporting. Investors often ask for a parent or personal guarantee and regular financial statements.

The SBA and 504 angle

If the reason for the cash is to pay the owners, SBA is out: SBA loan proceeds cannot fund a distribution to owners, or refinance debt that did. A cash-out refinance for a distribution has to come from a conventional lender. Buying out a partner is different: that is a change of ownership, which a 7(a) loan can finance directly as a purchase of the partner's interest, under its own rules, rather than as cash taken out of the building. See SBA financing for a partner buyout. Where the goal is to lower the cost of existing debt on owner-occupied property, SBA 504 is often the better tool. It finances owner-occupied real estate, typically 50% from a bank, 40% from the CDC and 10% from the borrower, and the borrower must occupy at least 51% of an existing building. See refinancing with an SBA 504 loan and SBA 504 vs a conventional commercial mortgage.

Which one fits

A cash-out refinance fits when the proceeds a lender will advance are enough for the purpose, the business can carry the payment with room to spare, and the building is strategic: specialized, hard to replace, or likely to appreciate. It also keeps options open for a future sale of the business, when a buyer may prefer to lease the building from you; see buying the building vs leasing it in an acquisition.

A sale-leaseback fits when the business needs more cash than a loan will provide, the use of the cash earns more than the rent costs, and the owners are content to be tenants for the long term. It suits companies with strong, steady earnings, because investors price the rent on the tenant's credit. It suits poorly a business whose coverage is already thin, because the rent lands on the same cash flow every lender measures.

On the refinancing side, Transparent's book holds 1,148 lenders that write term and private credit and 278 that write SBA 7(a) and 504. Owners weighing the two paths usually get the most out of seeing what the loan route can actually raise before committing to a lease they cannot undo. See what we do.